Sunday, February 10, 2013

Which school of thought should an investor subscribe to? Which parameter would be the most reliable indicator of how your stocks are likely to perform? We came across an interesting article in the Business Line that drew a link between the direction of the rupee and corporate profits. The financial daily carried out an analysis of quarterly profits of the 1,300 NSE-listed companies for the last five years. The analysis suggested a nearly one-to-one correlation between the direction of the Indian rupee and the trends in corporate profits. In other words, when the rupee falls, corporate profits tend to dip.

Of course, there are several other factors such as interest rates, commodity prices, demand-supply dynamics, etc that affect corporate profitability. But the fact remains that the rupee's movement has a substantial impact on the corporate sector as well as the Indian economy at large. The main reason for this is that India is still heavily dependent on imports compared to several other major economies.

A weak rupee increases the fiscal deficit because of higher subsidies. It widens the current account deficit by inflating the import bill. It leads to higher inflation and impacts savings and investments. This shows how vulnerable our economy is to the rupee-dollar exchange rate.
This correlation could prompt some investors to think that the best way to know where the markets are headed would be to get the direction of the rupee right. If the rupee is set for a sustained appreciation, then dive into stocks right now. Or else, exercise caution.

This theory seems appealing, isn't it? But is it practically possible to guess where the rupee is headed? The answer is no. The fate of our currency is intricately linked to hordes of domestic and global factors. Guessing the direction of the rupee would mean reading the minds of central bankers and policymakers across the world. Moreover, it is important to note that since December 1990, the dollar has appreciated by over 200% against the rupee. Despite this, the BSE-Sensex has managed to shoot up by about 1,850% during the same period.

This leads us to conclude that trying to outguess the rupee's movement would be an effort in the wrong direction. On the contrary, investors must look for great businesses with solid moats that have flourished despite all the problems and hurdles that India faces, including a weak currency.