India’s above average economic growth has attracted not only domestic, but also overseas investors. If you are a non-resident Indian (NRI) who remits money onshore, you are in a unique place given the long-term investment opportunity in the Indian equity market. An aspect of investing that you should consider is currency risk, which you face when converting funds from another currency to invest in Indian rupees. A part of the return gets hit by the change in the value of the rupee. Typically, this is the rupee value against the US dollar.
Why does currency matter?
In the last couple of years, the Indian rupee has depreciated around 17% against the US dollar. So regardless of the performance of the domestic equity market, your effective dollar investment may have suffered.
While it may not always be relevant to consider currency risk, it helps to be aware. Says Feroze Aziz, director (investment products), Anand Rathi Private Wealth Management, “NRIs who invest small amounts into Indian equity are not concerned about currency risk as they typically have some local expenditure which gets taken care of by the rupee investment. Investors who put in large amounts hedge currency risk through forward contracts on the dollar.”
Hedging through options
Once you have invested in Indian equities and want to take the earnings back overseas you will have to convert the funds into dollars. Now if the rupee has depreciated against the dollar during this time you stand to lose. To avoid this risk, investors can enter into a contract in the forward market where they can sell dollars and buy back Indian rupee. This is an opposite transaction to the above, which can negate the possible currency loss.
The reason you will have to enter into such a contract is if you have the view that the rupee is likely to move lower versus the dollar, but at the same time you don’t want to miss out on the opportunity of investing in Indian rupee.
Be careful though, such contracts work better in the short term as visibility of currency trend is more accurate in the next few months rather than the next two years. And secondly it can get costly. Says Aziz, “Cost of hedging is expensive as dollar typically quotes at a premium.”
If hedging through options seems too complicated for you, look for a natural hedge. What does this mean? Consider this, if you stand to lose out from converting rupees to dollars when the former has depreciated, then who stands to gain? Indian exporters. Exporters sell their products or services in overseas markets and earn revenues in overseas currency, for the sake of simplicity let’s say in US dollar. They also bring back revenues earned in overseas markets to India, so any time the rupee depreciates against the dollar, it works in their favour as they are able to buy more rupees for the same dollar value.
So if you want to create a natural hedge in your equity portfolio by investing a portion in good quality export companies, these can include companies from the software space or even automakers. According to C.J. George, chairman and managing director, Geojit BNP Paribas Financial Services Ltd, “NRIs invest mostly through funds, and when they do invest directly they only consider the fundamentals and pick companies they like regardless of the currency exposure.”
Another way to get exposure to Indian equities is through offshore funds. These are equity funds which invest in Indian companies but are available through a foreign institutional investor route for those who prefer investing in dollars rather than rupees. The fund is available for investment and redemption in dollars, hence, there is no issue of currency conversion for the investor. Do consider aspects like minimum ticket size of investment, charges and the underlying portfolio before picking a fund.
Safety in long term
If you are a long term investor, then simply pick good quality companies and stay invested for a few years. The rupee may fluctuate in the short to medium term, but over a period of time, if the Indian economy continues to grow at a pace relatively higher than the global average, currency will also adjust itself. If on the other hand you tend to book profits every few months, then you should take into account currency risk. Unless you are a seasoned trader, equities are best invested in for at least 5-10 years.