Whether the rally in the Indian markets will sustain or not depends to a large extent on the currency movement by China and the Indian govt's ability to stick to the fiscal consolidation plan
The BSE Sensex bounced 2.5% on Monday, tracking gains in equity markets around the world, after the Chinese Year of the Monkey started off with the biggest one-day gain in more than a decade for the Chinese onshore yuan.
The yuan offshore counterpart CNH, which is traded outside the mainland, has appreciated around 1% in the past week, when the Chinese markets were shut because of the New Year.
The chart shows that whenever the CNH/USD has strengthened, the BSE benchmark Sensex has also staged a rally. The last bounce was seen around September-end. And whenever the CNH/USD has depreciated, the Indian markets have also fallen sharply, as seen in the second week of August and in the first week of January.
The question then is: Is the depreciation in the yuan over?
True, in terms of investor sentiment, the move to strengthen the yuan by the Chinese central bank is definitely a positive development. “There were still lingering concerns whether there is going to be another round of CNY (renminbi) devaluation post the Lunar new year holidays. The comments over the weekend and the stronger fix have put those worries to rest, for now," said Divya Devesh, Standard Chartered Plc.’s Asia foreign-exchange strategist in Singapore. Over the weekend, People’s Bank of China (PBOC) governor Zhou Xiaochuan shrugged off fears about capital outflows and maintained there were no plans to weaken the renminbi further.
But the movement of the Chinese central bank should be seen in the context of shrinking reserves. The PBOC has spent huge amount of reserves in propping up its currency, which has led to massive capital outflows from China. “China has lost $612bn (16%) of its reserves over the past 13 months—thanks in part to policy mistakes and thanks in part to currency revaluation effects (reserve holdings in euros and yen lost 20% of their dollar value). The surge in China’s foreign reserves in 2013/14 is gone. Holdings are back at January 2013 levels of $3.2trillion," according to DBS Group Research.
Moreover, the fixing of the yuan at lower levels has not really helped China bolster its exports. Chinese exports continued to slide and were down 11.2% in dollar terms in January, despite the depreciation of the yuan in recent months.
Given these concerns, further devaluation of the yuan seems very likely. “Given the increasing risks around the currency, we see the recent pullback in USDCNH spot and forward points as good opportunities for investors to rebuild long USDCNH exposures," said Barclays’ Mitul Kotecha. In short, the current calm may not last long.
Fast and furious rallies are a feature of bear markets and the sharp rally on Monday was a short squeeze. NSE data show that strong selling by foreign investors persisted on Monday in the cash market and it was the locals who were buying. That does not augur well for a sustainable rally.
Nevertheless, whether the rally in the Indian equity markets will sustain or not depends to a large extent on the currency movement by China and, to some extent, on the government’s ability to stick to the fiscal consolidation plan in the upcoming budget.