Effect of currency exchange rates on the Indian investment portfolio

The foreign exchange market is the largest financial market in the world, and currency exchange rates can be found on a variety of websites, such as those of banks and financial news organisations. It is important to note that currency rates change constantly and should be checked for the most up-to-date information. These rates fluctuate based on various economic and political factors and can be affected by a wide range of market participants, including central banks, governments, and individual traders. Currency exchange rates affect other asset classes and have an effect on your investment portfolio. Here we understand how currency exchange rates on the Indian investment portfolio.

Indian Currency Market

It is difficult to give an exact figure for the size of the Indian currency market, as it is constantly changing due to factors such as economic growth, trade flows, and investment activity. However, as of 2021, it is estimated that the average daily trading volume in the Indian foreign exchange market is around $150 billion.

The Indian currency market is prominent for the following reasons:

1. Economic stability:
   The Indian currency market plays a crucial role in maintaining the stability of the Indian economy by ensuring that foreign exchange rates remain within a certain range.
   
   
2. Trade:
   The Indian currency market is important for facilitating international trade by allowing businesses and individuals to convert Indian rupees into other currencies and vice versa.
   
   
3. Investment:
   The Indian currency market is also an important destination for foreign investment, as it allows investors to buy and sell rupees and participate in the Indian economy.
   
   
4. Hedging:
   TheIndian Currency market also provides a platform for hedging against currency risk. Indian companies and individuals dealing with international trade or investment can hedge their currency risk by buying or selling currencies in the currency market.
   
   
5. Speculation:
   TheIndian currency market also provides an opportunity for speculators to make money by buying and selling currencies based on their expectations of future currency movements.

How do currency exchange rates affect investments?

A currency’s exchange rate can have a significant impact on investments. A stronger domestic currency can make foreign investments less profitable, as the returns will be worth less when converted back to the domestic currency. On the other hand, a weaker domestic currency can make foreign investments more attractive, as returns will be worth more when converted back. Additionally, changes in exchange rates can affect the value of domestic investments, as many companies have international operations and revenues in foreign currencies. Therefore, currency risk is a factor that investors must consider when making investment decisions.

Impact of currency exchange rate on retail investors

Currency exchange rates can significantly impact retail investors, as they can affect the value of their investments. For example, suppose an investor holds assets held in any foreign currency where the value of the currency decreases as compared to the value of the domestic currency. In that case, the value of the asset of the investor will also decrease. This can lead to losses for the investor.

Additionally, changes in currency exchange rates can also affect the price of goods and services, which can impact the overall inflation rate and consumer spending. This can have a ripple effect on the economy and ultimately affect the value of investments.

1. Mutual funds:
   Currency shift is a key factor in determining how your investment in the mutual fund will perform if you have invested in any mutual fund scheme wherein the fund manager has invested in global bonds or stocks. In that case, your mutual fund would also have international exposure and would appreciate in value if the dollar strengthened. Similarly, your investment can lose value if the value of the dollar declines.

2. Equity investments:
   Even if you just own local assets and have no international interests, you may still be subject to currency risk in the global market. Many corporations listed on the stock market have assets in foreign firms; if the value of that nation’s currency falls, your investments may also suffer.

3. Companies in export businesses:
   Many businesses also export their products and services to nations with different currencies. A reduction in the foreign exchange may result in a drop in their earnings, which would have a negative effect on the success of the business and, consequently, your investible surplus in the business. As such, the corporation would earn less from its international activities.

4. Companies in import businesses:
   It’s possible that an Indian business is importing American raw materials. The corporation has to pay more in rupees if the dollar appreciates versus the rupee, increasing its costs and eroding its net profit. This can lead to poor financial results, affecting the results of its stocks and your stock portfolio.

Holding any of these export/import companies in your portfolio could adversely affect your holding.

Conclusion:

Forex swings can significantly affect your investment portfolio whether or not you invest in international equities. Individuals who have assets in foreign stocks and mutual funds will inevitably suffer the most from currency changes. However, the indirect effects of price volatility may also be felt by individuals holding domestic assets. If you are looking for expert opinions on mutual funds investing, reach out to the Tata Capital Wealth team for more information.