CURRENCY DEPRECIATION GUIDE: WHAT IT MEANS FOR THE STOCK MARKET

STOCK MARKET

Currency depreciation is when the value of a currency falls in terms of its exchange rate relative to other currencies. Currency depreciation is often confused with currency devaluation but both of these measures are starkly different by design. Devaluation is a deliberate decision by a country’s government to reduce the value of their currency to a particular exchange rate. The former is common in floating exchange rate while the latter is more in use during fixed exchange rates regime. In this blog, we will take a deeper look at what currency depreciation entails!

How is a country’s currency valued?

The value of a currency is determined by a country’s growth fundamentals. So, when a country is riddled with issues like high inflation rates, high and constant current account deficits, currency depreciation is a common phenomenon. A lot of currency depreciation is never good news, foreign investors start worrying that they might suffer through losses if the currency further falls and pull their investment out of the country causing the country’s economy to further suffer.

Factors impacting currency depreciation

Currency depreciation can be caused by a wide variety of events like declining revenues from exports, increasing level of imports, central bank intervention in the market, actions of traders and speculators in the forex market, reduced interest rates, and so on. When this occurs, it has many consequences. Debt instruments become less pricey due to rising interest rates (which in turn is caused by rising inflation), increased supply of foreign goods in domestic markets, prices rise, financial instruments become pricier, etc. 

Apart from the aforementioned effects, another unexpected effect is on the stock market. The stock market and the exchange rate of a currency are more closely related than you would think. 

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Naturally, companies whose operations rely heavily on imports and exports are the most affected by the fluctuations in the exchange rate. For instance, when a currency appreciates, the export dependent companies in that country are negatively affected as their earnings reduce despite supplying the same amount as before. Similarly, imports-based companies are better off since they receive higher earnings for the same quantity being supplied. If these companies are listed on stock exchanges, the difference in earnings affects their stock price. 

On the contrary, when a currency depreciates, the exports-based companies are better off while the imports-based companies are worse off. In the former case, companies are able to earn higher for the same quantity supplied and vice versa for the latter case. Sectors like IT and pharma which export a lot majorly benefit from currency depreciations.  

Just like how the exchange rate affects the stock market, the stock market also influences the exchange rate. When the stock market does not perform well, it worries the existing investors and they end up pulling out their investment and the currency ends up depreciating. Similarly, when the market does perform well, the currency appreciates. 

Instances of currency depreciation in the last decade & the impact on the economy

  1. In May 2013, the world saw the value of the Indian Rupee (INR)fall from Rs. 55.48 per dollar to Rs. 57.07 in the span of just fifteen days. By the end of June, 2013, the value had further fallen to Rs. 60.72. This accounted for a 6% fall in just one month. Then matters further worsened and the rupee fell to an all-time low of Rs. 62 in August, 2013. This was one of the largest depreciations in the Rupee’s value.
  2. The cause for the depreciation was the widening current account deficit. Foreign investors had stopped investing in India and the existing ones had started pulling their investments out. In the first quarter of 2013, the current account deficit stood at 6.7% of the GDP as compared to the 4.7% at the same time during the previous year. Overall, there was a 11% fall in the value of the Rupee in the first half of the year. Naturally, the supply of dollars was way less compared to what was being demanded. On top of this, the US economy was recovering well in 2013. This coupled with the economies of Japan and the Reserve Bank of Eurozone printing large amounts of currencies further increased the value of the American Dollar.
  3. At this time, there was also a lot of volatility in the stock market and this further prevented the investments of Foreign Individual Investors (FIIs) from flowing into the country. Stock market investors always need to keep an eye out for the value of the Rupee. This is because when the Rupee loses its value and affects the Indian markets (which are very sensitive to FFIs actions), FIIs pull out their investments, this weakens the Rupee further. In 2013, FIIs held about 24% of the BSE-500 shares
  4. While most sectors in the country suffered, there were a few sectors which were majorly benefitted by this depreciation. One of them was the IT industry. IT firms earned most of their revenues in American Dollars as they exported their products and services abroad. So, when the Rupee devalued, they were earning more per dollar for providing the exact same service as before. It was estimated that the earnings of the sector boosted up by about 4-7%. Stock prices of NIIT Technologies Ltd, Tata Consultancy Services, Tech Mahindra, Wipro, and other IT companies experienced a boost in this period since all these companies reported higher potential earnings. On a similar note, even pharmaceutical companies like Dr. Reddy’s Laboratories Ltd, Ipca Labs Ltd, Sun Pharma etc. gained. Some auto exporters like Apollo Tyres Ltd., Bajaj Auto also had positive price movements on their stock prices.
  5. On the other hand, companies which were heavily dependent on imports like oil and gas firms, lost out. Companies like Indraprastha Gas Ltd., Castrol Ltd., and other companies like Kajaria Ceramics which used gas as an input for production, saw a fall in their stock prices due to potentially lower levels of earnings. Here the worst affected companies were government owned oil and gas companies like HPCL and BPCL. In 2013, oil and gas subsidies were high, so there were only so much costs that the companies could pass on to the end consumers. Chemical industries, power companies (due to coal prices) were also negatively affected. 
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In the end, exchange rate fluctuations happen frequently, just like stock market fluctuations. These fluctuations mostly just affect import-export related companies. Moreover, these small fluctuations do not end up affecting the market too adversely unless the economy shows signs of barreling towards a recession. 

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