The present exchange rate puzzle has created a new 'trilemma' which involves the forex, bond and stock markets. The impressionistic feeling we get is that when the rupee falls and the RBI intervenes, the bond market goes into a tizzy and rates increase.
In sympathy, this prompts the stock market to move down as these signals are interpreted perversely. Quiet clearly there is a basis for this theory which needs to be explored further.
The turning point in the rupee was May 20, when the rate crossed 55 a dollar. From then on till now, which is just a little over 3 months, there has been a lot of measures taken by authorities, some of which have worked more than others.
The objective here is to examine two sets of issues. The first relates to the linkage between the exchange rate, 10-year Gsec and stock market movements as denoted by the sensex. The other is a theoretical exercise which involves the notional cost that has been involved.
RUPEE & SENSEX
For the record, on a point-to-point basis up to August 22, the rupee (RBI reference rate) has fallen by 17.5%, the 10-year yield has gone up by around 90 bps and the Sensex has declined 9.5%. In terms of the linkage between the two, a rudimentary statistical exercise shows that the coefficient of correlation between the rupee and sensex at absolute levels was -0.58 which is quite high with an inverse sign, indicating that the market does not like a declining rupee. At the incremental level, i.e. daily changes in both of them, the coefficient was -0.37.
In case of the rupee and the 10-year bond, it was as high as 0.70 at the absolute level and -0.07 at the incremental level. This shows that high rupee rates go hand-inhand with high bond yields. However, the exact changes in levels are not correlated. Last, higher bond yields are negatively correlated with sensex at 0.29 (for absolute levels) and 0.35 (for changes). At the second level, a causal relation could also be examined between these three sets of variables.
While such correlations do have somewhere an inbuilt assumption of causation, the causality tests do not support such a relation between any of these variables. This probably makes sense as bond yields are also driven mainly by liquidity conditions and regulatory conditions. The sensex reacts also to political actions and global developments.
Therefore, while there is a tendency to move in a pre-determined direction — the stock market does not quite like a weak rupee or high interest rates, which sounds logical, a weak rupee should go along with higher interest rates.
COST OF RUPEE DEPRECIATION
The second exercise can be in the direction of guessing as to what has been the cost of the rupee depreciation as there has been a sequential drop in the stock market and an increase in bond yields. The cost is notional as these numbers are at specific points of time and while the changes that have been mentioned earlier are in the same direction for this 3-month period, they exclude the peaks.
At the FY13 level of trade deficit of $190 billion, rupee depreciation means an additional cost of Rs 1.83 lakh crore.Interestingly, the FII withdrawal at this time means that not only were they moving out when the stock market went down but also the rupee depreciated. FIIs leaving today with May 20 as benchmark would have taken a loss of above 25% as the combined effect of rupee depreciation and stock market decline. Quite clearly, the perceived rewards from going back home on account of the US recovery are more attractive for these players.
In the bond market, the 10-year yield has moved up by close to 100 bps, though the increase has been higher at the lower end of the maturity spectrum. The government will be affected under ceteris paribus conditions. So far, it has completed Rs 2.6 lakh crore of the Rs4.84 lakh crore of borrowing. Therefore, the balance Rs 2.25 lakh crore could be at around 100 bps higher, which means an interest ofRs 2,250 crore.
The dealers in the secondary market will be affected adversely with the MTM losses and there are varying estimates of this being between Rs30-50,000 crore. Lending costs have gone up and 25 bps increase in base rates could mean an additional cost of Rs1,200 cr for the borrowing community assuming 14% growth in credit for the year and a balance of Rs4.8 lakh crore of borrowing to be undertaken during the rest of the year. Deposit holders could gain a little less than this as there is general stickiness in changing deposit rates.
Therefore, a slight increase in NII could be expected on this count. As everything appears to affect everything, we could alter Thomas Friedman's phraseology, and say that markets are flat. The external debt at $390 billion in March means that in future we will have to pay another Rs 3.76 lakh crore. At the same time the fall in the stock market can be captured by the movement in market capitalisation. During this period, there has been a fall of Rs 2.5 lakh crore — which may not at all be because of the exInterestingly, the FII withdrawal at this time means that not only were they moving out when the stock market went down but also the rupee depreciated. FIIs leaving today with May 20 as benchmark would have taken a loss of above 25% as the combined effect of rupee depreciation and stock market decline. Quite clearly, the perceived rewards from going back home on account of the US recovery are more attractive for these players.
In the bond market, the 10-year yield has moved up by close to 100 bps, though the increase has been higher at the lower end of the maturity spectrum. The government will be affected under ceteris paribus conditions. So far, it has completed Rs 2.6 lakh crore of the Rs4.84 lakh crore of borrowing. Therefore, the balance Rs 2.25 lakh crore could be at around 100 bps higher, which means an interest ofRs 2,250 crore.
The dealers in the secondary market will be affected adversely with the MTM losses and there are varying estimates of this being between Rs30-50,000 crore. Lending costs have gone up and 25 bps increase in base rates could mean an additional cost of Rs1,200 cr for the borrowing community assuming 14% growth in credit for the year and a balance of Rs4.8 lakh crore of borrowing to be undertaken during the rest of the year. Deposit holders could gain a little less than this as there is general stickiness in changing deposit rates.
