Chinese Yuan, INR and Indian Stock Market
The Indian equities in the last few months are witnessing a sharp cut in their value. Someone who is observing the index is not likely realised this as at index level the fall is contained, especially large cap indices. The broader markets are down by little more than 15 per cent, however, at an individual stock level, the falls are nasty. On daily basis, more and more stocks are touching their 52-week low on a daily basis. More than 100 stocks in BSE touched their 52-week low on July 2 in the first one hour of trading.
The reason for such fall has more to do with the international factors. Trump administration is high on its protectionist measures, especially against China with whom they have a huge trade deficit. This has provoked China to let its currency depreciate against the US$, which is accentuated by the rising US interest rates. The impact of this is that both currencies and stocks of China are set for their worst quarter fall since September 2015. China may be using a weakened yuan as a weapon against US trade restriction.
The problem is that the fall we’re seeing in the yuan has reverberated across the rest of emerging markets including India, given the size of the Chinese economy as well as the economic and financial linkages across the region. This fall can turn into a vicious cycle where sell-off in stocks and currency could spark a bout of capital outflows, which again will lead to more sell-offs in stocks. This may create a ‘financial panic’, according to a leaked report from a Chinese government-backed think tank.
This is not the first time that we are going through this situation, earlier in the year 2015, we went through the similar situation. The fall in yuan led to a fall in the currency of emerging markets including rupee, which ultimately led to a fall in the stock market. The graph below shows the relationship between Indian rupee against US dollar and Sensex. This clearly shows as the value of rupee drops against US dollar, stock market represented by Sensex also drops, though at a slower pace.
Going one step further we checked the statistical significance of this relation. There is a high correlation between Sensex movement and USD vs INR movement. For one year between FY15 and FY16 they moved in tandem at 94% of the time. Nonetheless, if we take correlation between their everyday returns the correlation drops to 0.45, which means only 45% of the time they moved in tandem.
We dig further to understand the relation between them and tested if fall in the value of INR triggers fall in the Sensex or fall in the Sensex causes fall in value INR. We found that although there is a high correlation between both the variables, fall in the value of INR does not directly causes fall in Sensex. On the contrary, depending upon the constituents of Sensex (if the weight of the companies such as Pharma and IT that derive major revenue in USD), fall may help Sensex to gain.
Therefore, though fall in the external value of INR and fall in Sensex coincide, they do not cause fall of each other directly. There may be factors that get triggered due to fall in rupee or which causes fall in the Sensex.