The Nifty was extremely volatile during the month and ended down 1.7% for the month. We believe the Nifty performance is not truly reflecting the underlying volatility in individual stocks – a few strong stocks and sectors with large weightage in the Nifty are masking the carnage among the other stocks in the indices as also in the mid-cap and small cap space. Concerns over the Rupee and the corresponding RBI action were the central theme dominating the business environment during the month. Though we are far from being experts on currency markets, we would like to address the issue over the currency movement, as it is important in the larger context.
2013 marks the twentieth year since FIIs were permitted to invest in Indian equities. In 1993, the rupee traded at 31.60 to the dollar for most of the year. At its current level of 61 to the dollar, the rupee has depreciated 3.3% per annum over the last 20 years. As per economic texts, a country with a higher rate of inflation should experience a depreciation of its currency to the extent to which its inflation is higher than the other country. With the US inflation at roughly 2% and India’s inflation at between 5-7%, the 3.3% depreciation in the currency is within the range of normal expectations. Between 2002 and 2011, the currency remained fairly stable, trading in a band of 40 to 50. This was also a period of relatively moderate inflation compared to the episodes of high inflation experienced in the 1990s. However, over the last few years, inflation in India has climbed as the government has raised minimum support prices of grains and implemented ambitious rural employment and social welfare programs. These coupled with the high current account deficits at a time, when exports are slow all over the world, have contributed to the sharp 33% depreciation of the currency over the last 2 years.
The RBI publishes data of the Real Effective Exchange Rate, which it defines as a weighted average of nominal exchange rates adjusted for relative price differential between domestic and foreign countries. The REER has remained within a band of 95 to 100 for most of the last 20 years. However, by October 2007, it had climbed to about 110, making the rupee at the time theoretically overpriced by 10%. In June 2013, it stands at 89, reflecting a reasonable undervaluation from this theoretical perspective. While it is of course difficult to predict short term movements, a move from an REER of 110 to 89 and after a sharp drop of 33% over 2 years, one is tempted to say that most of the damage to the rupee is done with and any big fall from here should be temporary.
Meanwhile, most of the companies that we have invested in, continue to report reasonably good results. With the benchmark stock indices remaining in the same place for 6 years now, the stock market represents good value at this point of time. For a foreign investor, there is the additional attraction that every dollar they invest fetches 33% more than it used to 2 years ago.