The rupee hit a series of record lows in August, rattling the stock market and forcing policymakers to step in. But the fall was necessary to correct India’s past mistakes and improve the dynamics of the economy. Stock markets were jolted because the rupee’s slide was sudden. But then that is how markets behave.
International markets, be it for currencies or commodities, are sensitive and therefore volatile due to underlying speculation that is difficult to control. Eventually, however, a stable point is reached at which point they settle down.
It was principally the currencies of emerging market economies that weakened. The declared intention of the U.S. Federal Reserve to taper quantitative easing (QE) created a scare that dollars would be in short supply. Most currencies in Asia, for instance, depreciated except the Philippine peso. The depreciation of currencies varied depending on the country’s internal strength and weakness.
The Brazilian real was the hardest hit with a drop of more than 16 percent in three months. The rupee was a close second, followed by the Indonesian rupiah. These currencies were already under some stress. Inflation was high in Brazil and India. Growth had dropped significantly. Investment, both domestic and foreign, had also slowed.
The currency fall had its repercussions. The repatriation of dollars by FIIs entails the sale of stocks and bonds. When the rupee fell to 65, the Sensex lost 2,000 points and the 10-year government bond yield jumped to over 9 percent.
It was always known that quantitative easing wasn’t going to be there forever. The Federal Reserve had indicated its discontinuation when U.S. unemployment was down to 7 percent. When the tapering does happen, world currencies will have to readjust. The fall in currencies and the drop in stock and bond prices are required adjustments that the markets have anticipated for different countries.
There might be some indication of QE tapering at the Fed’s next meeting on Sept. 17 and 18. That is when the markets for currencies, stocks and bonds will be able to reassess the likely impact and discover a relatively stable currency matrix.
So far, the market reaction was overdone. It is possible that there will be some correction in the weeks ahead. Already, the fall of the rupee, the Sensex and bond yields has been reversed to some extent. But this could be a flash in the pan.
The markets are rebalancing. A more realistic appraisal will come in September after the Federal Reserve meeting. That is when the rupee, the Sensex and bond yields will reach some stability. Still, the political uncertainty due to the upcoming elections in India will persist in the coming months and keep markets volatile.
Source : Reuters