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Monday, Nov 04, 2002

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Nothing new for the rupee!

V. Ravi Kumar

A FAIRLY busy week for the rupee as it bobbed up to 48.33 after touching its week low of 48.47. The fall was mainly due to the " month-end" demand for dollars. Now almost all importers, particularly the big ticket ones, are covering their requirements on a spot basis. There were also some large overseas loan repayments for companies to service at the end of last month.

Now we are into the new month, things are back to normal and having traded below 48.35, we are now on course for 48.25 later on this month. The credit policy had nothing new for the rupee. The narrowing of interest rates between India and the US was expected and as was said last week, this factor should not be a dampener to inflows seeking higher returns on the rupee.

As we approach the year-end, the only additional demand for the dollar could come by the way of FII's redeeming some of their investments for the year-end factor. Apart from that there is nothing in the horizon that alters our view of the rupee's bullishness continuing. Oil prices are soft and are not a potent factor as of now.

Now that the credit policy is behind us, the markets would now be focusing on the divestment issue in India. Any positive news in this regard will be the ballast for the rupee to break 48.25 in the medium term. As the weakening trend in the dollar continues, the rupee bullish factors will pick up steam as we go along.

As expected, the credit policy was silent on the issue of the announcement of rupee based currency options that some sections of the market were speculating on. There really is no case for the introduction of these products at this point of time as the dollar/rupee volatility in recent times has been abysmally low and unless we see good volatility in this pair on a two way basis, it is difficult to see a demand for currency options, much less finding customers willing to pay a premium for these!

The RBI has, however, set up a panel to look into the issue of introducing rupee derivative products in the market. If anything, interest rate options will be more in vogue, given the high level of volatility in these markets.

Forwards premium in the one-year segment should continue to trade in the 3.9-4.1 per cent ranges and all eyes are on the US Fed as it meets on November 6 to consider interest rates. In fact all three big central banks, the Fed, the ECB and the Bank of England meet next week to consider interest rates.

A study of Fed funds futures prices reveals that the markets have priced in a 25 basis points cut, to 1.50 per cent. March delivery euro-dollar futures hit lows this week, again suggesting a further 50 basis point cut by then! In fact, some analysts are suggesting we may see Fed funds at 0.50 per cent by this time in 2003!

Perhaps to pre-empt this, the RBI cut three key rates in its policy announcement, further reinforcing the perception that it is aggressively pursuing a soft interest rate policy. The Bank rate now is at a 28-year low and growth concerns, over those of inflation seems to have taken precedence in the minds of the policy makers.

The rates in India come in the backdrop of a slowing of growth in the large economies of the world, which are potentially threatening to our key export sectors of textiles and gems and jewellery sector. The US, which is India's biggest market, has interest rates at 41-year lows and so is the case in England where, the bank rate at 4 per cent is at 38-year lows.

No doubt, the drought this monsoon season, which is the third in four years, compelled the RBI to cut all three crucial rates. Shrinking agricultural production as a consequence has a spill-over effect on industrial goods apart from consumer goods as television sets and tractors.

The pace of industrial production is expected to slow down from November, again due to the monsoon, whose effect was 20 per cent below normal. Therefore, even though the RBI has suggested that rates will be on a hold from now, there seems scope for more cuts in the next credit policy in April next year. It seems doubtful that the recent cuts will spur larger industrial activity or will spur growth in any dramatic manner.

As this is written, in far away London, on a cold and soggy autumn day, it does seem that all the three major central banks may cut their rates during the following week.

A consequence of a troika of cuts could mean that there will be less appeal for "carry trades" wherein one borrows in a low interest rate currency such as the yen or Swiss franc and convert them to dollars.

In the event the cut comes through, we may see a weakening of the dollar against these currencies.

This will be once again, bullish for the rupee and we may see the 48.25 sooner than the projection of end November.

(The author is Head, Treasury, at Vysya Bank, Bangalore. The views expressed are his own and not necessarily those of his employer.)

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