Rupee vulnerable as +ve momentum fades

The Indian rupee continued to lose ground to the US dollar for a second successive week , as a widening trade deficit saw demand for dollars rise while capital inflows moderated. The Indian unit depreciated by close to 2% last week , taking its losses in the last fortnight to about 4%.

External fundamentals remain unfavourable for the Indian currency. With the positive sentiment generated by recent reform measures taken by the government weakening, fundamental concerns are coming back to affect the price action.

The momentum of appreciation was always going to be difficult to maintain , considering that most of the measures related to foreign direct investments (FDI) will attract capital over the medium term. The government is expected to announce more measures to prop up the economy and help improve the investment climate, however , till such time , market participants would shift focus back to global developments, especially those around the euro zone.  Events boosting investor risk appetite will be positive for the rupee.

Risk aversion and volatility increased towards the end of the week. Global stocks sold off amid a slew of disappointing corporate earnings reports in the US and reticence in Germany over an aid programme to Spain’s banking system. Concerns that the euro zone debt crisis may be prolonged weakened sentiment further , as Spanish Prime Minister Mariano Rajoy said that Spain was not under any pressure to ask for an official bailout.

In global currency markets, the euro dropped on Thursday against other major currencies on speculation that the European Union summit in Brussels will fail to provide clarity on potential financial aid for Spain, particularly as the Spanish government continued to maintain its stance of not wanting a bailout.

The single currency still gained over the week against the US dollar and yen on bets that the sovereign-debt crisis is easing. Earlier in the week, it reached its highest level against the US dollar in a month, after Moody’s Investors Service kept its investment grade rating for Spain, easing concern that the region’s debt crisis is worsening.

In Asia, the Chinese yuan advanced for an eleventh straight week, the longest streak of gains since 2008, as factory output and spending data fuelled optimism that the economic slowdown is coming to an end. The currency touched a 19-year high on Friday, after reports showed growth in industrial production, retail sales and fixed-asset investment accelerated in September. Over the week, the Chinese currency was little changed,   gaining 0.2%. The yuan has advanced 2.3% since reaching this year’s low on July 25.

This week, the Federal Reserve monetary policy announcement ought to be the centre of attention. This Fed meeting is unlikely to be as market-moving, coming on the heels of third round of quantitative easing announced last month. It seems unlikely that Fed chairman Ben Bernanke is geared to deliver anything significant besides a restatement of the new status quo.

Policymakers will be in a ‘wait-and-see’ mode for some time from here on, as they assess the effects of the new round of quantitative easing.

A heavy economic data release calendar from the US is likely to take on broader significance for financial markets, with investors interpreting data flow in terms of its implications for larger risk sentiment trends. Despite a still disappointing pace of recovery, the US remains a pocket of relative of strength compared with the other major engines of global output as the slowdown in China turns increasingly strong, while the recession in the euro zone shows no meaningful signs of improvement.

In this backdrop the, US GDP data for the third quarter of 2012 will be watched very carefully. Consensus market expectations are for real GDP growth of 1.8%, marking improvement from the 1.3% recorded in the previous quarter. This bodes well for risk appetite, which would weigh on the US dollar against most of its major counterparts as support from haven-seeking capital flows reduces.

Besides economic data, third-quarter corporate earnings data from the US stands as the other critical catalyst shaping market sentiment, and thereby the trajectory of the greenback. Guidance from cycle-sensitive names like Caterpillar is likely to be interpreted along the same lines as US economic data releases, helping to shape the degree to which US economy can lead a global economic recovery. Any weakness in corporate earnings as was seen last week, will dampen risk appetite and help the US dollar.

In the local market, the rupee may remain weak especially if the global investor risk appetite remains weak. Second quarter corporate earnings would continue to draw interest of the market participants and any guidance of improvement going ahead, would be positive as that would signal that the economy may have bottomed out.

In a positive sign for the rupee last week, India’s largest software services exporter reported better-than-expected earnings numbers for the second quarter, signaling that businesses world over are spending more to cut costs through outsourcing amid rising economic uncertainty. If this trend persists for the IT & ITES sector then this will help in bridging the large negative gap India’s run on trade in goods.

The rupee-dollar pair can trade in the range of 53.50 - 54.50 this week and the volatility in the pair is likely to rise as positive sentiment generated since mid -September is clearly fading.

The author is senior economist, Royal Bank of Scotland N.V.
Views expressed herein are personal.
E-mail: gaurav.kapur@rbs.com