Mumbai: Indian equities fell to a two-month low soon after trading began on Monday, tracking other Asian markets, on concerns that austerity measures in debt-ridden European nations and a slowdown in China would crimp the global economic recovery. However, a strong opening in European markets revived Indian shares that recouped most of their losses by close of trading.

Graphic: Paras Jain / Mint

Analysts said the direction of India equities in the medium term will be driven by Europe. With the earnings season coming to a close, the next big local factor that can move the market will be the monsoon, which is expected to hit India by the end of May.

Despite the euro zone’s common currency sinking to a four-year low against the dollar, European stocks were trading strongly and helped reduce losses in Asian markets. At 8.30pm Indian time, the UK’s FTSE 100 index was up 31.11 points, or 0.6% at 5239.96, while Germany’s Dax was up 1%. US markets opened flat and the Dow shed 73 points, or 0.7%, to 10,548 in early trading.

The euro sank on Monday, taking with it all Asian currencies, including the rupee that lost about 40 paisa against the dollar and fell to a 10-week low of 45.62 to a dollar from 45.205 on Friday. Importers from the euro zone rushed to buy euros and hedge their future receivables at the present level, taking a bet that the sovereign crisis would not last long and the common currency of Europe would soon start to strengthen.

One euro fetches around Rs56. In December its value was close to Rs70.

The 30-share Sensex, India’s benchmark index, plunged 443.6 points in intraday trading as investors dumped shares in markets across Asia, but pared losses to close 0.94% down to 16,835.56, a drop of 159.04 points. The broader 50-share Nifty fell 0.66% to close at 5,059.90.

The Shanghai index lost 5.07%, hammered by Europe and local problems of overheating in the Chinese economy while Japan’s Nikkei index shed 2.17%. “There is no catalyst for India to go higher on its own, so we are going to follow Europe," said Andrew Holland, head of equities at Ambit Holdings Pvt. Ltd. “When Europe opened better than expected, people started buying again."

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“The triggers driving the markets are global now," said Apurva Shah, vice-president of research at Prabhudas Lilladher Ltd. “Locally it’ll be the monsoons, but that will take some time."

India VIX, the volatility index of the National Stock Exchange, rose 2.41% on Monday to close at 27.17.

Europe has been in the eye of a storm that has engulfed global markets this past month as Greece threatened to default on its debt. Last week, the European Union and the International Monetary Fund put together a nearly $1 trillion (Rs45.7 trillion) package to rescue the continent from financial contagion. While markets initially cheered the move, investors are worried that the austerity measures which form part of the bailout package will derail economic recovery.

“The biggest problem may be weaning themselves off fiscal life support," Rob Carnell, chief international economist at Dutch bank ING Group NV, told reporters in Mumbai on Monday. “Europe’s debt is all tangled up. Foreign banks have significant exposure to Greek debt market," added Carnell. His reference is to the possibility of a default by one country resulting in the failure of some banks which, in turn, would affect other countries and banks. Greece is running a fiscal deficit at 13% of its gross domestic product (GDP). Others such as Spain, Portugal and Ireland all have government debt well in excess of 60% of GDP and have all announced fiscal austerity plans, including freezing public pay and cutting benefits.

Adding to the problem is China, the world’s fastest growing economy, where a threatening asset bubble and inflation could lead to more monetary tightening and a slowing of the economy. The country’s manufacturing growth, as indicated by the purchasing manager’s index, fell to a six-month low in April.

All the uncertainty led to foreign institutional investors (FIIs), one of the largest categories of share buyers in India, to sell stocks worth $665 million in the past month, as they rushed to safer assets such as US treasury’s and gold. They have so far purchased nearly $6 billion worth of Indian stocks in 2010. As FIIs withdrew from the market, the local currency sank 0.9% to 45.62 per dollar.

While equity investors are uncertain, importers and exporters are convinced that the sovereign crisis will pass and that the euro and dollar will appreciate against the rupee.

So far, this calendar year, the rupee has strengthened 19% against the euro but gained only 2.2% against the dollar. The euro zone is India’s second largest trading partner after China. Importers are buying cheap euros and dollars and hedging their future earnings, taking a bet that these will strengthen against the local currency. Exporters, on the other hand, are selling forwards and staying away from the spot market, said Rugved Dhumale, associate vice-president of risk management at Mecklai Financial Ltd. Exporters are selling forwards as they expect the rupee to depreciate. This will help them earn more rupees per dollar.

Importers, especially those who import from the euro zone, are buying euros from the spot market as they are betting that the euro will bounce back. This means they would need to spend more rupees to buy euros in future.

Ashwin Ramarathinam contributed to this story.