Posts tagged exchange rate
Purchasing Power Parities (PPP) explained
In our endeavour to enrich the knowledge of our readers we regularly come up with articles giving simple explanantion of economic and financial terms. Next in this series is the Purchasing Power Parity (PPP). Please write to us if you have further queries or you would like us to post explanation of any such term.
What is Purchasing Power Parities (PPP)?
Purchasing power parities (PPPs) are currency exchange rates obtained by comparing the prices of identical goods and services in different countries. These price comparisons are made by dividing the price of a specific good or service in one country by the price of the same item in another country.
For example, if a 300 milliliter can of Pepsi costs Rp16.42 in country A and $3.24 in country B, a price relative can be calculated as 3.24/16.42, or 0.197. This is the “Pepsi PPP” for countries A and B. Also called “price relatives”, PPPs are calculated for several hundred items covering all the final expenditure components of GDP. These PPPs for individual goods and services are then combined to obtain PPPs for higher levels of aggregation such as “Bread and Cereals”, “Food and Beverages”, “Household Individual Consumption” and, eventually, GDP as a whole.
How are PPPs used?
PPPs are used in two ways:
- First, they are used to convert GDP and its expenditure components to a common currency so that GDP comparisons can be made in real terms. “Real terms” means that differences in price levels between countries have been eliminated so that it is the underlying volumes of goods and services in each country that are compared.
- Second, PPPs are used to measure differences in price levels among countries. Market exchange rates are currency convertors that include differences in price levels among countries; PPPs are currency convertors that exclude these differences. The ratios of PPPs to exchange rates, therefore, measure the differences in price levels among countries. These ratios are called price level indexes.
Where does India stand in terms of PPP?
As per data compiled by International Monetary Fund (IMF), India ranks fourth in terms of PPP behind only USA, China and Japan. Following is a list of top 15 countries in terms of PPP as compiled by IMF for the year 2009.
Top 15 countries as per PPP (2009)
(Source: IMF)
Adapted from Asian Development Bank (ADB) publications.
USD-INR Charting its own course…
Equity markets continued their journey north with all major markets closing in the green for the week. The Sensex was up 100 points with indices worldwide crossing recent highs. Gold ended unchanged from last week at 1107. The European leaders seem to have a worked up an arrangement to help Greece ending the long stalemate between the leaders. The help from IMF might be necessary and unavoidable but does not bode well for the European Union. The US Dollar strengthened across the board rising against all major currencies. Supported by strong fundamentals inside and sovereign worries in other parts of the world the USD continues to stage a notable rally. On the contrary the USDINR seems to be much less affected by risk appetite in the global front. While the USD strengthened against almost all currencies it depreciated almost 30 paise over last week against the INR before closing at 45.23-24 levels. Strong fundamentals and high returns are driving capital inflows in the country could drive the USDINR further down however we see strong support at these levels and some importer demand might take the pair to 45.50 levels this week.
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RBI Raises Repo, Reverse Repo Rates
Before getting into the details, let us first understand -
What is Repo Rate?
Definition of Repo Rate: Whenever the banks have any shortage of funds they can borrow it from RBI. Repo rate is the rate at which commercial banks borrow rupees from RBI. A reduction in the repo rate will help banks to get money at a cheaper rate. When the repo rate increases borrowing from RBI becomes more expensive.
What is Reverse Repo Rate?
Definition of Reverse Repo Rate: It is the rate at which Reserve Bank of India (RBI) borrows money from banks. Banks are always happy to lend money to RBI since their money are in safe hands with a good interest. An increase in Reverse repo rate can cause the banks to transfer more funds to RBI due to this attractive interest rates. It can cause the money to be drawn out of the banking system.
In order to tame inflation, anchoring inflationary expectations and considering the signs of strong economic revival RBI on March 19 , 2010 announced Monetary Policy Measures with immediate effects:
- to raise the repo rate under the liquidity adjustment facility (LAF) by 25 basis points from 4.75 % to 5 %
- to raise the reverse repo rate under the LAF by 25 basis points from 3.25% to 3.5%
This is the second action since January when RBI announced a 75-basis point rise in the cash reserve ratio (CRR) to 5.75 per cent. But, unlike CRR, which is used to manage liquidity in the system, an increase in the repo and reserve repo rates is aimed at signaling an increase in interest rates.
Rating upgrade, rate hike – Growth on track
Equity markets continued the uptrend with all major markets closing in the green for the week. The Sensex was up 500 points. On the global front, nothing much changed vis-a-vis risk appetite as stand-off over Greece continued to haunt the Euro, which shed 300 pips during the week. The week also saw concerns over asset bubble in China and more pressure being put on China to appreciate its currency. While the global outlook continues to be bleak over the sovereign risk, the domestic outlook gained a fillip with S&P raising India’s rating from negative to stable. This seems to be a reward for the fiscal prudence being followed by the government and also the stable economic and political environment. Inflation crossed RBI target of 8.5 % and was 9.89% for Feb 2010 prompting RBI to raise policy rates by 25 basis points. USDINR was in range for the week and did not break 45.60 and 45.33 on either side. We see continued consolidation in this range with importer buying and state-bids conflicting with the positive sentiment that would otherwise take the pair downwards.
