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When Modi Euphoria Hurts: Why Dollar Inflow Can Be Tricky

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On May 16th, when the general election results indicated a landslide victory for Narendra Modi led BJP, Sensex, the bellwether index of Bombay Stock Exchange, rose to a record high. But, not all shares gained. The share prices of all major public listed pharmaceutical companies, considered to be the most defensive of all stocks, fell. 
The reason why pharma stocks did not follow the market sentiment – which cheered Modi’s ascent towards Prime ministership – was simple. The stock market rally was caused by the dollar denominated investments made by the foreign institutional investors (FIIs), and the surge of dollar had resulted in rupee appreciation against dollar. 
As Reserve Bank of India (RBI) data indicates, conversion rate of one US dollar on May 16, 2014 was Rs 58.86, lowest since June 19, 2013, when the rate was Rs 58.75 a dollar. 
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More than anyone else pharmaceutical industry, which earns approximately $12 billion as sales revenues from the US market, had reasons to worry. 
Appreciation of rupee against dollar meant less revenue in rupee terms. “It can affect 2–3 per cent of their sales revenues and 5–6 per cent of their profits”, says Ranjit Kapadia, Vice President-Institutional Research at HDFC Securities.
In the days that followed, pharma stocks showed slight improvement, so did the exchange value of rupee against dollar.
The euphoria that is associated with the electoral success of BJP is creating problems for not just the pharmaceutical industry. Modi himself will find his government fending against the rupee appreciation if the continued flow of short term dollar denominated investments into the stock market pushes down the value of dollar further. It can affect the export competitiveness, and earnings of a host of industries both in the manufacturing as well as services sectors.
It is not the industry alone that will suffer. Apex banker Reserve Bank of India (RBI) will have a tough time managing the value of rupee vis-a-vis dollar as the more dollars it buy to maintain the value of rupee, the more rupees it will be pumping into the system, thereby pushing up domestic inflation, the biggest worry of the common citizen.
Modi’s ascent and resultant dollar inflow has already started showing its impact in the RBI’s foreign currency purchase pattern too. According to the latest data available, the RBI’s foreign exchange reserves started swelling because of such market interventions well before election results came in. Ever since the talks of a Modi wave started, the dollar inflow and RBI’s dollar purchase had been on the rise. As on May 9, the foreign exchange reserves with RBI was $313.83 billion, highest ever since it started decreasing from $314.34 billion on November 11, 2011, RBI data indicates. The reserve, a week before, on May 2, 2014 was $311.86 billion.
With reports suggesting that the Sensex could rise to 30,000 points from the current 24,298 points (as on 21 May, 2014) by the year end, it’s going to be an anxious wait for the exporters, the consumers, RBI and the Modi government to see what the dollar movement has in store for each of them in the coming months.