Investor, mind the rupee

In recent times, rupee volatility has played an important role in defining portfolio returns.

Historically, the rupee has depreciated against the dollar to the tune of about 5 per cent a year, which is broadly the inflation and the interest rate difference between India and the US.

This rule was followed but for the brief period between 2003 and 2008, when the rupee actually strengthened against the dollar. This period saw huge amount of portfolio inflows into the country, although the core fundamental macroeconomic reasons remained more or less unchanged.

However, this was followed by a period of sharp depreciation of the rupee against the dollar. Currency experts and forex watchers have a consensus view that the rupee will depreciate 5-10 per cent against the dollar depending upon their own matrix and research.

In the last two years, FIIs have pumped in $58 billion into the country and they have a strong role to play in the way any portfolio performs.

Indian market returns have the highest correlation to FII equity flows, compared to other emerging markets since March 2005. According to a recent study by India Infoline, in the five years since January 2008, the Sensex has scaled the peak of 21,000 but if the index is adjusted only for the top 15 stocks with highest FII holding, then the Sensex should be close to 42,000 levels. If you take an index adjusted for the top 15 stocks with least FII holding, then the Sensex would have been close to 17,000 levels.

This clearly shows that anything which has the FII blessings tends to outperform by a huge margin. Investors should be cognizant of the reverse, too. When FIIs decide to sell their holdings, these stocks could be hit.

Volatility impact Having said that, the investors have to keep two factors in mind while constructing their portfolio; a) how the rupee volatility impacts the core earnings of the investor, and b) the broad impact of the portfolio inflows as the rupee moves. Any significant rupee depreciation will affect stock returns. For example, if the portfolio investment was made when the rupee was 40 to a dollar and the rupee moves to 60 to a dollar, then even if the underlying stock has done well, most of the gains will be offset by currency losses.

We believe India has reached a stage where the rupee will depreciate against the dollar in the medium term. The reasons are inflation, interest-rate differential and macroeconomic situation.

Companies

The rupee volatility can impact companies in three ways; a) Income, if earnings are in forex b) Costs, if they import, c) Interest costs if they raise foreign debt. In a situation, sectors that generate income from exports are the natural beneficiaries. IT, pharma and textiles top the list here.

Companies which have import component could get affected whenever the rupee depreciates unless they are naturally hedged by an almost equal amount of export earnings.

Our recommendation to investors is to have a portfolio of debt, IT and pharma stocks to play the rupee because they are natural beneficiaries. Our top recommendations are Sun Pharma, Infosys, Wipro, TCS and HCL Tech.

The writer is MD of India Infoline CM

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