Rupee weakening and equity market bottoming cycle

Weakening of Rupee and Equity Market Bottoming cycle

The way the rupee has fallen over the last few days vis-à-vis the USD dollar implies it could get into a vicious cycle if the Reserve Bank of India (RBI) or the Central Govt does not take immediate and significant steps to control the current account deficit (CAD).

While a cheaper Rupee makes Indian stocks even more attractive for the Foreign Institutional Investors (FIIs), who are yet to meaningfully invest in India, it hits the existing FIIs by taking away a part of the earned appreciation in stocks.

If the Rupee keeps falling or stays at weak levels for long, the impending end to the monetary stimulus by the US could advance selling by the FIIs who would not like their stock appreciation taken away by currency fluctuations. In a sense, it could also later turn into a rush to the exit door. 

Currencies are strange animals that may be easy to predict for a certain period of time, but once they change trajectory, it becomes difficult to anticipate the extent of moves and the time when they would reverse direction. Only a few months back, few large MNC brokerages were bullish on the Indian Rupee putting a target of 52 to a dollar in 2013.

It is also very difficult to predict as to what measures will result in reversal of the mood. This is true especially when a lot of emerging market currencies are already facing pressure (South African Rand down 10%, Brazilian Real down 6%, Turkish Lira down 6% since early May 2013) in an era when the US dollar is anyway appreciating against most currencies. Further when the US and Japanese stock markets look tempting enough, the attraction of emerging market equities anyway is on the fading side.

While the street would want everything from liberal FDI regulation to curbs on Gold imports to faster policy making in the domestic industry/infrastructure space, one is not sure as to what extent the RBI has the flexibility to make large sharp interventions in the USD INR markets and to what extent the Government is keen to carry out the measures expected given that the ruling UPA faces a general election less than one year from now. 

In the recent past whenever the INR saw a sharp depreciation vis-à-vis the USD, once the process ended, the equity markets bottomed out. This happened in Mar 2009, in Dec 2011 and again in June 2012. Hence it could be rewarding to anticipate the end point of this Rupee weakening cycle. However in the past the weakening process continued for at least 4 months and in some instances went on till 14 months. In the current cycle we are just into the second month.

Let us anyway keep our eyes and ears open for such a bottom formation to happen in the equity markets

Sensex Chart

USD INR chart