Currency is a double-edged sword for emerging markets (EMs). A stable currency helps global fund managers place a higher weight on EM investments compared with the respective benchmark indices. A volatile currency on the other hand may trigger redemption pressure since a weaker local currency reduces the dollar-denominated returns of investment portfolios. The assumption of a stable currency reduces the cost of equity ascribed to compute fair value of a stock while rising volatility lowers the fair value and compresses the dollar returns.
At present, Indian equities are facing the consequence of the latter scenario after the volatility of Indian rupee has reached 7.2 per cent, the highest in three years. It is 56 per cent higher than the threeyear average. The three-month implied volatility of the rupee rose by 46 per cent in the past two months compared with that of 13 per cent, 25 per cent and 5.4 per cent for Brazil, South Africa and Russia respectively, according to Bloomberg data.
The rising volatility in the rupee will have more impact on the stocks where foreign portfolio investors (FPIs) have increased their holding significantly in the past five years due to significant returns. There are 28 companies in the BSE 500 index where FPIs have raised their stakes by more than 10 per cent. These stocks have delivered more than 25 per cent annual dollar returns over the past five years.
The prominent companies in this sample are Indiabulls Ventures, Avanti Feeds, Navin Fluorine International, TVS Motor, Bajaj Finance and Eveready Industries, according to Capitaline and Bloomberg data. For instance, in Indiabulls Ventures and Avanti Feeds, 100 and 91 FPIs have invested respectively, according to the BSE. Indiabulls Ventures has lost 42 per cent and Avanti Feeds lost 13 per cent on bourses within a month.
