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  • 4 questions you may have about rupee depreciation

    Publish Date: 17th August, 2018

    1) Why does rupee deprecation affect FIIs flows to India

    Any fluctuation in the exchange rate of the rupee, whether appreciation or depreciation, will affect the Foreign Institutional Investments. This is because their returns/profits are to be converted into their local currency. Hence, FIIs are majorly wary of volatility in the rupee. A falling rupee affects the FIIs as it decreases their net earnings in both the stock and bond market.

    When a foreign investor puts Rs 60,000 in a rupee bond yielding 8% a year. At the time of investment, the US dollar was at Rs 60. Therefore, his investment was $1,000, on which he earned $80 (at 8%) as interest. Now, if the dollar is at Rs 70 at redemption, that is, the rupee has depreciated, the value of his investment will decrease to $857. This will reduce his interest earnings to $68. The value of his investment at the end of the year will be $925, an overall loss of 7.5%.

    With the decline in the value of their investments, foreign investors may engage in distress sales of funds. When these investors pull out their funds from the market in panic, the value of rupee may depreciate even further. This is because a lot of foreign investments will be taken out from the market with the hot money.

    Also read: The impact of US-China trade face off on Indian Economy

    Foreign investors may even panic on account of an expected rise in the current account deficit in the country. This was experienced FIIs pulled out USD 5.4 billion from the bond market in June 2013. At the same time, US ten-year treasury yield rose from 2.1% to 2.5% making it more attractive to the investors.

    In terms of the Indian securities markets, FIIs hold more than one fourth of the BSE-500 companies. Thus, any outflow of foreign funds will have a significant impact on Indian equities markets.

    Click here to read more about the importance of FIIs in Indian Economy

    2) Can rupee depreciation have a positive impact?

    Yes, rupee depreciation will positively affect the Indian exporters. Export-oriented businesses with their earning in dollars will have increased revenue when rupee depreciates. For each dollar of their earnings, they will get more rupees.

    In India, the IT and the pharma sector will be benefitted from the rupee depreciation. These sectors being highly export oriented will get higher value on their exports. IT companies earn most of their revenue in terms of dollars and more than half of sales by pharma companies are exports. However, some of their profits may be reduced due to price of hedging.

    Also read: Rupee at 70. What should you do?

    3) What is the dollar index and how it is affected by rupee depreciation?

    US Dollar index is the measure of the USD relative to a basket of currencies of its six major trading partner countries viz. Euro, Japanese Yen, Swiss Franc, Pound Sterling, Swedish Krona and Canadian Dollar. Since it is a trade-weighted index, it is affected by changes in foreign exchange rates. Thus, when rupee depreciates w.r.t. USD, the value of the Dollar index will gain strength.

    Also read: Know India’s correlation with the global markets

    4) Why do experts measure Nifty/Sensex returns in dollar terms, especially when rupee is volatile?

    When the rupee is volatile, experts calculate Nifty/Sensex returns in terms of USD to balance the exchange rate variation. This has particular importance for FIIs since they consider returns in terms of USD.

    Consider, the current situation where rupee has hit an all-time low in relation to USD. In this scenario, Nifty/Sensex returns calculated in terms of the dollar will be less in comparison to the same calculated in terms of rupee.

    Also read: Know India’s correlation with the global markets

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