Monday, April 12, 2010

>FX Rates Outlook for Q1 FY11: Global and Indian Rates

The economic data releases for the last quarter of 2009 gave hope of a solid global economic recovery. USA, the largest economy of the world grown at a pace of 5.9% in the fourth quarter with significant improvement in the domestic private investment. Consumption expenditure has been improving with stabilization of the labor market. China and India- leading members of the BRIC nations gave a solid force to the global rebalancing and most of the emerging economies are poised for a better growth in the latter half of the 2010.

However, the contagion risk arising in the Euro zone economies and UK’s rising deficit have dampened the recovery sentiment recently. The fresh “risk aversion” created by the EU and the UK economy pushed the US dollar higher and European currencies started depreciating towards the crisis levels.

Greece- the south European economy and a member of the European Monetary Union-16 is facing criticism due to worse fiscal management. Greece’s public debt to gross domestic product ratio is approaching 120 per cent, its budget deficit has swollen to 12.75 per cent of GDP, and it has lost around 30 percentage points of international competitiveness over the past decade. As Latvia and Ireland's recent experience with budget austerity suggests, attempting to bring Greece’s budget deficit down towards the Maastricht criteria's 3 per cent of GDP limit by savage expenditure cuts and without recourse to currency devaluation could result in a cumulative contraction in Greece’s GDP over the next few years.

The Spain and Portugal which were also known for bad fiscal control are creating “contagion risk” in the common currency area. The Euro zone may witness slower growth in the 2010 and may read negative growth in 2nd quarter of 2010. We see a major downside in the Euro in this quarter with heightening risk aversion.

From UK also, the pressure is mounting on rising public debt and risk of the country losing credit rating has mounted. The economy is fighting with fragile growth and rising inflation. It registered a growth of 0.3% in the fourth quarter of the 2009 while inflation is at 3% YoY, above the targeting limit of the BoE.

The recent set of data releases suggests a negative growth in the 1st quarter of 2010. We see the
“stagflation” in the UK to put downside pressure on the pound.

And in Japan, falling prices has raised fear the deferred domestic consumption expenditure. With
deflationary expectations, producers are expected to get hit and the private investment to slow down. The country faces the risk of rating cut which debts are at an alarming level. To increase spending, the BoJ loosed the monetary policy further and this resulted slide in yen against the major currencies. From the domestic point of view, Indian economy has been very strong with sequential upticks in economic indicators. However, rising food prices prompt the central bank to raise the benchmark repo and reverse repo rate by a quarter basis point, in an unexpected move in March. We are expecting further monetary tightening by the authorities in their coming meets. Rate hikes at this point may slowdown the growth level to some extent and impact may be seen in the 1st quarter of FY11. From the currency context, rising price level may reduce the RBI intervention in the market.

We are quite optimistic in the global economic recovery in the Q4, 2010, but see some downside risks for growth in the next two quarter of the calendar year.

We are bullish on the Indian Rupee, but see limited upside against the US dollar. In terms, of the Euro and the GBP further appreciation is expected

To read the full report: FOREX OUTLOOK