Investing in Asia’s worst-performing currency is all about the interest rate.
While the rupee fell 0.4% versus the dollar this year, flows from stock investors turned positive in March amid slower inflation, an improved current account and budgetary discipline. Including interest, investing in rupees will earn 2.6% from now until December 31, according to strategists’ forecasts compiled by Bloomberg, the most in emerging Asia.
“The rupee remains a very attractive play over a one-year horizon,” said Viraj Patel, a London-based strategist at ING Group, among the most-accurate rupee forecasters in Bloomberg’s rankings. “Lower inflation, a subdued current- account deficit, high growth and carry will all pay dividends in the future as the global economy turns the corner.”
Interest rates below zero in Europe and Japan are attracting investors to a nation that has the second-highest yield among key Asian markets and the fastest growth among major economies. The rupee’s allure has been burnished by central bank Governor Raghuram Rajan’s success in replenishing foreign- exchange reserves and taming consumer prices and the trade deficit.
Prime Minister Narendra Modi’s February 29 budget sparked a rally in India’s rupee, bonds and stocks as the government’s resolve to narrow the fiscal deficit to a nine-year low boosted investor sentiment. Data showing inflation eased to a four-month low in February also increased odds of interest-rate cuts by Rajan, while demand for emerging-market assets has picked up amid global central bank stimulus.
Ten-year bonds in India pay 7.50% even after the yield has slumped 28 basis points from February 26, the last trading day before the budget. Similar-maturity notes offer 7.64% in Indonesia and 2.82% in China. Foreign holdings of rupee-denominated government and corporate debt rose Rs44.9bn ($678mn) in the last two weeks, the most for such a period since October, the month in which India relaxed curbs on overseas ownership of sovereign bonds.
The limit on foreign portfolio investments will increase by Rs105bn from April 4 to Rs1.9tn, the central bank said in a statement after the close of markets on Tuesday. The cap will rise further to Rs2tn from July 5 till the end of the quarter in September.
“We are in a very-low interest rate world,” said Vishnu Varathan, a Singapore-based economist at Mizuho Bank. “India’s superior growth versus rest of the region alongside the central bank’s commitment to inflation stability means that on a risk-adjusted basis, the carry proposition of the rupee will look quite alluring.”
The rupee has surged 3.1% in March to head for its biggest monthly advance in two years. The jump follows a 3.3% decline in the first two months of 2016, during which it fell to the brink of its record low of 68.845 a dollar seen in August 2013. The rebound provided the RBI an opportunity to accumulate foreign-exchange reserves, which reached a record $355.95bn in the week through March 18.
Mizuho forecasts the rupee to end 2016 at 64.50 a dollar, a level that is 2.9% stronger than the currency’s close of 66.3850 in Mumbai yesterday. ING has an year-end projection of 66.
These predictions are at odds with Barclays Plc and Morgan Stanley, which say a strengthening dollar and weak global risk appetite will bring more pain for the Indian currency, with Morgan Stanley estimating a drop to 73 by December 31.
The rupee “could be slightly stronger than this if foreign currency inflows” improve, India’s Finance Minister Arun Jaitley said in an interview in Sydney. “There is a pressure from exports to keep it competitive, there is a pressure from politics to make it stronger. Therefore discretion is that the rupee finds its own level.”
India has eclipsed China as the world’s fastest-growing major economy with gross domestic product projected to expand 7.6% in the fiscal year through March. The slump in Brent crude prices has benefited the net oil importer, with the trade deficit for Asia’s third-largest economy shrinking in February to the smallest since September 2013. The current-account deficit in the three months through December narrowed to $7.1bn, from $8.7bn in the previous quarter.
The Federal Reserve’s decision this month to scale back expectations for the path of interest-rate increases came as a shot in the arm for developing-nation assets. Fed Chair Janet Yellen on Tuesday reasserted the central bank’s gradual approach to raising borrowing costs, prompting gains in Asian and European shares on Wednesday.
Global funds have poured a net $3.1bn into Indian stocks in March, taking inflows for the year to $209mn. That’s propelled the benchmark S&P BSE Sensex index 10.2%, putting it on course for its best month in more than four years. Investing in rupees returned 3%, including interest, in the past four quarters, data compiled by Bloomberg show, the highest in Asia. The currency weakened 4.7% in the period.
“With the Fed now taking the foot off the pedal in terms of rate hikes, high-yield emerging-market currencies will be back in vogue and the rupee will be among those in demand,” said Patel of ING. “Oil prices remain the key. If we start to get a sharp rebound, then both the current account and monetary policy could come under scrutiny.”