Adding to the nervousness were apprehensions the Reserve Bank of India (RBI) might resort to more controls to contain dollar outflows on the back of the measures initiated on Wednesday. While the Indian currency closed the day at $61.65, the Sensex crashed 769.41 points to end the session at 18,598.18 while the yield on the benchmark bond surged 50 basis points to 8.89%. While the government forked out 53 basis points more to borrow 10-year money at the bond auction on Friday than it did last week, yields on corporate paper jumped 20 basis point on Friday over Wednesdays closing.
US 10-year treasury yields soared to near two- year highs of 2.78% on Thursday and were trading at similar levels on Friday at 7.40 IST.
Better-than-expected US economic data on Thursday a drop in US jobless claims to its lowest level since October 2007 has led to anxiety that the tapering of QE3 would begin at the Feds September meet. The tapering is expected to suck out liquidity from the markets, especially emerging markets which have seen large foreign flows over the past year.
Since May 22, when the Fed indicated it would begin rolling back QE, foreign institutional investors have pulled out $5.75 billion from domestic bonds and $ 5.4 billion from the equity markets, as a consequence of which the rupee has depreciated by 11.2%.
"The rupee has been unanchored. We could see levels of 65 and I wouldn't rule out a move towards 70 either," Bhanu Baweja, global head, emerging market strategy, UBS, observed. Brijen Puri, head, India markets, JPMorgan, concurred, saying a fall to 65 cannot be ruled out. The RBIs measures for individuals and corporates have increased fears of capital controls on foreign investment, Puri said.
Samir Arora of Helios Capital , however, felt that while there could be many legitimate reasons for the weakness, attributing it to a move towards capital controls was plain ridiculous. The forex markets like nothing other than momentum and they are getting carried away," Arora.
The falling rupee, together with the weakness in the Asian equity markets, hurt the sentiment for Indian stocks; all key Asian indices ended in the red on Friday with the Jakarta Composite giving up 2.5%.
The Sensex has fallen 1,493 points or 7.4% in 11 out of the last 16 sessions and has lost 15.6% in dollar terms, among the worst performers this year, next only to Brazil, which has given up 27.3%.
Meanwhile, several foreign brokerages, including Goldman Sachs, Deutsche and Morgan Stanley have trimmed their targets for Indian equities. Nomura reduced its FY14 Sensex target to 20,000 from 21,700 citing weak economic growth and renewed upward pressure on the interest rate cycle.
Since the Fed's indication of QE tapering, the Brazilian real has shed 14.5%, the Russian rouble has weakened 5% while the South African rand has lost 4.3%. The fixed Chinese renminbi has strengthened by 0.3%.
Central bank sources clarified that the cap on overseas direct investment (ODI) by corporates had been lowered to 100% of their net worth from 400% for the automatic route and that higher amounts could be considered for the approval route. On Wednesday, the central bank had restricted the amount individuals can remit abroad to $75,000 from $200,000, under the liberalised remittance scheme, and barred any real estate investment.