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The pound dropped to a record low against the euro last week, falling close to parity against the single currency, as UK economic data continued to deteriorate. Expectations were that the Bank of England (BoE) would cut interest rates, which stand at 2%, at its policy meeting this week. Data showed a fresh decline in UK home prices while a report suggested that the economy could shed 6,00,000 jobs this year. BoE figures showed that UK mortgage approvals reached a new series low in December while a survey of the bank’s credit conditions showed that the supply of credit continued to be heavily restricted and banks expected “a further decline” in availability over the next three months.
The pound fell to a new low against the euro on Tuesday, its weakest level since the launch of the single currency in 1999. It recovered ground later to stand down 0.5% over the week. The pound also dropped to a six-and-a-half-year low against the dollar, falling 0.8% last week.
The euro also pared some of the gains that saw it hit a series of trade-weighted highs in December. The euro’s decline show that the rally in the single currency, which climbed by a record 10% against the greenback in December, was unsustainable given the negative implications it had for growth in the Eurozone. The assumption that the European Central Bank (ECB) will continue its gradual approach to easing monetary policy had supported the euro. But this key pillar of support is now crumbling, as it becoming clear that the ECB approach is contributing to maintaining overall monetary conditions at inappropriately tight levels. The euro fell 1.3% against the dollar over the week. The greenback climbed 1.7% against the yen on the week, pulling away from the 13-year low it hit against the Japanese currency last month, as fears grew that Japan’s authorities would intervene to stem the yen’s advance.
In the local market, the rupee depreciated by 0.3% against the dollar, after trading in a band of 48.20-49.12 last week. The greenback’s strength and a sharp rise in oil prices kept rupee under pressure. A 6.7% bounce in the equity market, along with the announcement of the second stimulus package and RBI rate cuts helped restrict the rupee’s losses.
A slew of important economic data, especially on the external sector, was released last week. The balance of payments (BoP) data released by the RBI showed that overall BoP fell into a deficit in July-September 2008 and stood at a quarterly record of $4.73 billion, against a surplus of $29.24 billion in the same quarter a year ago. The overall BoP in April-September 2008 was also in a deficit of $2.5 billion against a surplus of $40.4 billion in the first half of the previous year. This data summarises the problems faced on the external finance front, with slowing capital inflows and ballooning trade deficit putting pressure on the rupee.
Another important set of data released last week relates to the country’s external indebtedness. India’s total external debt stood at $222.61 billion as on September 30, 2008 — down $1.2 billion from $223.8 billion at the end of June 2008. However, based on residual maturity, total long-term external debt was $130.69 billion at September end, while the debt maturing by September 2009 was $91.92 billion. This short-term debt position, while largely dominated by trade-related credit that is revolving in nature, may maintain the pressure on the rupee this year. Pressure on the rupee from a widening trade deficit is also likely to persist despite a sharp low in crude oil prices. Data shows that India’s merchandise trade deficit rose 60% to $84.34 billion in April-November 2008 against $53.19 billion the previous year, with cumulative value of imports rising to $203.6 billion and exports from the country declining to $119.3 billion. Exports dropped for a second month with shipments from the country down 9.9% at $11.5 billion in November 2008 against $12.8 billion in November 2007.
The scenario on the economic activity front is also deteriorating. A leading indicator of activity in the manufacturing sector — the ABN Amro India PMI survey — showed that business conditions in the sector deteriorated further in December. The headline PMI slipped to 44.4 from 45.8 in November, signalling contraction in overall activity on the back of a record drop in output and shrinking new business. External demand, in particular, contracted sharply on the back of recession in major parts of the global economy.
The manufacturing sector is undoubtedly facing one of the toughest periods this decade and conditions are unlikely to improve in the near future. Recent measures taken by the government and the RBI to prop up the economy will help only in the medium term. The manufacturing sector will have to cope with contracting demand, especially on the exports front, and stalling investment activity. Macro-economic data therefore points towards weakening fundamentals of the overall economy, especially the external sector.
That does not augur well for the strength of the rupee over the next 3-6 month period.
The strength of the dollar will also be a crucial driver for the rupee.
This week, the market will get another round of data points for gauging how severe the US recession is. The most market-moving piece of data is coming Friday’s non-farm payrolls (NFPs) report. More than half a million Americans lost their jobs in November.
Another contraction would suggest the economy is in much worse shape than suspected. The ISM services report and FOMC minutes will give a more encompassing reading of activity. Broadly, the fundamentals will continue to be bearish for the dollar. That, along with the positive sentiment built on the back a larger-than-expected rate cut by the RBI, could support the rupee. The rupee-dollar pair could trade in the range of 48.00-49.00.
The author is senior economist, ABN Amro Bank. Views expressed herein are personal. Email: gaurav.kapur@in.abnamro.com