Rupee slide to weaken equity return; IT and pharma stocks look good

The broader market doesn't like a weak rupee. Historically, stock market returns have been poor in the year when the Indian currency has depreciated against the dollar and vice versa.

The rupee is down 7.1 per cent against the dollar since January and the benchmark BSE Sensex index is up only 2.8 per cent during the period, sharply down from the 17 per cent rise in the same period last year. The rupee had risen 5.3 per cent during the first six months of calendar year 2017.

Ten of the 14 major sectoral indices are in the red so far this year. In comparison, all sectoral indices were in the green last year, with the BSE Realty and BSE Consumer Durable indices leading the charts with 106 per cent and 102 per cent return, respectively. Health care and information technology (IT) were the worst performers and had grossly underperformed the broader market in 2017 (see chart).

Stocks in export-oriented sectors such as IT services and health care, however, react positively to currency depreciation. The BSE IT index is up 22.2 per cent during the year so far, the best in six years. That index was a gross underperformer in 2017, up 10.8 per cent against a 28 per cent rally in the Sensex. The rupee was up 6.3 per cent against the dollar last year. IT stocks together account for 17.5 per cent of the Sensex's market capitalisation.

Beside favourable news from the US drug regulator, the FDA, the rupee's recent weakness has also pushed up health care stocks, at the bottom of the market in the past three years. The BSE Healthcare index has been top performer in the past month and is up seven per cent against a stagnant market during the period. The health care index is, however, still down on a year-to-date basis.

This is a repeat of 2013, when there was a sharp depreciation in the rupee due to monetary tapering by the US Federal Reserve. IT (up 56 per cent) and health care stocks (up 22 per cent) were the top performers that year. While domestic market-focused sectors such as financials, consumer goods, automobiles, energy, consumer durables, metals, capital goods and realty either ended in the red or grossly underperformed the benchmark index that year.

Analysts attribute this to net dollar revenue (export revenue) of export-focused companies. “A depreciation translates into higher revenue and profit in rupee terms for net exporters. This explains investors’ current preference for IT and pharma stocks,” says Dhananjay Sinha, head of research at Emkay Global Financial Services.

In the listed space, IT and pharma companies are the biggest net exporters. Followed by agrochemical companies, automobile component, textile and garment makers. The latter group of companies are, however, relatively smaller and do not have representation in the index.

Corporate India, however, remains a net importer at the aggregate level and this explains why the broader market reacts negatively to currency depreciation.

Some experts, however, caution against using the 2013 template in trying to find winners and losers in the current market. “Currency depreciation in 2013 benefited net exporters but I don't see gains this time, as India has lost cost competitiveness in many sectors over recent years. Volume growth in the IT industry is now in single digits, textile exports are shrinking and pharma exports to the US are languishing, despite weakness in the rupee,” says G Chokkalingam, managing director at Equinomics Research & Advisory Services.