Tenuous link between currency and stock markets?

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Linking currency depreciation to stock market fall in emerging markets is like asking the proverbial question: What came first - the chicken or the egg?

While the Indian rupee and the stock markets are down this year because of high current account deficit; the Shanghai benchmark index has seen a much sharper fall, even as the country has a current account surplus; and the Chinese renminbi has appreciated. In case of Russia, however, both its currency and the stock market are down, despite the country running one of the largest current account surpluses among the emerging markets.

In a majority of the emerging markets, currency depreciation has led to a fall in the stock market, but the correlation between the two vary greatly. The rupee, for instance, has been the second-worst performing currency among the seven key ones, but the BSE Sensex has done better than all but its two peers. This indicates at best a tenuous link between the currency and the stock market. Only in three countries - Brazil, Russia and Turkey - the correlation between the movement in the currency and the stock market seems high.

Analysts blame the countrywide divergence on global risk aversion. The fear of monetary tightening by US Federal Reserve, coupled with real positive interest rates in the US (adjusted for inflation) resulted in capital flight from riskier emerging countries to the developed market, regardless of their macroeconomic fundamentals. A run to safe havens of North America and Europe has been facilitated by a sharp fall in the economic growth in emerging markets and the underlying corporate earnings.