Rupee return seen best in emerging markets as growth beats China

Mumbai: The rupee’s retreat this quarter hasn’t dented forecasts for returns in the high-yielding currency as India overtakes China as the world’s fastest-growing economy.

Investing dollars in rupees will earn 5.2% this year, including interest, according to predictions by 32 strategists compiled by Bloomberg. That’s the highest total return among 23 emerging markets and compares with gains of 3.1% for Mexico’s peso and 2% for China’s yuan. India’s currency has lost 2.3% since 31 March, wiping out the first quarter’s 0.9% advance.

Growth looks set to accelerate as Prime Minister Narendra Modi opens more industries to foreign investment and Reserve Bank of India (RBI) governor Raghuram Rajan cuts borrowing costs. India’s sovereign bonds offer the second-highest yield in Asia and rupee swings have declined from a one-year high as rising currency reserves shield the nation from the risk of outflows as the Federal Reserve prepares to raise interest rates.

“Among emerging-market currencies, India still looks relatively attractive,” said Mitul Kotecha, head of Asia- Pacific currency strategy at Barclays Plc in Singapore. “The rupee’s high yield, and India’s improving economic and political fundamentals are likely to remain attractions for longer-term investors.”

Bond returns

Indian government bonds have handed investors the best gains in Asia in the past six months in local-currency terms. Rupee-denominated debt returned 5.7% compared with 2.6% on Chinese notes and 2.3% on Indonesian securities, indexes compiled by Bloomberg show. Indian 10-year notes pay 548 basis points more than similar-maturity US Treasuries.

Investors borrowing in dollars to purchase rupee fixed- income assets earned 1.6% this year, the third-best carry-trade return in Asia. Global funds have increased their holdings of Indian government and corporate debt by $6.1 billion this year after a record $26 billion of inflows in 2014. The rupee has climbed 7% from a record low of 68.8450 a dollar in August 2013, as the nation reduced current-account and budget deficits and lower oil prices cooled inflation.

“The complete picture is one of relatively strong growth, improvement in the current-account and fiscal deficits and the Modi government putting India on a higher growth trajectory,” said Kotecha from Barclays. “If we look at the carry and risk- adjusted returns, the rupee comes out top among Asian currencies.”

Growth forecast

Asia’s third-largest economy expanded 7.5% in the three months to December, compared with 7.3% growth in China. The International Monetary Fund (IMF) predicts India’s gross domestic product will increase 7.5% in 2015, the most in five years, while China’s expansion will slow to 6.8% from 7.4% in 2014.

Modi’s government has increased foreign investment limits in businesses such as insurance, defense and railways, deregulated fuel prices and pledged to cut red tape in a nation ranked 142 out of 189 countries by the World Bank in the ease of doing business.

“The Indian story is in better shape than back in 2013,” said Jonathan Cavenagh, a currency strategist at Westpac Banking Corp. in Singapore. “India’s reserves position looks exceptionally strong. Rajan has done an excellent job to mitigate those risks.”

Record reserves

Foreign reserves rose to a record $353 billion as of 15 May. That along with faster growth and reduced twin deficits provide India with layers of defense to tackle any volatility in fund flows, RBI’s Rajan said 22 May.

ABN Amro Bank NV said the rupee will still weaken when the Fed starts raising rates later this year. The Dutch lender on 19 May cut its year-end forecast for the currency to 65 a dollar from 64. That’s weaker than the median forecast of 63.90 in a Bloomberg survey of 32 strategists. The rupee fell 0.6% to 63.9775 on Tuesday.

“When the Fed starts raising rates, the rupee won’t be immune to volatility,” said Roy Teo, a Singapore-based currency strategist at ABN Amro. A rebound in oil prices may also reignite concerns about India’s twin deficits, he said.

Foreigners pulled $1.3 billion from Indian bonds this month as a 19% jump in oil prices this quarter threatens to fuel inflation and increase the nation’s import bill.

Even so, one-month implied rupee volatility, a gauge of expected swings, has still fallen 236 basis points to 6.43% from a one-year high reached on 11 May.

“India is slightly better placed on possible improved economic growth amid an investment upswing,” said Saktiandi Supaat, head of foreign-exchange research at Malayan Banking Bhd. in Singapore. He predicts the rupee will strengthen to 63 by year-end, though the current-account deficit remains a source of vulnerability. Bloomberg