Posted by: Deepa Vasudevan on Mon, Aug 20th, 2018
Booming Sensex, Crashing Rupee
In 2013, when the taper tantrum set off an emerging market currency crisis, the rupee fell by 13% against the US dollar. The BSE-Sensex mirrored market anxiety by falling almost exactly in line with the depreciating rupee; and then rising slowly as the exchange rate stabilized (Fig 1). This year is different. The rupee has dropped nearly 10% against the US Dollar, but the Sensex has gained over 12% (Fig 2). In other words, while the external value of the currency is depreciating, the most widely tracked index of market sentiment is booming and touching new highs. What explains this phenomenon?
Source: Sensex data from www.bseindia.com, exchange rate from RBI. For each year, the value for 1 Jan is set at 100 for both sensex and nominal Rs.$ exchange rate
The explanation lies in the different reasons underlying the collapse of the exchange rate in 2013 and 2018. The crisis of 2013 was due to India’s external account vulnerability- high current account deficit driven by high oil and gold imports, rising short term debt, and a sudden pull-out of foreign portfolio inflows reflecting a lack of confidence in the economy. However, the weakening of the rupee in 2018 is largely due to geopolitical reasons: the US-China trade war, rising protectionism in trade partners, volatile oil prices, and strengthening US dollar. These factors are certain to push up India’s current account deficit (market estimates for FY19 CAD range between 2.6% to 3% of GDP), but, nevertheless, global investors seem to be confident about the India growth story. The economy is expected to grow at around 7.5%, RBI has acquired a reputation for managing inflation, income tax collections have risen, and GST systems seem to be stabilizing. A view is emerging that the depreciating rupee may actually improve growth by (i) benefiting exports (especially revenues of IT firms, which form a significant part of stock indices) and (ii) increase market shares of domestic producers by making imports more expensive. At this point, domestic fundamentals appear sound enough to overcome the rupee’s fall. No surprise then, that foreign portfolio investors returned in July and August with $1 billion of inflows, after three months of continuous outflows! That is why the Sensex can afford to ignore the weakening rupee and look forward, instead, to stronger growth and higher profits!
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