Will rupee slide speed up FII selling of Indian shares?

Santosh Nair, Riken Mehta

Finance minister P Chidambaram Thursday tried to pacify jittery markets, saying foreign capital flows were strong enough to bridge the current account deficit. But will the flows sustain going forward?

Theoretically, a weak rupee provokes foreign funds into selling Indian equities, as it would lower their portfolio value, if the stocks have not been performing.

Assume a foreign fund buys one share of a company for Rs 52 when the rupee was 52 to the dollar. If the stock price remains constant, and the rupee depreciates to 57 to the dollar, the value of the portfolio is now less than 1 dollar. But if the stock had risen to Rs 62, the foreign fund would not be worried, since the appreciation could more than cover up for the weakness in the rupee.

India is among the emerging market countries which have gained from the low interest rate policies of the US Federal Reserve and the European Central Bank. Generous dollops of liquidity resulting from those policies found their way into Indian shares, keeping share prices higher even during periods of weakness in the rupee.

But now market is not so sure if the liquidity flows will sustain, as there are doubts that the Fed may now start cutting back on its monetary stimulus.

Since the big sell off in global markets a couple of weeks back on these concerns, foreign fund flows into India have slowed.

And there is bad news on the debt front as well. FIIs have net sold close to Rs 4000 crore of Indian debt as bond yields are softening in anticipation of a decline in interest rates.

If capital flows slow down at this stage, this could trigger a vicious cycle of weakening rupee and foreign fund outflows.

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