What explains ongoing anomaly in Nifty and dollar-rupee price movements

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Observed behaviour has been that whenever markets go up, so does the rupee. Meaning when the Nifty goes up, the value of the rupee also goes up. This is what usually happens. But, charts are showing an odd behaviour now.

Between June 17 and now, the Nifty has gone up but the rupee has depreciated. Rupee depreciation means more rupee per dollar as represented in the USD/INR chart.

Also read: Rupee settlement unlikely to see widespread use: Capital Economics

This aberration may just be a sign that one of the two markets is going to take a new turn, according to market experts. Then, will the Nifty correct or will the rupee reverse gear?

According to Soumyajit Niyogi, Director (Core Analytical Group) at India Ratings and Research, the equity market seems to be experiencing a pullback rally after the markets corrected sharply. From the peak of around 17,780 in April 2022, the markets fell around 15 percent by mid-June.

“Until the past, Nifty’s price movement and rupee value mirrored each other because the domestic equity market was driven by FPI flows. Whenever the FPI flows go up, the equity markets go up and the rupee strengthens too, and vice versa. But, over the last couple of years, even when FPIs sold in large numbers, the equity market has held up because of the domestic investors,” he said.

 The equity market remained elevated between October 2021 and April 2022 despite heavy FII selling. FIIs sold Rs 1.4 trillion in FY22 in all, which according to IIFL is the highest ever selling by FIIs in a single financial year in the last 27 years. In fact, FPIs sold Rs 2.5 trillion or $32 billion between October 2021 and May 2022, which wiped out seven years of FPI investments (Rs 2.2 lakh crore from 2014 through 2020).  But DIIs have held on strongly with net inflows at Rs 2.21 trillion in FY22. 

Nifty began trending downwards from April 2022 and this, Niyogi thinks, is because domestic investors - both retail and institutional - are becoming cautious. While the FPI pulling out may not reflect in the domestic investor sentiment initially, when it is persistent and there are headlines on the FPIs pulling out, it will affect domestic investor sentiment too, he said.

Their caution also comes from macro conditions–of inflation, rising interest rates and geopolitical risk–starting to weigh on margins of companies. Over the last two years–2021 and 2022–the corporate balance sheets have shown healthy deleveraging despite the pandemic. Now in a worsening inflationary environment, their margins and cash flows will start to feel the pressure, said Niyogi. With demand weakening, they can’t even pass on the elevated input cost prices. Eventually, the weakening domestic investor sentiment and corporate earnings will start affecting valuations too, according to him.

Against this context, the Nifty’s climb again in the second half of June, despite the rupee continuing to fall, looks like a pullback. “If the rupee stabilises and the macro environment improves then this (upturn) can sustain, otherwise the overall sentiment in the financial markets (equity or debt) will continue to be volatile,” he said.

Therefore, the chances are that Nifty will correct and set the correlation right again.

Earlier instances

Rohit Srivastava, the founder and market strategists of Indiacharts, has noticed this odd correlation between Nifty and USD/INR twice in the recent past. One was in 2018, between April and August, which is 16 weeks of the Nifty going up but the rupee was not appreciating against the dollar. Two was in 2021, when the Nifty was making new highs between May and October, but the rupee wasn’t.

In 2021, Srivastava said that FII selling could have stopped the rupee from rising despite the Nifty making new highs. Nifty topped out first, in early April 2022.

 In the current market, Srivastava sees a potential short-covering rally that would last till the end of July.

 “From April to June, we have seen a pretty prolonged decline. By the end of June, we are getting readings that show that the market has gotten pretty oversold, not just in terms of price value, but actually in terms of sentiment. The index futures position of FIIs had reached a short position of around 145,000 contracts at the end of June, which is the highest since the pandemic. Typically, when we get to a point where traders are that short, you do get a short covering technical rally in between,” he said.

 This pullback rally could last till the end of July, and then the markets could fall between April and October, according to him.