USD Dollar vs INR and Nifty Returns

The US Dollar index was up by 5 per cent in the last two months ending May 15, 2018, and against rupee, it was up by 4.5 per cent. It is the highest level that the greenback has achieved since the start of the year. A higher US Dollar usually is a warning bell for the Indian equity market. One of the common pearls of wisdom prevalent in the equity market is strengthening of the US dollar against the Indian rupee is a negative news for the equity market. The reason being, in the past on various occasions they both have moved in opposite directions. The best recent example that supports this theory is the drastic fall in the value of Indian rupee in the year 2013 due to US Fed’s tapering tantrum. It was accompanied by a sharp fall in the Indian bellwether indices Nifty and Sensex. 

To understand the relation between US Dollar index (proxy to the strengthening of US Dollar) and Nifty, we plotted the last nine-year data to identify if there exists a relation between both the indices.

If you look at the last nine years data, nothing concrete comes out of it and you can conclude nothing. Since April 2009, US dollar has appreciated by approximately 10 per cent while Nifty has gone up by a huge 208 per cent. If this is the case, why should the market worry about the rising dollar or weakening rupee?

To understand it in a better way, we analysed the correlation coefficient between weekly returns of Nifty and weekly movement of US Dollar index. For the period between April 2009 and March 2018, there has been a negative correlation between both, and it is not by fluke. Statistically, the correlation between Nifty returns and USD index is significant and is -17.94 per cent.

Scratching the surface further, we found that yearly correlation has changed over the years. Till the mid of 2013, there was a strong negative correlation between Nifty and USD Index. This means that when USD Index went up the equity market represented by Nifty dipped. Similarly, when Dollar went down, the market goes up.

Nonetheless, from the fag end of 2013, there has been a positive relationship between both. The positive relation, however, has come down in a couple of years.

The reason for such shifting correlation is attributed to some fundamental change in the way Nifty constituents have changed over the years. For example, the positive correlation can be explained by the presence of Information technology, Pharmaceutical and some of the auto companies who benefited from the falling rupee or strengthening dollar. Currently, however, financials form a major part of the Nifty, which are least impacted by dollar movement, hence we see a weak correlation now.

Another factor that has led to such weakening relation is the rise of domestic institutional investors (DII) as a prominent equity market player in India. Hence, the importance of Foreign Institutional Investors (FIIs) has somewhat come down. Therefore, any flight of FIIs from the equity market in India is well matched by DIIs.

Therefore, we are witnessing that in the long run rising US Dollar does not make much of an impact to the broader Indian equity market, however, in the shorter term, they continue to have a little impact on the market.