No relief in sight for rupee

Downward pressures on the rupee intensified last week and the Indian unit depreciated to an all-time low against the US dollar.

Various factors worked against the rupee, starting with a much anticipated sovereign rating related action on Tuesday. International ratings agency Standard & Poor’s downgraded its outlook on India’s long-term sovereign rating to “negative” from “stable”, citing concerns over the deterioration in public finances in the current fiscal.

Rating, however, remained unchanged at BBB+.  Despite these signs of worries about the dismal state of public finances, the government went ahead and announced another round of indirect tax cuts worth Rs 29,100 crore. This boost failed to cheer the market much as focus is now on the possibility of a rating downgrade in the near future.

Month-end demand for dollars from importers and an arbitrage opportunity between the onshore forwards and offshore non-deliverable forwards market, pushed the rupee further down. The NDF market opportunity emerged as the US dollar strengthened against other currencies in the Asian region. FIIs remained net sellers of Indian assets and withdrew $414.6 million from Indian stocks and bonds last week. A 12.2% increase in crude oil prices over the week added to rupee’s woes.

On Friday, market participants were disappointed, as data for the quarter ended December 31, 2008, showed that real GDP growth had slipped to 5.3% on an annualised basis. This was the slowest quarterly growth rate in six years and that in turn created doubts about the government’s estimate of 7.1% growth for the whole year.

Market participants also scaled back their GDP growth estimates for FY10, in light of the Q3 GDP data. That too dampened the sentiment towards the rupee.

The RBI on its part intervened in the market to provide some support to the rupee. The central bank, however, only looked to ease movements in the rupee-dollar pair and did not look to protect any particular level. Over the week, the rupee depreciated by 2.8% against the US dollar and the pair traded in the range of 49.66-51.17.

This week, too, the rupee could remain under pressure and the pair could trade in the range of 50.50-51.50. Scales are again clearly tipped against the Indian unit. After moving in a range-bound manner between mid-November 2008 and early February this year, the rupee is under pressure again.

External fundamentals remain weak and we could see another year of tepid capital inflows. The rupee could get some support as dollar-selling by exporters could emerge at these unprecedented levels for the rupee-dollar pair.

The RBI’s actions in curbing further rupee depreciation is crucial now, considering that the rupee remains undervalued in real effective exchange rate (REER) terms by about 4-5%. The central bank’s support to the rupee, however, is constrained by the fact that it will have to maintain easy liquidity conditions and a low interest rate regime to help the market absorb the massive government borrowings.

Thus, the RBI could only look to break the fall in the rupee-dollar pair. This is especially true for March when there tends to be some pressure on liquidity. 

In the overseas market action last week, the yen dropped to a three-month low against
the US dollar and put in its worst monthly performance for 13 years as Japan’s economic condition deteriorated and funds flowed out.

Following a 3.3% drop in Japan’s GDP in the fourth quarter of 2008, its biggest fall since the early 1970s, economic data continued to show that the country’s export-driven economy was suffering in the face of a sharp slowdown in global trade.

Data released last week showed Japanese exports plunged 45.7% on an annualised basis in January, taking the country’s trade deficit to record levels, while industrial production dropped a record 10%.

Meanwhile, data from Japan’s finance ministry reveals capital has been fleeing the country, with net outflows of 1,721 billion yen last week. This took outflows over the past three months to record levels.

There seemed to be a switch in market perception towards the yen, which until recently had acted as a safe haven currency, rising when global equities sold off and falling when shares rallied.

The yen had been the best-performing currency amid the recent market turmoil as investors unwound carry trades, in which the purchase of riskier, higher-yielding assets had been funded by selling the low-yielding yen. It now appears that that process had run its course.

Over the week, the yen fell 4.7% against the US dollar, taking its monthly loss to 8.4%, its largest fall since August 1995. The yen also lost 3.3% against the euro, dropped 3.8% against the pound and fell 3.8% against the Australian dollar over the week.

Meanwhile, the US dollar continued to be supported by safe haven demand as speculation over the health of the global banking system intensified and US GDP was revised lower in the fourth quarter. Over the week, the greenback rose 1.3% against the euro, gained 1% against the pound and climbed 1.5% against the Swiss franc.

The Swedish krona dropped to a fresh record low against the euro as figures showed the Swedish economy put in its worst performance since 1940 in the fourth quarter. Over the week, the Swedish krona dropped 2.3% against the euro and fell 3.3% against the US dollar.

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