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BL Research Bureau

When stocks rise, bonds normally fall (yields rise) and when stocks fall, bonds rise (yields fall).This is a typical market scenario.

Where foreign investments are permitted in a country’s financial markets, there is the currency market angle also to be considered.

The co-movement of the Indian rupee with the Sensex on Friday’s trading, as the accompanying chart shows, was an instance of a local currency responding to stock market flows.

The Indian rupee appears to be facing downward pressure in the face of a generalised withdrawal of capital from stock markets globally.

The local currency usually goes up when the (foreign) capital inflow environment is strong.

Equity valuations get a boost and bond valuations may be under some strain if the appreciating stock markets draw in more investments.

Bonds could still be supported in that scenario if some foreign capital also flows into that market.

When foreign capital withdraws from the domestic markets, the local currency need not necessarily fall.

For instance, a withdrawal from the stock markets could be compensated, at least to some extent, by a flow into the bond markets.

The currency market, in that scenario, could be broadly stable.

But where the stock market is the only meaningful investment avenue available for foreign investors, a withdrawal from it necessarily translates into downward pressure on the local currency as capital is repatriated out of the country.

The rupee opened on Friday with a gap of around 35 paise from Thursday’s close at 41.35 against the dollar.

Asian stock indices led by the Japanese Nikkei had fallen quite heavily earlier in the day and the Indian currency market was, therefore, positioning itself for the local stock markets continuing their fall (with the consequent repatriation demand for dollars).

True to expectations, the stock market fell quite heavily in the early part of the day and the rupee continued to remain weak around 41.65 levels till mid-day.

But as stocks recovered somewhat during the latter part of the trading day (closing around 200 points lower from the previous close against a low of 600 points less during the day), the impact was felt on the rupee too.

The local currency erased some of its earlier losses to close around 41.40 for the day.

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