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Exchange rate and Stock marketsExchange rate and Stock markets

By:Sanjay Kumar

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HistoryHistory

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Early 1990s

Increase in trade deficit , led RBI to undertakedownward adjustment of Rupee in 2 stages

September 24, 1975Adjustable nominal peg to a basket of currencies of

major trading partners with a band

1950-1951 until mid-December 1973

Rupee linked to the Pound Sterling

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As of today

Exchange rate are market determined but RBIsometimes intervene to keep a check

March 1993LERMS was replaced by the unified exchange rate

system.( Market determined exchange rate)

March 1992

Introduction of dual (official as well as marketdetermined) exchange rate

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Factors

affectingExchange

rates

Differentialsin inflation

Demand &Supply

Differentialsin interest

rates

Current-accountdeficits

Public debt

Politicalstability and

economicperformance

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Capital Account ConvertibilityCapital Account Convertibility

y Freedom to convert local financial assets into foreign financialassets at market determined exchange rates

y Unrestricted mobility of capital

y India presently has current account convertibility, which meansthat foreign exchange is easily available for import and export for

goods and services.

y India also has partial capital account convertibility

y Case: South east Asian currency crisis

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To be achieved before CACTo be achieved before CAC

Fiscaldeficit

needs to bereduced to3.5% of the

GDP

Monetaryexchangerate band

of plusminus 5%should beinstituted

Forexreserves

should notbe lessthan 6

months

importcover

Inflationrates need

to becontrolled

between 3-

5%

CRR needsto be

reduced to3%

NPAs to bebrought

down to 5%

Interestrate to be

fullyderegulate

d

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RBI measures to check Exchange rateRBI measures to check Exchange rate

RBIMeasures

Interestrate

OMO

CRR

Primaryplacement

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Case to think uponCase to think upon

US Interest rate 2% 6% India Interest rate

Exchange rate 44

$ borrowed in US $1,000 Rs. 44,000 Converted to Rs and invested in India

Payback $1,020 Rs. 2,640 Earnings in Rs

Rs. 46,640 Total

Convert Rs back to dollars

Old calc (If Exchange rate remains same)

US dollar $1,060

Repay loan $1,020Net Earnings $40

Its not so easy to make money , rate will/might change

45.4 New exchange rate

New calc

US dollar $1,027

Repay loan $1,020

Net Earnings $7

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Movement of exchange rate and stockMovement of exchange rate and stockmarketmarket

y Depends on stage of the economy

y In case of India, USD/INR exchange rate and stock market mostlyhas a negative correlation but with other currencies there is nospecific relationship as such.

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ContCont

High growth MoreInvestments

Demand for

homecurrency

Home

currencyappreciates

Exportsaffected

Decrease in

Interestrates

Investment

becomeslessattractive

Home

currencysupplyincreases

Rates settledown End

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NIFTYand Exchange rate movementNIFTYand Exchange rate movementgraphsgraphs

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35

40

45

50

55

USD/INR

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60

65

70

75

80

85

90

GBP/INR

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50

55

60

65

70

75

EURO/INR

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30

35

40

45

50

55

60

YEN/INR

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