Have you come across reports telling how the value of the Rupee is depreciating against the dollar? Did you think this spelled doom for the Indian stock market just because of how the word ‘depreciation’ feels?
You might want to think again.
Yes, any currency depreciation leads to a reduced value of the currency, but it is what major IT companies rely on to make additional profits, resulting in a bullish market.
Read on to know how!
Decoding appreciation and depreciation of the Rupee
Depreciation of currency refers to a fall in the currency’s value in a floating exchange rate system where demand and supply determine the value of a currency.
Hence, rupee depreciation is the fall in the value of the Rupee against the dollar, implying that the Rupee has become less valuable and weaker against the dollar.
Example: If the value of 1 U.S dollar increases from Rs 70 to Rs 75, the change will be termed depreciation of the Rupee.
On the contrary, appreciation of currency refers to an increase in the value of the currency. Hence, Rupee appreciation will imply the strengthening of the Rupee against the dollar.
Example: If the value of 1 U.S dollar decreases from Rs 75 to Rs 70, the change will be termed an appreciation of the Rupee.
The import-export business, pharma, and IT sector are susceptible to changes in the forex rates and have enormous stakes in the Indian stock market.
Let’s understand how Rupee fluctuation affects these sectors and how it impacts the stock market on the whole.
Impact when Rupee appreciates
No doubt, appreciation of the Rupee against other currencies boost the economy. On the flip side, it can translate into a slump in the stock market.
Let’s understand how this happens with an example.
When Rupee appreciates, the primary sectors that take the most blow are IT and Exports. When the Rupee is trending higher against the dollar, IT firms are severely hit since most of their revenue is accounted for by exports.
With the appreciation of the Rupee, exports become more expensive and less profitable for the domestic exporter since they end up earning less Rupees when exchanging the dollar. Of course, the actual cost may remain the same for the buyer (the foreign receiver), but Indian accounts would reflect a lower cash balance due to the currency difference.
Therefore, companies relying majorly on exports (IT, pharma, gems & jewellery, petroleum products) will be hit by Rupee appreciation or over-valuation. This may convert into a dip in their share prices at the stock market.
It is important to note at this juncture that an effect on entire sectors may drag market movement, albeit momentarily. Therefore, when the IT stocks witness a downward trend due to Rupee appreciation, it may have a domino effect on the overall stock market since the IT sector accounts for a significant chunk of the leading market indices. To put this in perspective, the IT sector has an 18% weightage in the Nifty as of 31 August 2021.
Impact when Rupee depreciates
Most people associate depreciation of the Rupee with economic distress. While it may be partly true, you may see the stock market in green with reports of the Rupee depreciating.
Intrigued? Let’s understand how this works.
Companies importing commodities like oil & gas, food & beverages suffer the most out of Rupee depreciation. This happens as the value of the Rupee dips against the US Dollar, and imports become more expensive. Therefore, companies importing raw materials, capital-intensive sectors, and foreign borrowings will be hurt the most. This will directly translate into the stock prices of such companies tanking at the market.
On the other hand, companies relying on exports (as discussed above) will benefit the most from Rupee depreciation since exporting goods becomes lucrative.
As a result, the IT and the pharma sectors will lead the stock market with a bullish trend.
Nevertheless, it is essential to note that depreciation can affect the market sentiment since it leads to a reduction in foreign investment. When the Rupee starts to weaken, foreign investors tend to pull their investments out, which can have an adverse reaction in the stock market.
The currency exchange rate movements across the globe are small and gradual. As we saw, the fluctuation in exchange rates immediately affects the stock market; but it gets balanced out without having a mammoth impact on the stock market unless there is an impending long-drawn-out recession in the making.