Currency markets at crucial point….
Markets seem to come out of the consolidation mode and increase in risk appetite saw the US Dollar being sold across the board. Almost all markets closed in the green and all currencies except the JPY saw strength against the greenback. The Dollar index closed below a key support level at 80 before closing 79.83. Sustained move below these levels would initiate further downside for the dollar. The Euro saw movement of 250 pips with 1.3800 being tested on Friday in the European market. The INR strength continues buoyed by strong fundamental coming on the back of a strong IIP numbers for a second month in a row. Movements on both side were very erratic with 45.38 levels bringing in importers and state bids while 45.63 level bringing further shorts into play. We would maintain an intraday range of 45.38-45.63 with bias tilted towards buying the dips. Technically 45.28 is yet to be tested and exporters are “not yet” panicking. Once exporters start panic booking with a simultaneous drop below the 45.28, it is likely to bring further downside.
Market Developments
Global Outlook
- The US Dollar fell against all majors except the Japanese Yen, breaking out of its tight range against the Euro and testing its recent lows. A limited week of economic event risk initially left the heavily-traded currency relatively motionless, but the latter half of the week saw the Greenback considerably lower through Friday’s trade. The declines were perhaps surprising given a significantly stronger-than-expected US Retail sales report on Friday morning; robust spending gave modest hope that the US consumer may prove more resilient than previously predicted. CFTC data is mixed with Dollar’s net long positions fell from $5.58 billion to $3.99 billion, however Euro shorts rose to another record of 74551 contracts suggesting that 1.3800 would be hard to break. After the break of 80 levels in the dollar index we feel that 78.56 would a decisive level to watch. A busy week of economic event risk likewise promises considerable volatility in the days ahead.
- EUR/USD was encouraged by better equity market and stronger than expected EU Industrial Production to hunt for stops through 1.3750, despite initially hampered by Russian selling. Prices made a run close to 1.3800, but lost momentum. Equity markets were majorly buoyant for the major part of last week with S&P 500 breaking January’s high of 1150. Nikkei managed to rise 382 pts to close at 10751. Markets are cautiously looking at the upside after the consolidation which has lasted for almost two months. However only a weekly close above the 1.3800 levels should show more upside. Market is still short ahead of FOMC next week and that’s going to limit dips within a range of 1.3600-1.3800.
- The British Pound rose to 1.5200 levels and may continue to rise if the Bank of England is able to convince the markets about its current stance The British Pound may benefit if the BOE succeeds in branding themselves as standing truly at the center of the policy spectrum. Rating agency Fitch said the UK’s AAA credit rating may be jeopardized if it doesn’t do more about its fiscal shortfall reminding us that political risk could be a major factor in the United Kingdom.
- Commodity currencies continue to be bullish on the backdrop of strong economic data from Canada, Australia and New Zealand. Australia is the first country to raise rates to 4%. RBNZ left rates unchanged at 2.5% and reiterated the already stated stance of removing stimulus in the middle of 2010. The key risk for commodity currency comes from the tightening policies to cool down China.
- Key Data for the coming week are Euro-Zone Employment and US industrial production on Monday. Tuesday would be crucial with Euro-Zone CPI, ZEW survey, US Housing data and the most important FOMC rate decision (rate may not be hiked but the wordings need to be watched). On Wednesday we would see the UK Jobless and other unemployment figures for the UK with Thursday bringing focus back to the weekly jobless claims. Friday would see housing, retail sales coming out of various regions.
Indian Economy – Review and Analysis, February 2010
Readers, as promised, we have posted the market review for February without delay this time. Month of February witnessed the most important calendar event for Indian economy, the Budget 2010. Our reports on the same would have kept you updated. Hopefully this will update you about its affect on various markets.
Equity
After correcting for most part of January and early February, Sensex touched a monthly low of 15725 on Feb 5 and thereafter gained strength from positive news on the budget front. It touched a monthly high of 16669 on the day of budget and closed the month at 16429, about 2 % above the last month’s close and 4.5% above the monthly low.
USD-INR retracing the fall
The USD/INR retraced the highs of 45.28 and has settled at around 45.78 levels. Equity markets were directionless with the Sensex and the Nifty closing a tad lower than last week. The high point from the data point was the 11.3 % growth in IIP against expectation of 10%. Inflation for the month of December was 7.31% which was as per expectation. In Euro news, the ECB kept rates unchanged but reiterated the need for fiscal discipline from its member states. While we expect the USD/INR to be more weighed by foreign inflows and underlying strength of the Indian economy, momentary surges in the US dollars may take the pair back above 46 levels.
