How closely are the rupee and stock market movements correlated? – Economic Times

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Since the start of 2017, both the Sensex and the rupee have gone from strength to strength.

While the Sensex has shot up by about 18%, the rupee has appreciated by about 6% in the past five months. Does this mean one can predict the future movement of the Sensex based on the trajectory of the rupee and vice-versa.

Well, yes. The data of the past 10 years shows that both the Sensex and the rupee movements share a strong positive correlation: When markets go up, the rupee appreciates, and vice-versa. There is a correlation of 0.44 between the two. It means, 44% of the movements in the Sensex in the past 10 years can be linked with the movements in the rupee and vice versa.

“The correlation is positive, which means a rise in the index usually accompanies appreciation of the rupee and vice versa,” says Anupam Singhi, Chief Operating Officer, William O’Neil India, a markets research firm.

The Sensex and rupee follow a similar trend
Barring the period 2012-2014, the rupee has risen and fallen with the market—though not by the same degree

How closely are the rupee and stock market movements correlated?
Source: MarketSmith India

Why a positive correlation
The Sensex and the rupee are directly and indirectly affected by several similar factors, including the outlook for the Indian economy, governance, trade deficit/surplus, foreign institutional investors’ (FII) inflows and outflows, forex reserves, monetary policies undertaken by governments across the globe, among others.

Among the various factors, say experts, the primary one behind the positive correlation between the rupee and the Sensex is FII flows. As a direct consequence of FIIs pouring in money, the market rises. Since FIIs need the Indian currency to invest in the Indian market, the demand for the rupee goes up, in turn, boosting the currency. A stronger market leads to a better outlook for the rupee leading to further inflows and thus to the rupee’s appreciation.

This is a mutually beneficial, positive cycle. But the reverse too is very much a possibility. For instance, in bad years, when there are FII outflows, the markets go down and the rupee depreciates.What is noteworthy is that in either of the cycles, the rupee and the market move in a similar direction.

FII inflows strengthen the rupee and the market
When FIIs pour in money, the market rises and so does the demand for the rupee, appreciating the currency.

How closely are the rupee and stock market movements correlated?
Source: MarketSmith India

A temporary disconnect
Sometimes, there could be a temporary disconnect between the Sensex and the rupee movements. For instance, during 2012 to 2014, markets were rising, but the rupee saw a decline. This was mainly because of some temporary, albeit strong factors, influencing the currency. These included global geopolitical developments, local political issues, rise in crude oil prices, lack of adequate rains and its impact on growth and inflation, etc. But, even so, during this period, the Sensex and the rupee had a positive correlation of 0.47.

A strong performance in 2017
So far, in 2017, both the Sensex and the rupee have seen a strong performance. Experts point out that US President Donald Trump’s policies have led to a weakening of the US dollar and a relative appreciation in the rupee. The BJP’s landslide victory in the latest Assembly elections, boosting its chances of retaining power in 2019 in the Centre, have also boosted FII investments and the stock market

What to expect
“While the Sensex currently seems overbought, it could rise a little and turn back, the rupee could also move in tandem,” says Deepak Jasani, Head, Retail Research, HDFC Securities. The correlation between the two will likely increase in the years to come, say experts. “After a period of appreciation, the rupee may start to fall in line with the Sensex,” says Jasani. Singhi concurs: “With the greater financialisation of the economy and an increased number of market participants, we believe the Sensex will go on to represent the overall economy a lot better than previously, with greater correlation with the rupee.”