Therefore, a slight increase in NII could be expected on this count. As everything appears to affect everything, we could alter Thomas Friedman's phraseology, and say that markets are flat.change rate.
In sympathy, this prompts the stock market to move down as these signals are interpreted perversely. Quiet clearly there is a basis for this theory which needs to be explored further.
The turning point in the rupee was May 20, when the rate crossed 55 a dollar. From then on till now, which is just a little over 3 months, there has been a lot of measures taken by authorities, some of which have worked more than others.
The objective here is to examine two sets of issues. The first relates to the linkage between the exchange rate, 10-year Gsec and stock market movements as denoted by the sensex. The other is a theoretical exercise which involves the notional cost that has been involved.
RUPEE & SENSEX
For the record, on a point-to-point basis up to August 22, the rupee (RBI reference rate) has fallen by 17.5%, the 10-year yield has gone up by around 90 bps and the Sensex has declined 9.5%. In terms of the linkage between the two, a rudimentary statistical exercise shows that the coefficient of correlation between the rupee and sensex at absolute levels was -0.58 which is quite high with an inverse sign, indicating that the market does not like a declining rupee. At the incremental level, i.e. daily changes in both of them, the coefficient was -0.37.
In case of the rupee and the 10-year bond, it was as high as 0.70 at the absolute level and -0.07 at the incremental level. This shows that high rupee rates go hand-inhand with high bond yields. However, the exact changes in levels are not correlated. Last, higher bond yields are negatively correlated with sensex at 0.29 (for absolute levels) and 0.35 (for changes). At the second level, a causal relation could also be examined between these three sets of variables.
While such correlations do have somewhere an inbuilt assumption of causation, the causality tests do not support such a relation between any of these variables. This probably makes sense as bond yields are also driven mainly by liquidity conditions and regulatory conditions. The sensex reacts also to political actions and global developments.
Therefore, while there is a tendency to move in a pre-determined direction — the stock market does not quite like a weak rupee or high interest rates, which sounds logical, a weak rupee should go along with higher interest rates.
COST OF RUPEE DEPRECIATION
The second exercise can be in the direction of guessing as to what has been the cost of the rupee depreciation as there has been a sequential drop in the stock market and an increase in bond yields. The cost is notional as these numbers are at specific points of time and while the changes that have been mentioned earlier are in the same direction for this 3-month period, they exclude the peaks.
At the FY13 level of trade deficit of $190 billion, rupee depreciation means an additional cost of Rs 1.83 lakh crore.Interestingly, the FII withdrawal at this time means that not only were they moving out when the stock market went down but also the rupee depreciated. FIIs leaving today with May 20 as benchmark would have taken a loss of above 25% as the combined effect of rupee depreciation and stock market decline. Quite clearly, the perceived rewards from going back home on account of the US recovery are more attractive for these players.
In the bond market, the 10-year yield has moved up by close to 100 bps, though the increase has been higher at the lower end of the maturity spectrum. The government will be affected under ceteris paribus conditions. So far, it has completed Rs 2.6 lakh crore of the Rs4.84 lakh crore of borrowing. Therefore, the balance Rs 2.25 lakh crore could be at around 100 bps higher, which means an interest ofRs 2,250 crore.
The dealers in the secondary market will be affected adversely with the MTM losses and there are varying estimates of this being between Rs30-50,000 crore. Lending costs have gone up and 25 bps increase in base rates could mean an additional cost of Rs1,200 cr for the borrowing community assuming 14% growth in credit for the year and a balance of Rs4.8 lakh crore of borrowing to be undertaken during the rest of the year. Deposit holders could gain a little less than this as there is general stickiness in changing deposit rates.
Therefore, a slight increase in NII could be expected on this count. As everything appears to affect everything, we could alter Thomas Friedman's phraseology, and say that markets are flat. The external debt at $390 billion in March means that in future we will have to pay another Rs 3.76 lakh crore. At the same time the fall in the stock market can be captured by the movement in market capitalisation. During this period, there has been a fall of Rs 2.5 lakh crore — which may not at all be because of the exInterestingly, the FII withdrawal at this time means that not only were they moving out when the stock market went down but also the rupee depreciated. FIIs leaving today with May 20 as benchmark would have taken a loss of above 25% as the combined effect of rupee depreciation and stock market decline. Quite clearly, the perceived rewards from going back home on account of the US recovery are more attractive for these players.
In the bond market, the 10-year yield has moved up by close to 100 bps, though the increase has been higher at the lower end of the maturity spectrum. The government will be affected under ceteris paribus conditions. So far, it has completed Rs 2.6 lakh crore of the Rs4.84 lakh crore of borrowing. Therefore, the balance Rs 2.25 lakh crore could be at around 100 bps higher, which means an interest ofRs 2,250 crore.
The dealers in the secondary market will be affected adversely with the MTM losses and there are varying estimates of this being between Rs30-50,000 crore. Lending costs have gone up and 25 bps increase in base rates could mean an additional cost of Rs1,200 cr for the borrowing community assuming 14% growth in credit for the year and a balance of Rs4.8 lakh crore of borrowing to be undertaken during the rest of the year. Deposit holders could gain a little less than this as there is general stickiness in changing deposit rates.
Therefore, a slight increase in NII could be expected on this count. As everything appears to affect everything, we could alter Thomas Friedman's phraseology, and say that markets are flat.change rate.
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