Weak rupee makes stocks lose strength

Sensex falls 2.34% but the currency recovers on RBI intervention after touching a new intra-day low

Stocks crashed on Tuesday as a drop in the rupee to record lows raised worries the Reserve Bank of India (RBI) might introduce more measures to tighten liquidity. Investors were concerned more steps to withdraw cash from the system might hurt economic growth further, while the current account deficit (CAD) would continue to drag down the rupee.

The rupee, which hit a low of 61.81 against the dollar in early trade on Tuesday, staged a sharp recovery later in the day after RBI intervened in the market by selling dollars. The rebound also coincided with the government announcing Raghuram Rajan was succeeding D Subbarao as RBI’s governor. The announcement was made after stock trading hours.

The rupee ended the day at 60.81 a dollar, compared with its previous close of 60.88. Currency analysts said the Indian currency fell earlier in the day as the central bank’s effort to squeeze liquidity failed to yield desired results, with the high government spending ensuring funds in the banking system.

The BSE Sensex fell 449.22 points, or 2.34 per cent from last close, to 18,733. The NSE’s Nifty dropped 143.15 points, or 2.52 per cent from its previous close, to end the day at 5,542.25. Bank shares led the indices’ decline on worries a tighter monetary policy would lead to an increase in non-performing assets. The banking index slumped 3.9 per cent.

“Investors are focusing on high CAD, the real issue dragging down the rupee. The liquidity-tightening measures are just a temporary solution to keep rupee higher,” said Anand Shah, chief investment officer, BNP Paribas Mutual Fund. “Till the government announces concrete measures to boost manufacturing and reduce imports, the markets will be worried about higher CAD and the stability of the rupee,” he said.

A poll of 10 currency experts by Business Standard showed the rupee was expected to trade at 62.45 a dollar by the end of this month.

NSE’s Volatility Index, a measure of traders’ expectations of near-term market risks based on Nifty options prices, rose 9.28 per cent to 22.73 — the highest level in a year.

“Investors will find comfort if they see the government intends to solve issues like CAD, rather than just postpone it. Else, they will continue to remain sceptical and the rupee’s slide will continue,” said Ritesh Jain, chief investment officer, Tata Mutual Fund.

RBI might take further steps, including an increase in the cash reserve ratio, albeit temporary, to choke liquidity, said analysts. Banks’ borrowing from the marginal standing facility — the rate for which was on July 15 raised 200 bps to 10.25 per cent to make the rupee costlier — came down sharply to about Rs 5,000 crore on Monday, from a high of Rs 26,000 crore a week ago. Overnight rates also fell below the double-digit mark.

The ongoing shift in monetary policy to stabilize the rupee may be similar to the situation in 1997-98 amid the Asian financial crisis, said Edelweiss Securities. The rate tightening by Reserve Bank of India then helped currency stabilize, but there was some collateral damage with industrial activity slowing and banks’ bad loans increasing, it said. Edelweiss said attracting fresh flows through bond issuances would be better than monetary tightening in these times.