 "Forget currency, FCNR redemption will test the equity markets the most")
In 2013, when Rajan had just taken charge of the central bank, he was faced with the daunting task of reigning in the rupee which was within sniffing distance of the 70 mark against the US dollar. Rajan introduced a product – the Foreign Currency Non-Resident (Banks), or FCNR, deposits – which allowed no-resident Indians to park dollars in India for a fixed tenure of three years. The three year lock-in period will expire between September and November 2016.
The impact on the withdrawal of these investments on currency market is well documented, with analysts at Kotak Securities saying that rupee could pierce the 70 mark against the dollar and the banking system could face a dollar shortage.
Though all eyes are on the currency markets, the impact on equity markets too can be severe if the rupee touches the 70 mark. Previous occasions when the rupee was close to the 70 mark led to an outflow of money from the equity and debt markets in India.
In 2013, the rupee started weakening from June 2013 to August 2013 when it pierced the 57.3 mark against the dollar and moved higher till 68.80. During this period, FIIs (foreign institutional investors) sold shares worth Rs 9,318.70 crore in June 2013, Rs 7,120.20 crore in July 2013 and Rs 6,200 crore in August 2013. Debt segment also saw selling with an outflow of Rs 31.583.80 crore, Rs 12,409.50 crore and Rs 8,658.90 crore respectively. As a result of this outflow, the BSE Sensex fell from a high of around 20,400 to a low of 17,448.
A weak currency has an impact on the returns of foreign investors. During the period of these three turbulent months while the BSE Sensex fell by almost 14.5%, the impact of Sensex in dollar terms was more severe. S&P BSE Dollex 30 which measures the same set of Sensex stocks in dollar terms fell from a high of 2,956 to 2,202 a drop of nearly 25%. FIIs would have lost one fourth of their wealth just by sitting around. Higher fall is on account of impact of both the markets – currency as well as equity. The impact on debt market is severe as volatility in currencies impacts returns in dollar terms.
Nearly 25% of foreign money coming in the equity market is through exchange traded funds (ETF), which many feel is hot money that can leave at a faster speed than at which it has come in. Added to that are hedge funds who are nimble in their trading and investing styles.
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If the rupee falls, as is expected by currency market experts, equity markets will not be far behind. Kotak Securities feels that is a global risk-off trade comes back, and then a dollar shortage due to the redemption may get amplified.
BJP’s Rajya Sabha MP Subramaniam Swamy, who has been critical of Rajan and his monetary policy, tweeted that Rajan had planted a time bomb in our financial system in 2013 that is timed for December 2016. Swamy was referring to the $20 billion redemption expected between September and November 2016.
How Rajan manages to cushion the impact of this redemption will decide the direction of the markets.