Three moving parts affect Indian markets more than most investors realise: the price of crude oil, the value of the rupee, and the direction of interest rates. Even a modest change in any of them can alter earnings forecasts and investor mood. When the Global Market shifts on any of these fronts, domestic screens often reflect it quickly. Traders who monitor SGX Nifty each morning are essentially watching how these forces are being priced in before the local session begins. This article breaks each factor down in plain language.
Crude Oil and the Indian Economy
India buys the majority of its oil from outside, and therefore, petrol prices are integral to the economy. An increase in crude prices would lead to an increase in the import bill and hence current account deficit and inflation. Transportation costs will go up, which will have a cascading impact on prices of food and manufacturing items.
Markets usually react badly to rising oil prices. Paints, tyres, aviation and chemical industries are some sectors which are vulnerable to oil price hikes. As oil marketing companies earn less profit due to controlled retail prices, upstream players stand to gain. However, a fall in crude prices benefits most of the economic sector and improves the value of the Rupee, which in turn is good news for equity investors.
The Impact of Rupee’s Value
The exchange rate of the Rupee impacts companies as well as investors. A weak rupee increases import costs, overburdens students who wish to study abroad, and adds to the burden of companies that have taken loans in foreign currency. However, it benefits exporters as their earnings in rupee terms improve.
Currency plays an important role in the case of foreign investors as they calculate their returns in their domestic currency. A consistently depreciating rupee discourages these investors as even though the number of shares they buy may increase, their returns will decrease. However, this concern is unwarranted as the Reserve Bank has plenty of foreign exchange reserves to smooth out the wrinkles. As an individual investor, focus should be on long-term trends and not on day-to-day fluctuations in currency value.
Interest Rates and Equity Valuations
Interest rates also have an impact on equity valuation. One way to look at it is that increasing rates make safer investments (fixed deposits, government securities) more attractive. This makes investors demand for higher returns from equity shares. Companies find it difficult to service their debts, and lower consumer spending reduces demand for housing and cars.
Declining rates make the opposite kind of impact, which is good for valuations. This is why announcements from the monetary policy committee carry so much weight. All eyes are on the central bank as rate sensitive sectors like banking, real estate and automobiles are impacted directly. A good way to deal with changing interest rates is to keep a portfolio with defensive stocks and sectors like healthcare and consumer staples which are not very sensitive to rates.
How the Three are Connected
These three factors are interrelated. Crude prices impact inflation, and hence there is likely to be a delayed reaction in terms of policy rate changes. If Rupee is depreciating against the dollar, it will make imported inflation worse and add to the woes of the central bank. Increased rates attract foreign debt inflows and strengthen Rupee, but negatively impacts stock prices.
As a shareholder, understanding this connection will help you gauge market reactions to news reports. If there is a sudden jump in oil prices, think of the impact it will have on different sectors and the possible responses from the government and the central bank. Do not get too worked up on a single day’s events as all three factors usually change over a period of time, negating the impact of one another.
What Individual Investors can do?
While there is not much an individual can do about oil prices, exchange rates and interest rates, he/she can do certain things to mitigate risk. Keep your portfolio balanced so that there are not too many shares exposed to one factor. Having a mix of exporters, domestic companies and counters that are not very sensitive to the three factors mentioned will help. Having some exposure to debt funds and gold will reduce risk.
It is always a good idea to read what company executives have to say about changing input costs and currency fluctuations during quarterly reviews, as they give good insight into how the revenues and profits are likely to be affected. Take care of your personal finances as well; for example, keep an eye on how your floating-rate home loan EMI is likely to be affected if and when the rates change. Finally, do not try to time the market, as even professional economists with high-end models fail to accurately predict these variables. A balanced approach is always best.
