USD-INR – A Window To Stock Markets

Stock markets in India and  other emerging countries are currently perched at peak . The movements of recent past have been zippy and surprising for most, leaving all of us wondering for the next direction.

Foreign exchange markets of respecitve countries can offer a peek into the future given the extremely high  correlation seen between appreciation in the local currency and rise in stock prices of all emerging markets . The appreciation of Indian rupee against US dollar form 49.00 levels in 2002 to the current 40.40 levels is correlated by rise in sensex from 2950 levels to current 15300 level. Another emerging country, Brazil, also saw ”Real” appreciate against US  dollar fom 4 to 1.87  while its stock index bovespa rose from 9000 to 57000.

This correlation speaks of  strong inclination of global capital inflows post 2002, into these economies, leading to perk up in asset markets . The inclination germinated owing to variety of congenial factors at that time as:

• Cyclical financial weakness of the US economy egging on dollar outflow,

• Highly depreciated  emerging market currencies (say Indian Rupee at 49.00 to a USD), leading to reduction in foreign exchange risk of these economies and altering the cost matrix in favor of the foreign capital ,

• Extremely low yields of AAA debt instruments in developed economies, 

• Availability of extremely cheap short term capital  in US and Japan enabling outflow of money , and

• the promise that potential of emerging countries offer to prospective investors.

The matrix of these and many other small magnitude factors initiated the movement of money from developed world to emerging Countries including India. Movement slowly turned into tide and assets markets there balloned .

This matrix has been gradually loosing its appeal  to stimulate further movement of capital . See how it has changed :

• The cyclical financial weakness of US is loosing pace and the new technology initiatives of the US companies are begining to bear fruit , promising good export potential.

• Appreciation in currencies against Dollar has elevated the exchange risk for new flows and taken away the cost advantage to the foreign capital available earlier. 

• The long term yields of AAA paper have improved significantly in the developed world since 2002. 

• The short term interest rates have risen impeding outflows from US.

• The exploitation of  potential of emerging countries  is crossing into ineffecient zones and running into resistances, and

• The central Banks of emerging markets have gone into control mode, under threat from rising inflation.

The new matrix of factors will alter the flows of capital and change the hitherto favorable inclination of global capital.  Any alteration of capital flows shall immediately find reflection in the respective currency exchange rates. In India the USD-INR exchange rate, therefore , shall be a good indicator of stock market directions.

The recent USD -INR rates have been in a small range after one stroke appreciation in early June,2007.  Even the huge demand for forward rupee buying by exporters, consequent to steep appreciation is  not showing up in price action so far .  This may be indicative of build up for reversal into depreciating phase of Rupee. Other emerging market currencies are also exhibiting overdone appreciation threatening to reverse themselves pretty soon.

These indications coupled with changing face of matrix of factors, discussed above, make any further siginifcant appreciation of Rupee, or most other emerging market currencies , seem unlikely . We may therefore be  near peaks for most stock,  commodity  and the currency  levels in India and other emerging markets .

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