The rupee seems to be caught in a vicious cycle. Sustained foreign portfolio outflows have exacerbated the rupee’s fall and the currency’s depreciation, in turn, has led to a flight of capital.

FPIs have net sold equities worth $21.8 billion since the war broke out between Russia and Ukraine on February 24. Net sales in the year to date is nearing $30 billion and is already the highest for any calendar year on record.

The outflows have come in the backdrop of a surge in the dollar against other currencies and India’s widening trade deficit. The dollar index has surged about 2% in the last one month and 11% in the year to date.

Foreign flows and the rupee have had a negative correlation. Between May 2020 and September last year, for instance, the rupee appreciated 3.7% even as Indian equities rose 74% amid steady flows.

“It’s a chicken-and-egg situation. A weaker rupee can discourage FPI investments in a big way. And FPI outflows can, in turn, put pressure on the rupee,” said a chief strategist who deals with institutional clients, adding that outflows from Indian equities this month have slowed somewhat as the dollar rally has paused for a breather. 

Experts believe there is no reason for  FPIs to turn large buyers any time soon  until the dollar and commodity prices stabilise and geopolitical concerns abate. The benchmark BSE Sensex has slid about 7.5% to 54767 in the year to date.

FPIs haven’t pulled out as much money in the debt market, though, with YTD  outflows limited to $2 billion. Earlier this month, the RBI announced a slew of relaxations for investment by FPIs in the debt market. FPI investment in government securities and corporate bonds between July 8 and October 31, for instance, has been exempted from any limits on short-term investments till maturity or sale of such investments.

“The debt market has seen muted FPI flows in the last two years. FPIs probably anticipated a fall in the rupee given the worsening fiscal deficit situation in the aftermath of the pandemic  and inflationary pressures. Since flows have been muted, outflows have also been lower to that extent as investors choose to stay invested till maturity,” said Ajay Manglunia, managing director and head of investment grade group at JM Financial.

According to him, the interest rate differential between the US and India 10-year sovereign bonds is currently at 4.5%, which is close to the currency hedging cost for FPIs, making reinvestment or fresh flows unattractive at this point.

“Given the RBI intervention and easing inflation, I don’t expect the rupee to drastically weaken from here on. A stable rupee may offer a good entry point for FPIs; we expect some inflows by the fourth quarter of this calendar year or the first quarter of next year,” said Manglunia.

Some market participants, however, believe that the rupee could be in for more pain this year. “We could see the rupee depreciate to 82 against the dollar or more if the dollar index strengthens further,” said the institutional strategist quoted above.