Rupee depreciation stymies dollex returns

Foreign Institutional Investors (FIIs) who have invested in the Indian equity markets would have been hit by a double-whammy this calendar. Akin to other investors, their portfolios too have suffered from the steep fall on the bourses (the Sensex is down 23.5 per cent since January). Compounding their woes would also be the sharp depreciation in the rupee (down 16.9 per cent against the dollar this year). This would have further eroded their returns in dollar terms. Net result: The 34.5 per cent fall in the Dollex 30 (the dollar-linked version of the Sensex) so far in 2011 is much steeper than the dip in the Sensex. Likewise, while the BSE 100 has fallen 23.6 per cent this calendar, the Dollex 100 has dipped by a higher 34.6 per cent.

Self-feeding cycle

While market movements affect investors across the board, those who bring in foreign currency to invest in India also have to deal with the vagaries of foreign exchange fluctuations. A strengthening rupee aids their cause while a weakening rupee negatively impacts the return (in foreign currency terms) they make on their investments. Let's consider an example: Assume a FII invested $100 in the Sensex in the beginning of January 2011. With the rupee then trading at 44.7 to a US dollar, the original investment in Rupee terms would have been Rs 4,470. With the Sensex falling 23.5 per cent since then, the Rupee value of the investment currently would be Rs 3,420. Had the INR continued trading at 44.7 levels, the FII could have realised $76.5 on conversion. However, with the rupee falling sharply and currently trading at 52.25, the FII will be able to realise only $65.45 on conversion. The sharp fall in their portfolio value could prompt some FIIs to sell their holdings, and draw out their dollars. This could lead to more weakness in the rupee, which in turn further erodes returns in dollar terms — a self-feeding cycle.

Déjà-vu

The situation at present is reminiscent of 2008 when the precipitous fall in the market (the Sensex was down more than 50 per cent) and the sharp fall in the rupee (down almost 24 per cent against the dollar) led to the decline in the Dollex 30 (around 61 per cent) being much sharper than the fall in the Sensex. Also, the Dollex 100 registered a 64 per cent fall that year, compared with the 55 per cent dip in the BSE 100.

For most of the last decade (in seven out of 11 years since 2000), the Dollex has done better than the Sensex, thanks to the rupee appreciating against the dollar. This was especially pronounced in 2007 when the Dollex 30 gained more than 65 per cent due to a sharp rise in the Sensex (47 per cent) and the steep appreciation (up 11 per cent) of the rupee vis-à-vis the dollar. Yet, given that the rupee today trades close to its all-time lows (around Rs 52 per dollar), the compounded annual return of around 15 per cent on the Dollex 30 since inception (July 2001) is lower than that on the Sensex (around 16 per cent).

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