Despite concerns that Narendra Modi’s historic demonetisation drive would hit the Indian currency hard, it’s not all bad news for the rupee.
Estimates have predicted a big fall for the currency: A Reuters poll of some 30 foreign exchange strategists found that the rupee could fall to a record low this year against the US dollar, mainly because of demonetisation. But, according to Credit Suisse AG, investors should “forget about demonetisation” and “go long on the Indian rupee.”
Compared with currencies of other emerging markets and Asian economies, the rupee has performed relatively well, Koon How Heng, senior investment strategist at Credit Suisse, told Quartz in an email interview.
“On a total return basis, we expect the Indian rupee to outperform the rest of the Asian currency complex across Asia,” he said, explaining that the rupee is a “suitable portfolio hedge” at a time when the US dollar is strengthening.
A surging dollar leads to capital outflows from emerging markets, weakening local currencies. But, India’s lack of reliance on exports and strong economic growth might shield the country from this fate, Heng told Bloomberg TV last week.
“If a currency or asset has high yield, followed by low volatility, then it will have high or superior risk-adjusted return. This is precisely the case for the rupee, in which it has reasonably high yield of about 7% per year in the money market and low implied volatility,” Heng told Quartz.
The low volatility of the Indian rupee is primarily because the currency has stabilised thanks to the cooling inflation in Asia’s third-largest economy.
Global risks
The Indian currency has performed well despite major global risks. The election of Donald Trump as the next American president sent shockwaves across global financial markets as Trump’s proposed restrictive trade policies made investors nervous. But since the election, in early November, the rupee has fallen only 1.5% against the US dollar, according to Heng. During the same period, the Asia Dollar Index fell over 3%, he added.
Modi’s demonetisation move was announced exactly at the same time, and a fall in domestic consumption is threatening India’s GDP growth. But the rupee “may be shielded from the domestic consumption slowdown by its strong risk-adjusted return,” Heng said. Additionally, India’s basic account balance is also favourable for the rupee.
“Unlike other emerging market currencies, like (the) South African Rand (ZAR) and Turkish Lira (TRL), the rupee is backed by a strong and growing basic surplus from India. The growing basic surplus is also backed by strong foreign direct inflows (FDI) inflows following the deregulation of the services industry,” Heng added.
“Typically, emerging market currencies with positive basic surplus will be better equipped to withstand the stronger USD environment,” he said.