Rupee may be firm on easing pressures, high inflation

Soaring levels of inflation and ways of combating it continue to be the focus of the local market. The headline WPI inflation rose to a 3-year high to touch 7% last week.

While the government has taken various measures to curb inflation, market participants are divided on the monetary policy actions to rein in inflation. Speculation about the action of the central bank remains one of the key drivers of financial market action. It is clear that the monetary policy will have to remain restrictive.

The RBI could decide to raise interest rates and/or hike the banks’ cash reserve ratio at its monetary policy meeting on April 30. Tight monetary policy would push up interest rates in the economy, which would be beneficial for the rupee.

Moreover, since inflation is rising on account of record high prices of food, energy and other commodities globally, ensuring a strong and stable value of the rupee would also help in reining in inflation.

As of now however, the RBI is curbing rupee appreciation through its dollar purchases. Last week, the central bank actively intervened in the spot market. Overall, it appears that rising inflation and the continuation of hawkish monetary policy stance would prove helpful for the rupee.

The main downside for the Indian unit emanates from the placid capital inflows in the face of a burgeoning trade deficit. In this context, the local equity market conditions assume a lot of significance. The inflow of capital through the equity market route has come down sharply and FIIs remain net sellers so far in this calendar year.

The global financial market conditions, which hitherto were negative, seem to be improving though. Last week, equity markets in the US and Europe rallied and even credit market conditions improved.

That, in turn, helped improve the risk appetite among investors. This could prove to be a tentative recovery considering that the US economy looks all set to enter a recessionary phase. If, however, the calm in the global equity markets persists, it would have a positive impact on Indian equities and the rupee.

In the meantime, international commodity prices, after spiralling to new highs in March, seem to have stabilised. One of the reasons is the US dollar has held its ground in the recent weeks while other global currencies, particularly the euro, appear to be under pressure. 

Last week, the euro fell from record highs against the greenback as signs of a slowdown in the Eurozone economy weighed on the single currency. News of large write-downs at European banks suggested problems emanating from the US sub-prime market were spilling over into Europe.

Economic data seemed to back that notion. Data released over the week showed Euro-zone retail sales fell unexpectedly in February and a survey of purchasing managers’ suggested activity in the Euro-zone services sector slowed in March.

Meanwhile, the greenback was boosted by relative stability in the global equity markets. Market expectations shifted from expecting a 0.50% rate cut towards predicting a 0.25% move in the April monetary policy meeting of the US Federal Reserve.

A weaker-than-expected US employment report, however, tempered the greenback’s strength on Friday. Non-farm payrolls fell 80,000 in March, worse than the expected 63,000 decline and the biggest drop for five years - and there were downward revisions to the previous two months’ figures. The unemployment rate increased from 4.8% to 5.1%, the highest level since September 2005.

For the week, the euro, which on Monday neared a record high above $1.59 against the dollar, fell 0.4%. The greenback also rose 1.1% against the Swiss franc over the week. 

The euro also dropped from a record high against the pound sterling, falling 0.3% on the week. This was in spite of a flurry of weak UK economic data and a warning from the Bank of England that tight lending conditions could continue as the credit crisis spread into the economy.

Market participants expect that this news would pressure the BoE to cut interest rates at its policy meeting this week. However, the pound rose following talk of strong mergers-and acquisitions-related demand for the currency and the pick-up in risk appetite. The pound surged 2.3% higher against the yen, but fell by 0.1% against the dollar over the week.

The yen also slumped against other major currencies as rising risk appetite drove investors away from the safe haven of the low-yielding currency. The yen fell 2.4% against the greenback over the week, dropped 2% against the euro and shed 3% against the Australian dollar.

This week, the rupee could remain on a relatively firm footing given that the downward pressures seem to be easing out. A lot also depends on the print of inflation this week.
If it prints above 7%, it could prove beneficial for the rupee.

Otherwise, the equity market conditions would also remain the key for the sentiment towards the rupee.

Rising inflation has kept the equities market in the negative territory last week and any further deterioration would put pressure on the rupee. Overall the rupee-dollar pair could trade in the range of 39.65-40.15 this week.

The author is India economist, ABN Amro Bank. Views expressed herein are personal.
E-mail: gaurav.kapur@in.abnamro.com