A stronger rupee is luring foreign funds to Indian bonds
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The rupee has shown a stellar performance over three months and that seems to have set off a virtuous cycle for investors. The currency gained 3.6% in the last seven weeks to hit a near 18-month high against the US dollar on Tuesday.
In the same period, foreign institutional investors have been pumping in dollars into the local debt market, which was until December treated with caution. In January, the rupee had appreciated over 1%, which helped foreign investment in rupee bonds turn a corner in the ensuing months. Outflows turned inflows from February onwards with investors pouring in $2.6 billion in the last seven weeks.
The logic is clear. The forecast for the rupee is still bearish, although many analysts now believe that the fall of the currency would be lower than earlier expected. The median estimate forecast for the rupee by December-end is 68 to a dollar, according to a Bloomberg survey.
Given that the interest rate differential between the US and India is still heavily favouring the latter, the interest of foreign investors in local bonds continues to be strong. An investor putting dollars into Indian bonds now will stand to gain from not just the yield differential but also currency depreciation.
A foreign investor’s rupee investment today will fetch him a higher interest rate later (on the premise that the Reserve Bank of India is done with rate cuts) and as the rupee depreciates, it will fetch more dollars to take back home.
What is working in favour of the rupee and local bonds is the shift in the outlook for the dollar and the fiscal policy of the US. Emerging views that President Donald Trump may not be able to push through his fiscal plans have given the dollar a boost and sent US treasury yields plummeting.
But virtuous cycles seldom hold for long and any disturbance in global markets could put a premature end to this. For now, the outlook on India’s interest rates and currency is positive for foreign investors.