More Tightening To Underpin Rupee

The central bank of India tightened policy last week by raising the reverse repo rate 25 bp to 5.75%. It is the fourth tightening move in five months and more tightening is likely in the coming period.

The central bank raised its 2010 GDP forecast to 8.5% from 8% last weekand lilfted its inflation forecast to 6% from 5.5%. The strength of the economy is running into capacity constraints and officials have signalled more forceful restraint is needed.

Two sectors highlight the pressure. First, truck and motorcycle sales were particularly strong last month. Second, bank lending may be a problem in the developed countries, but it is not in India. Bank lending last month stood 21% above year ago levels, the strongest pace since Jan 2008.

Earlier today India reported July PMI at 57.6, up from 57.3 in June. Factory output jumped to 62.3 from 60.5. Export orders were also strong,above 60 and holding above the 50 boom/bust level for the 14th consecutive months. Foreign investors have been particularly active, purchasing both stocks and bonds. Foreign purchases of Indian equities was about $3.8 bln in July, which is more than a third of the amount bought year-to-date. This itself is a 40% increase above year ago levels.

India's 10-year yield stands at about 7.77% today. Compared with other countries in emerging Asia, this is a relatively high yield. Only Indonesia (leaving aside Pakistan) is higher and barely (~15 bp). This is a three month high for Indian bond yields. Bond yields have risen in five consecutive, the longest streak in a couple of months. New bill supply added to the fundamental pressure. The government announced that it would sell INR85 bln (~$1.8 bln) of bills this week, which is nearly 3-times more than last week.

India's 2-year yield is 7.06%. Indonesia, by comparison, which attracts amny yield hungry investors, offers 5% on its 2-year bond. Year-to-date currency moves are similar. The rupee is up 1.16% and the Indonesian Rupiah is up 1.33%.
The dollar may find initial support near INR46, but over the next few months, it has potential to slip toward INR44, which corresponds to the lows from late Q1/early Q2.

In terms of the upcoming calendar, industrial production and wholesale prices (Aug 12 and 16 respectively) are the next important releases. Although, it was reported today that June CPI rose 13.73% year-over-year, down from 13.91% in May, it seems policy makers put more weight on the WPI, which rose to 10.55% in June from 10.16% in May.
More Tightening To Underpin Rupee More Tightening To Underpin Rupee Reviewed by Marc Chandler on August 02, 2010 Rating: 5
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