Sensex, FII Flows, and Rupee Show Strong Positive Correlation
A recent study by Bank of Baroda has established a robust positive correlation between the Indian equity benchmark Sensex, foreign institutional investor (FII) flows, and the domestic currency. The report indicates that movements in the Sensex are directly linked to changes in foreign capital inflows and the value of the Rupee. Specifically, from April 2022 to March 2026, the correlation coefficient between the Sensex and the Rupee reached 0.6, while the correlation between the Sensex and FII flows stood higher at 0.7. These coefficients, which range from -1 to 1, indicate a strong positive relationship where variables move in the same direction.
Analysis of Macroeconomic Indicators from FY2000 to FY2026
The research analyzed macroeconomic data spanning fiscal years 2000 to 2026, establishing a firm causal relationship between the Sensex and the Rupee, as well as between the stock index and FII flows. The report noted that a positive correlation implies a mirror relationship: an increase or decrease in one variable leads to a similar change in the other. Conversely, a negative correlation would indicate opposite movements. The study highlighted that the post-COVID period exhibited an even higher level of positive correlation among these variables.
Spillover Effects Across Financial Markets
The report emphasizes a clear spillover effect across Indian financial markets, where past market movements directly influence future behavior. According to the study, "given the presence of volatility clustering, it has been observed that there is a spillover effect between the changes in the past Sensex returns to their future outcome." This effect is also applicable to FII flows, though not as strongly for the Rupee, as one coefficient in the mean equation for INR was not significant. The interconnectedness extends to international capital behavior, with fluctuations in the equity benchmark altering the investment environment for foreign players.
Impact of Sensex Returns on Exchange Rates and FII Volatility
The study further found that changes in Sensex returns can lead to changes in the exchange rate, as validated by one model. Additionally, "Change in Sensex return also has a volatility spillover effect on FIIs. Therefore, changes in the Sensex returns do actually influence the volatility of FIIs," the report added. This underscores the bidirectional influence between the stock market and foreign investment dynamics. The report also noted that INR and FII flows reflect a positive correlation, reinforcing the interconnected nature of these financial indicators.
