China's central bank surprised markets around the world as it devalued the Yuan, also known as the Renminbi, by 4% - the largest devaluation in two decades. The move was aimed at reviving China's growth engine by giving it an export advantage. Data from China for the month of July revealed a six-year low in the Chinese producer prices index, which was 5.4% lower on a year on year basis, and a fall in China's exports of 8.3% year on year.

Following the developments in the Chinese economy, the Indian rupee breached Rs 65 mark against the U.S. dollar with international selling pressure surmounting. The Indian rupee is nearing the levels witnessed at the end of 2013, when India was facing a Balance of Payments (BoP) crisis. Nevertheless, on a (Real Effective Exchange Rate REER) basis, the Indian rupee has outperformed other emerging market currencies over the last one year.

A weaker Indian rupee has many advantages for exporters. However certain exporters may face stiff competition from their Chinese counterparts as a devalued Yuan could give Chinese players an added advantage. Indian domestic players in sectors such as steel and textiles may face stiff competition from their Chinese counterparts, as prices of Chinese products would be reduced, prompting import of their goods in India…and perhaps even lead to dumping. If the Peoples Bank of China (PBoC) decides to devalue the Yuan further, an even more challenging environment may emerge. A devaluation of the Yuan by PBoC cannot be ruled out. But it is unlikely that PBoC will cut rates anytime soon as measure to provide impetus to China's economic growth.

FII flows and vulnerability of the Indian rupee
Foreign Institutional Investors (FIIs) have been quite wary after devaluation of Yuan and markets too appear to be nervous (although some short covering is evident in the recent few days). India is among the fastest growing economy in the world and that's encouraging them to evince interest. But going forward, along with the domestic macroeconomic panning out one would need to closely monitor the happenings in the Chinese economy, U.S. economy and the Eurozone to ascertain how FII flows take course.

The Indian rupee vs. U.S. dollar and the markets
Data as on August 17, 2015
(Source: ACE MF, PersonalFN Research)

The Indian rupee would face further pressure on account of the devaluation. There are chances that Yuan devaluation might ignite a currency war where exported oriented Asian countries such as Taiwan, South Korea, and Thailand may devalue their currencies to retain competitiveness. Europe and Japan are into quantitative expansion, which could lead to further devaluations of the Euro and Yen. Therefore, more than just devaluation of Indian Rupee, what may haunt Indian importers and exports is Rupee volatility which may make it difficult for them to rightly hedge their forex positions.

Moreover, the Indian rupee may remain vulnerable against the greenback as talks loom that the Federal Reserve in the U.S. would increase policy rates soon this year as signs of economic vigour are depicted by the U.S. economy.

However with India's BoP situation being much better than that in 2013, the potential downside for the Indian rupee seems limited. The RBI is also well equipped to stem a fall in the rupee.

Will there be a sell-off in the Indian equity market?
Well, the Indian equity market does appear vulnerable at this juncture as valuations appear stretched and corporate earnings for the first quarter of the fiscal year 2015-16 have failed to please investors. Any negative news inflows could spark a sell-off in equities. Certain domestic sectors such as steel and textiles could be especially vulnerable to a fall in stock prices if Chinese manufacturers gain competitiveness resulting from the pricing. The I.T. sector on the other hand could benefit from the devaluation of the rupee as this sector has a high foreign exchange exposure and does not compete with Chinese players. So the environment may emerge mix yet challenging for companies in India and may even go on to limit India's economic growth rate. FIIs are evincing interest in India, but would keenly watch the situation.

PersonalFN is of the view that given the aforesaid backdrop there are global headwinds in play. The Government has envisaged ambitious plans to transform India into a manufacturing hub, and big companies from around the world are already looking towards Indian shores to set up manufacturing units here. But how well the reform measures are implemented remains to be seen; because India yet needs to go way forward as far as infrastructure development is concerned although the Government has made a higher allocation for the same.

Investment strategy…
Going gung-ho and investing all your money could turn to be imprudent as the margin of safety seems to have narrowed down. Nonetheless, if your risk appetite permits and if your asset allocation calls for you to invest in equities, staggering your investment would be a prudent approach while taking exposure to equity. You shouldn't buy aggressively, rather buy selectively. Thoughtlessly investing or speculating can be hazardous to your wealth and health.

PersonalFN recommends one to opt for the SIP (Systematic Investment Plan) mode of investing, as it will enable you to mitigate the volatility through rupee-cost averaging and power your portfolio with the benefit of compounding. However, while selecting mutual funds for your portfolio, prefer the diversified equity funds which follow strong investment processes and systems, and invest with a long-term horizon of at least 5 years. Also PersonalFN believes that your investment discipline and asset allocation would decide your success in investing.

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