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Why markets are wrong about India’s macro concerns

The current account deficit is set to widen and it looks like the surge in oil prices could upset the fiscal balance.

May 08, 2018, 10.22 AM IST
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The rupee fall comes at a time of increased dominance of TCS, software behemoth and India’s most valuable company by market cap.
Mumbai: With an increase of 6 per cent in the Nifty since the end of March this year, Indian markets appear to have confounded experts who predicted a decline in the index on account of macro worries and incessant selling by foreign funds. And their concerns were not baseless; the macro picture, after a healthy four-year recovery, indeed looks wobbly. The current account deficit is set to widen and it looks like the surge in oil prices could upset the fiscal balance.

But the markets clearly ignored all the negative chatter and instead listened to the good news: earnings are recovering and the Met department has predicted a normal monsoon for the third year in a row.

Plus, surging oil prices are unlikely to worry the markets because the correlation between crude and the Nifty has always been positive and that has stayed true this time as well. What this means is that whenever crude surges, the Nifty rises, too.

A positive correlation means the two indices move in the same direction with one being the highest level of correlation — both go up or down together at the same rate — and a negative correlation means both move in opposite direction with minus one being highest level of negative correlation — both move in the opposite direction at the same rate.

The 10-year average for the correlation between Brent crude and the Nifty is a positive 0.249, while the current reading as of May 7 is a positive 0.24. The current reading is line with the 10-year average.

This is also the case with the correlation between the 10-year G-Sec yield and the Nifty. The current correlation between the two is a negative 0.09, while the 10-year average is a negative 0.10. Whenever bond yield rises, the Nifty also rises in tandem and that is in sync with the current trend. One must also be careful and point out here that this positive correlation may not extend indefinitely. A spike in yields to over 8 per cent may trigger a Nifty fall. Ditto with crude, which is still below $80 per barrel.

What is surprising is the divergence in the movement of the rupee and the Nifty. Usually, the Nifty falls whenever the rupee depreciates, but this time that has not happened. Based on 10-year data, the Indian rupee has a negative correlation of -0.549 with the Nifty, while the current reading of the correlation is -0.11. The Indian rupee with respect to the US dollar has depreciated 5.1 per cent since the beginning of the year, while the Nifty is up 1.7 per cent during the same period.

This may lead to two possibilities. Either the rupee has to appreciate for the Nifty to go up, or the rupee will depreciate, and the Nifty would change movement and may fall. Also, statistically it has been observed that when such variables show high divergence from mean, they return to their mean to maintain correlation.

The rupee fall comes at a time of increased dominance of TCS, software behemoth and India’s most valuable company by market cap. The stock has risen 26 per cent since January 1 and is the second-best performer in the Nifty after Tech Mahindra. Every 1 per cent increase in TCS price leads to a 12 point increase in the Nifty. The dominance of the IT companies and the rebound in pharma has helped the Nifty weather the rupee storm.

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