Rupee could get boost from RBI’s monetary policy stand

Signs of stabilisation in global economy and the financial sector helped equity and credit markets add to their gains last week. Global stock markets recorded a sixth consecutive weekly rise, as equities around the world rallied amid growing confidence that the financial sector might have passed its worst phase.

Better-than-expected quarterly results from Goldman Sachs and JP Morgan helped financial stocks lead the equity market rally. The rally in financials reflected an improvement in the risk appetite among investors, which helped drive most equity indices higher. As a result, the appetite for safe havens such as the US dollar fell and there was demand for riskier currencies such as the pound sterling.

In fact, the pound was among the best performers last week, rallying against almost all other leading currencies after strong showings on UK equity markets by financial stocks. The FTSE 100’s banking index rose 5% over the week. Boosted by appetite for risk, the pound gained 0.8% against the US dollar over the week after briefly climbing above the $1.50 level mid-week. Against the euro, the pound rose 2% but fell 0.7% against the yen.

The other European major, the euro, fell 2.7% against the yen and by 1.1% against the US dollar after hitting a one-month low of $1.3030. Falling inflation and subdued inflation expectations led many market participants to believe that the European Central Bank (ECB) will announce a further 0.25% rate cut on May 7 and possibly further measures to boost economic activity. This was the impression given by Axel Weber, a member of the ECB governing council, on Tuesday. On Friday, ECB president Jean-Claude Trichet was more measured, saying the bank will wait until the meeting to decide on “non-standard” measures. The non-standard response is expected to come in the form of quantitative monetary easing by the ECB.

Concerns about the health of the Eurozone were compounded when Moody’s Ratings said on Friday it may cut Ireland’s sovereign debt rating given the “severe economic adjustment” taking place there.

For the US dollar, it was a mixed week. After losing ground over the first three days of the week, it recovered in the last two sessions. Gains for the US dollar during the last two days were driven partly by weak data on Thursday that showed slowing Chinese growth, tumbling Eurozone industrial production and a 10% fall in new US home builds in March. The US dollar also won support as some market participants speculated about the return of risk aversion. During the equity sell-off prior to March’s recovery the greenback benefited from its perceived safety as the dominant foreign exchange reserve currency.

However, in recent weeks investors have regained an appetite for risk, prompting a bounce in equity markets and a retreat for the US dollar, as the search for yield has brought about a revival of the carry trade. But on Friday, equity markets and the greenback moved higher in tandem. Even with equities trading higher, the dollar made modest gains. Although the US dollar was weaker over the week, it rallied 0.8% against the pound on Friday. Over the week, the greenback was 0.9% stronger against the Swiss franc, but fell 1.5% against the yen.

In the local inter-bank market, the rupee finished the week marginally stronger against the US dollar. It appreciated by 0.2% against the greenback over the week, after trading in the range of 49.33-50.07. The rupee was helped by the stock market gains and dollar inflows from FIIs. Over the week, FIIs bought local equities and bonds worth $403 million and the BSE Sensex gained 2%. Exporters also sold dollars noting rupee’s strength. Rupee’s gains, however, were curtailed by the volatility in the stock market and demand for dollars from importers.

This week, the key event for the local market is the announcement of the annual monetary and credit policy by the RBI for the current fiscal on Tuesday. The central bank would continue to support economic growth by maintaining a soft interest rate regime and ensuring adequate credit delivery. In the backdrop of the global financial crisis-driven rapid slowdown in growth, the RBI has already eased monetary policy levers quite aggressively since October last year. The central bank could therefore choose to keep policy rates unchanged at this juncture or reduce the size of the rate cuts to 0.25% from 0.50%.

While the general market consensus is for a status quo on rates, a surprise rate cut would boost the equity market and thus the rupee. Equally important will be the RBI’s assessment of the economy with special emphasis on its growth target for the year and guidance on the time required for the economy to pick up. There have been some signs of recovery in economic activity and if the RBI endorses the same view, it will boost market sentiment. Moreover, any norms for allowing restructuring of bank loans to avoid a build-up of non-performing assets will be of help. However, any signs of caution or pessimism could lead to a correction in both equity and the rupee. A turn in global sentiment towards risk aversion could also prove negative for the rupee, as that could lead to a slide in the stock market and the strengthening of the US dollar. Overall, the rupee-dollar pair could trade in the 49.50-50.25 range this week, with mild strengthening bias on the rupee.
      
The writer is senior economist, ABN Amro Bank. Views expressed here are personal.