Weak currency, strong stock markets, or strong currency, weak stock markets! Which & Why?


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When one observes things, objects or approaches a subject with limited data or on a self-contained basis, it is abstract and the mind draws conclusions based on Negativity bias believe that one is less well off.

However, when statistics and data from converging broader contours, other regions, other geographies are introduced, it forces the mind to rationally rethink the changes taking place in the world.

Analyzing this data and delving into the reasoning behind it suggests that despite the fuss, chaos and turmoil in the world, Bharat is not only in a comfortable position, but is today in pole position.

This note will cover two basic fundamental questions that are spinning in everyone’s mind today.

Why is the stock market in Bharat (India) rising, while stock markets around the world are experiencing severe weakness?

If Bharat stock markets are rising due to a strong underlying economy, as discussed in my previous notes, why is the Indian rupee weakening?

Let’s start with the second question first. Why is the Indian rupee weakening?

1. Collapse of asset classes and the energy conundrum

Does this happen rarely, when all asset classes experience a fall simultaneously?

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Debt, stocks and gold have seen cuts, deep cuts this calendar year. The chart above shows how asset classes have been hammered everywhere.

Reason for the fall

Excess money supply in the system due to covid, disruption of supply chains and an increase in demand after the covid era has led to higher inflation, higher interest rates to curb a rise inflation, a rise in interest rates, increasing borrowing costs, thereby creating a deleveraging trade in asset classes globally. To top it off, the Russian-Ukrainian war with a pending nuclear threat and a food supply and fertilizer shortage to make matters worse.

Thus, global institutional investors and fund managers rushed for safety and protection.

The US dollar signifies protection as the demand for the US dollar is constant due to the settlement of energy contracts. The global oil and gas market is worth around $6 trillion. More than 85% of the market is settled in US dollars and therefore the demand for energy keeps the demand for the USD dynamic.

Why crude is settled in USD and its history is covered in the note https://www.firstpost.com/opinion/weak-currency-strong-economy-how-india-is-on-the-path-to-become -aatmanirbhar-10698081.html.

Additionally, since crude oil and gas are settled in USD, most energy importing countries must also maintain excess reserves or foreign exchange reserves in USD to ensure that importing countries are not affected. by the double-edged swords of the USD move and the oil price move. This constant demand to maintain foreign exchange reserves gives stability to the USD and creates a perpetual demand for the USD. Nearly 60% of the world’s central bank total rainy-day reserves are held in US dollars or dollar-denominated assets, making the US dollar resilient.

2. Depth and Breadth of US Financial Markets

The United States has the largest amount of overall national debt amounting to $31.12 trillion. Since the United States has large borrowings, it needs deep and advanced financial markets to ensure that there is no liquidity/impact cost while placing such large borrowings. Transparency and full access to information make debt placement easy.

Efficient systems, market creation and ease of transactions through technology have made the US dollar is the most traded currency in the world with a huge lead with 44.14% (nearly half of all currency trades involving the USD) in terms of value, with the Euro lagging 16.14%.

According to the Bank for International Settlements, dollar-denominated credit to non-banks outside the United States is approximately $12 trillion. Next in line is Euro-denominated credit, which stands at ~$3.8 trillion.

Since the loans were made in USD, countries and companies therefore have to repay in USD, which leads to an increased demand for USD.

The USD remains a Vehicle currency as well. In other words, most international forex traders first convert local currency to USD and then convert USD to currency as needed. In other words, the US dollar makes it easier to trade currencies, thereby inherently creating more requirements for the USD.

Both Bharat and RBI have pushed for a Rupee-settled trade to reduce the need for USD, but there is still some time to go.

3. Big dollar bait

The biggest conundrum with the dollar is the vested interest of global investors and their alignment with the US dollar.

According to IMF data, the financial obligations, liabilities and debt of the United States that the United States government, American companies and American citizens owe to the rest of the world amount to approximately $53 trillion (to put the things in perspective, how big is $53 trillion?, the total size of the global economy in 2021 was $94 trillion).

