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ShareRising oil prices and FII outflows don't bode well for the Indian unit
Central banks drove the currency market action last week. At home, theReserve Bank of India announced another round of monetary tightening on June 24. The Indian central bank raised the repo rate and the cash reserve ratio (CRR) by 0.50% each to 8.50% and 8.75% respectively.
This action came within a fortnight of a 0.25% repo rate hike on June 11. The trigger for such unprecedented tightening was the wholesale price index (WPI) inflation rising to 11%, highest in 13 years, along with the possibility that it could remain in double digits for the next couple of months at least.
The RBI's action proved beneficial for the rupee, as it helped in improving the relative yield advantage. Market participants were surprised by the central bank's decision to hike the CRR too, considering the already tight liquidity conditions.
However, by using a combination of instruments, the RBI has ensured that interest rates in the economy will rise to higher levels and stay there. Moreover, driven by concerns about inflation and persistence of strong inflationary pressures, the central bank is likely to raise rates again in the coming months.
Such expectations helped the rupee appreciate by about 0.4% against the US dollar over the week and the pair traded in the range of 42.66-42.97. Another factor that worked in the favour of the Indian unit was the decline in the value of the greenback itself in the overseas market.
Otherwise downward pressures gained traction. Crude oil prices surged past the level of $140bbl, local equity market slipped by another 6% and foreign institutional investors (FII) continued to pull out their funds from local financial assets. The FIIs have offloaded Indian equity and debt worth over $2.5 billion in June.
On its part, the RBI continued to intervene and prevent any further depreciation of the rupee. It has prevented the rupee-dollar pair from falling below a level of 43. However, a rapid spiral in oil prices or a sharp rally in the greenback is likely to test the central bank's resolve in the next couple of months. This week, the pair is likely to trade in a range of 42.60-43.00, with a depreciation bias.
The immediate future for the rupee does not look too promising either. It would remain under pressure at least until September. That is on account of placid capital inflows, weak equity markets, burgeoning trade deficit especially considering the robust pace of non-oil imports coupled with rapidly growing oil imports and greenback strength.
The other major event last week was the US Federal Reserve's monetary policy meeting. All eyes were on the Fed as it was expected to move to 'status quo' on rates after cutting them by 3.25% since August last year. Market participants were also expecting some hawkishness from the Fed along with a call for a stronger dollar, on the back of rising inflation in the US economy. That had helped the greenback rally over the past couple of weeks.
The Federal Reserve left its overnight Fed funds rate unchanged at 2% on Wednesday, as expected. Although it sounded a more hawkish tone than in its previous post-meeting statements, the FOMC did not cement market expectations of higher rates or explicitly support the greenback.
In particular, there was nothing to indicate that the Fed would act to reinforce comments from its chairman Ben Bernanke, who earlier this month spoke of the central bank's desire to see the dollar strengthen to fight inflationary pressure caused by soaring commodity prices.
Expectations of a rate hike in the next meeting in August were also toned down. Fed funds futures on Friday priced in a 26% chance of a hike, down from 67% on Monday. Over the week, the greenback fell 0.9% against the euro, was down 0.6% against the pound and 0.7% against the yen.
The coming week would only bring more negative news for the greenback. Important data releases, particularly the non-farm payrolls and manufacturing ISM index for June are due for release. Given the recent layoff announcements and cutbacks by companies across the US in response to higher energy prices, job losses will continue. And, the non-farm payrolls are likely to drop for the sixth month in a row. Market consensus is for 55,000 job cuts. The greenback therefore could weaken further, if the number is worse than that.
The European Central Bank (ECB) monetary policy meeting is due this week. That too is likely to be negative for the US dollar. Last week, ECB president Jean-Claude Trichet cemented expectations that it would raise rates by 0.25% to 4.25% at this meeting. That will help the euro gain ground against other major currencies.
Before the end of this year, even the Fed is likely to raise rates. Markets remains convinced that the Fed monetary easing has ended and the next move is likely to be a hike. Fed funds futures from October onwards imply a 0.25% increase is a certainty. The Fed's latest statement lends some weight to that thesis. That would provide support to the greenback and help keep oil prices in check too.
The author is senior economist, ABN Amro Bank.
Views expressed hereare personal.
E-mail: gaurav.kapur@
in.abnamro.com
