In an apt description, the head of treasury in a leading financial institution described the rupee as a runaway train, with no engineer or mechanical device to halt it. The rupee was under pressure throughout last week. The extent of its decline over successive days, even over trading sessions, has been unprecedented.

Its lowest point was on Wednesday last. The rupee fell to yet another all time low of 68.75, the biggest one day fall in 20 years. Another big psychological mark of 70 appeared to be ominously close. The decline in the rupee on Wednesday was matched by a fall in the stock prices. The latter, however, recovered towards the close.

Moving in unison

While, on most occasions, the stock markets and the rupee have invariably moved down in unison, the recovery in stock prices even when the rupee remained weighed down is a recent development. It probably gives hope that the markets are able to discern the different factors that pull down the rupee and the stock prices. It is a tantalising thought but are some foreign investors buying Indian stocks even while a majority of them are seen deserting the domestic bourses? Much of the recent analyses has centred on the reverse movement of short-term capital flows to the U.S. and other developed markets in the wake of a possible ‘tapering off’ of quantitative easing by the Federal Reserve. As returns from the developed markets improve, the incentive to stay invested in big emerging markets such as India vanishes.

The pull out by foreign institutional investors — selling Indian stocks and repatriating proceeds in dollars — has hit the financial markets hard through lower stock prices and lower rupee.

It would, however, be hard to break the nexus between the rupee and the stock prices any time soon.

Meanwhile, the negative impact of the phase out of U.S. monetary policy has been spectacularly felt in almost all emerging markets. Currencies of Brazil, Indonesia, Russia, Turkey and South Africa are witnessing extreme volatility.

Fears over possible military action by the U.S. in Syria have further aggravated concerns over the stability of currencies.

On Tuesday last, the Indonesian rupiah hit a four-year low on corporate dollar demand. The Malaysian ringgit fell to its lowest in three years. Thailand and the Philippines have also seen their domestic currencies fall sharply in tandem with their stock prices.

But India was the worst affected, probably due to its higher dependence on foreign flows.

The reasons

Very importantly, India’s macroeconomic woes — its twin deficits (current account deficit and fiscal deficit) — were in focus.

There is the usual month-end demand for dollars from the real economy such as for oil payments. The swap arrangements put in place by the Reserve Bank of India on Thursday have helped in changing the sentiment. The rupee gained by more than 200 paise, and the stock markets staged one of their biggest one-day rallies. Yet, their closing levels, significantly better than on Wednesday, give no room for complacency.

The passage of the Food Security Bill raised concerns over the ability and willingness of the government to consolidate the fisc. In fact, the sensational drop in the rupee on Tuesday was attributed to the Food Security Bill alone. But on more considered opinion those fears are seen to be exaggerated. After all, the Bill has been in the works for more than a year and budgeted for. Its full financial implications will be felt only over the long-term. Petroleum under-recoveries, lack of traction in disinvestment/spectrum sale and question marks of revenue projections are the bigger reasons for the fiscal drag.

It is appropriate that the Prime Minister in a special address on Friday stressed on fiscal consolidation and continuation of reforms.

The unprecedented decline in the rupee is due to domestic and global factors. It ought to be viewed as one of those short-term tasks, which is a consequence of the globalisation process. He ruled out capital control and reversal of reforms.

The Prime Minister’s speech did nothing to anchor expectations which are clearly unhinged. But the RBI measures to insulate dollar purchases by oil companies have made an impact at least temporarily with the rupee closing at 65.69 on Friday. Whether this is going to endure remains to be seen.

narasimhan.crl@thehindu.co.in