This debt or obligation is denominated in US dollars. So, if the value of the US dollar dips, the assets or net worth of the rest of the investors around the world will also drop. So, keeping the US dollar strong is good economics for large institutions and investors outside of the US, spread across the globe.

Similarly, US investors own about $35 trillion in foreign assets entirely denominated in foreign currency. For these American investors, if the dollar depreciates, they are well off or better off.

On a net basis, although the United States owes the rest of the world, the rest of the world has an alignment of interest in maintaining the strength of the US dollar.

Moving on to our first question, Why are the Indian stock markets or listed stocks seeing a boost in these uncertain times?

1. Rise of retail trade and financialization of savings

While India’s economy began to grow at a rapid pace only three decades ago, it has achieved significant milestones over the past decade to become the world’s fifth largest economy, on its way to being the third in a decade.

Government reforms such as demonetization, implementation of GST and financial inclusion policies such as Jan Dhan and PAN Aadhar linkages, direct transfer of subsidy benefits have not only allowed an increase in discretionary demand, but have also accelerated the pace of the financialization of savings. Covid has accelerated this journey of household and business savings from physical to financial assets and technology has democratized financial education and facilitated execution.

As a result, the FIIs that once controlled the fate of Indian stock markets have been displaced, with power migrating into the hands of the Indian public.

Ten years ago, in the financial year 2012, the total number of Demat accounts held by Indians stood at around 19.9 million. More than a decade later, in August 2022, that number stood at 100 million+, recording a five-fold jump in ten years.

Bharat’s real GDP grew by 13.5% thanks to investment, consumption and manufacturing. This makes Bharat the growth engine of the world, leapfrogging other major economies in the world and making them look seriously at Bharat with an underlying thought of “TOO BIG TO IGNORE”.

As noted above, the democratization of education has taught small investors that patience pays and Volatility is a friend, not a foe. So, despite the extreme ups and downs during covid and the period of the Russian-Ukrainian conflict, retail money hit full steam and remained patient.

Retail money flowing into Indian stocks through SIP or Systematic Mutual Fund Investment Plan. Monthly SIP flows to markets via the mutual fund route have been between INR 12,000 crore to 13,000 crore. Barely 6 years ago, this number was 3500 Crores, a growth multiplied by four in six years.

2. FOMO in REITs

In 2008, during the Great Financial Crisis, FIIs (Foreign Institutional Investors) then and now popularly known as REITs (Foreign Portfolio Investors) sold closer to $13.1 billion in Indian listed shares and Nifty 50 corrected from 6144 at the start of 2008 to close at 2959 on the last trading day of 2008. A whopping 52% loss.

In 2022, from January 2022 to June 2022, FIIs were net sellers every month. During these six months, FIIs sold ~$28 billion of shares listed in India. Despite this sale, the Nifty corrected by about 10%.

National institutions are now overwhelmed with retail money, retail savings and retail money bought from the sale of REITs.

REITs have realized that Bharat will remain the fastest or second fastest growing economy with favorable demographics, rising middle class and tech driven youth over the next decade. So getting out of Indian stocks is a double whammy.

When FIIs sell, they break the price themselves, and therefore the ultimate realization for them in USD due to impact costs is relatively low. DIIs (Domestic Institutional Investors), HNIs and domestic retail investors are buying steadily and driving the markets up slowly and steadily. When REITs return, to buy stocks again, they are forced to buy at a higher price due to the volumes as well as the dynamic flows of domestic investors and the bull market driven by the domestic currency.

Unfortunately, REITs are caught in the cross cycle of selling low and buying high, which is costing them dearly.

In summary, Bharat is a two-cylinder economy with demographically favorable youthful consumption on one side and manufacturing with Make in India, Make for India and make for the World on the other side. This is what drives Indian actions.

Reserve currency is a tightly wired system created by the United States to ensure that the hegemony of the dollar remains so that the excesses of the American government and the massive consumption of American nationals can be financed by the rest of the world.

How long this system can last is anyone’s guess. Those who have opposed or opposed this system thus far have fallen flat on their faces, but as one clever man said, “time is a great leveler“, but until then, the US dollar will continue to dominate the world.


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