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The story of a tumbling Rupee

| 10/10/2011 11:15 AM Monday

Believe it or not, everyone gets their due share of the lime-light sometime or the other, and that opportunity is more than enough to bask in the attention that one gets. Something similar seems to have happened with the Rupee, whose brisk depreciation has been in the limelight recently, in the midst of the already-brewing concerns in the US and Europe. The baffling part is that it has come at a time when the US is in its worst shape, with an anticipated double-dip recession, while India, even with an estimated FY12 GDP of close to eight per cent, is still looking bet-ter. Besides trying to make sense of whether it is good news or bad news in the first place, dumbfounded market participants are clueless as to how to react to this sudden development.

While a quarter ago, nobody could have thought that the rupee could ever depreciate so quickly, some are already prophesying doomsday theories of the rupee further weakening against the dollar. Others are busy trying to draw parallels to a similarly brisk depreciation seen in the second half of 2008. While it is easy to point out what has happened, not many have been able to put a finger on WHY it has happened – which is a very important question that needs to be answered. We, at Dalal Street Investment Journal, have gone beyond this development and have not only understood the real reasons behind this slide, but also have gauged the levels we could probably see the rupee at by March 2012. What adds strength to our conviction is the interactions that we have had with the many market experts on the subject. Two such interactions are included towards the end of the story, in order to help our readers understand the rupee depreciation conundrum better.

While it is easy to say that it is the dollar that is strengthening against other currencies, including the rupee, our research shows that actually, a mix of domestic and international factors is currently affecting the Indian rupee. These factors are enumerated further.

Key Factors
There has been a general shortage of the dollar in the domestic markets, as FII and FDI inflows have slowed considerably. To make matters worse, there is a risk aversion amongst investors, who are seen flocking back to the dollar. Barring the New Zealand and Colombo stock markets, which were up by one per cent and two per cent respectively, all the other stock markets are in the red on a Year-to-Date basis, with Europe being beaten down badly. Leave aside Europe, sentiments have been dented to such an extent, that investors are staying away even from emerging markets such as India.

The situation is so bad, that on a Year-to-Date basis, FII inflows (including debts) to India stand at a mere USD 4.25 billion, out of which only USD 96.42 million has flown into equity. In fact, since the beginning of August 2011, when the markets turned shaky, FIIs have turned net sellers with a massive USD 1.76 billion of net sales in the month of August itself. Net outflows in September 2011 stood at USD 342.38 million. FDI flows were no different. Between January and April 2011, the overall FDI inflows stood at Rs 29189 crore, down by about 10 per cent over the same period last year. In fact, over the last three fiscals, FDI has declined from USD 37.8 billion in FY09 to USD 39.38 billion in FY11. FIIs are said to be one of the most potent forces that determine the direction of our equity market. In addition to the equity market, FIIs also play an important role in determining the exchange rate movement of the Indian rupee. There exists a positive correlation between FII flows and the value of the rupee. What this means is, when there is a net inflow from FIIs, the rupee strengthens or appreciates against the US dollar, and when there is a net outflow, it depreciates.

 

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