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Rupee Seen Rallying 4.4% as Options Turn Bullish: India Credit

India’s rupee will extend its best rally in three years and strengthen past 50 per dollar in 12 months as the government’s biggest policy push since 2009 lures investors, according to the most-accurate forecaster.

The rupee will rise 4.4 percent in a year to 49.70, according to Oversea-Chinese Banking Corp., which had the closest estimates in the last six quarters as measured by Bloomberg Rankings. One-month contracts offering the right to buy the rupee are costlier than those to sell for the first time in three years, data compiled by Bloomberg show. The so-called risk reversal rate is below zero compared with 25 basis points for China’s yuan and 49 for the South Korean won.

Overseas funds bought a combined $4.3 billion of Indian bonds and shares last month, after global central banks added monetary stimulus and Prime Minister Manmohan Singh eased rules for foreign investment in retail and airlines and cut fuel subsidies. The measures will give the Reserve Bank of India room to reduce borrowing costs, boosting inflows and the rupee, according to second-ranked Credit Suisse Group AG.

“Recent moves to contain the fiscal deficit have been relatively well received by investors and steps to open up various industries to foreign participation are also perceived to be supportive,” Emmanuel Ng, a strategist at OCBC in Singapore, said in an interview yesterday. “It’s a matter of implementation, conviction and follow-through on the policy reforms.”

The rupee rallied 5.3 percent last quarter, the most since 2009, to become Asia’s best-performing currency from its worst in the preceding three months, data compiled by Bloomberg show. It rose 0.5 percent to 51.8825 a dollar today.

Policy Changes

India increased state-controlled diesel prices on Sept. 13 after a 14-month freeze, reducing the government’s fuel-subsidy burden and underpinning plans to curb the widest budget deficit among the largest emerging markets. The shortfall, which was 5.8 percent of gross domestic product in the 12 months ended March 31, may be contained at about 5.3 percent this fiscal year, two officials with knowledge of the estimate said last month.

Singh’s cabinet on Sept. 14 allowed overseas retailers such as Wal-Mart Stores Inc. to open outlets with 51 percent ownership, said foreign airlines can own minority stakes in local carriers and approved stake sales in four state companies including National Aluminium Co. On Sept. 21, the government cut the so-called withholding tax, a levy on interest earned by overseas investors and lenders from foreign-currency bonds and loans of Indian companies, to 5 percent from 20 percent for three years starting July 1, 2012.

Capital Inflows

Global funds responded by pumping $4.1 billion into holdings of Indian shares last month, the biggest inflow since February, while investments in debt increased $262 million, according to data from the securities regulator.

A stronger rupee makes oil imports cheaper for the nation that buys 80 percent of its crude overseas. This helps narrow the current-account deficit, further boosting the currency, according to Credit Suisse, which predicts an appreciation to around 50 a dollar in the next three or four months.

“The economic reforms are likely to make it easier to finance the deficit,” Robert Prior-Wandesforde, an economist with Credit Suisse in Singapore, said by e-mail yesterday. “By opening up more sectors to foreigners, inward direct investment should improve in time. This will enhance the quality of the inflows, hopefully improving the stability of the rupee.”

The Swiss bank predicts the gap in the broadest measure of trade will be 3.3 percent of GDP in the year through March 2013, compared with a record 4.2 percent the previous 12 months. The current-account deficit narrowed to $16.6 billion in the quarter ended June 30, from $21.8 billion in the preceding three months, official data showed Sept. 28.

Political Risk

Asia’s third-largest economy expanded 5.5 percent in the three months ended June 30, government data show. Growth was 5.3 percent in the previous quarter, the least since 2009. GDP increased an average 7.9 percent in the previous five years.

The biggest risk to rupee forecasts is the possibility that implementation of Singh’s policies will be hindered by political opposition, according to OCBC, Southeast Asia’s second-largest banking group. The measures prompted one of Singh’s main political allies to quit the ruling coalition and opposition parties held a nationwide strike on Sept. 20.

The rupee will touch 53 per dollar in the next 12 months and forward contracts will see slower appreciation than the spot rate, according to Morgan Stanley, the fourth-ranked forecaster. The U.S. bank said in a Sept. 28 research note it is “mildly bullish” on the rupee and “bullish” on China’s yuan.

‘Prospects Positive’

“Long-term prospects remain positive as long as funding markets remain liquid and the government remains committed to reform,” strategists at Morgan Stanley, including New York- based Ronald Leven, wrote in the report.

Credit risk is falling for government-controlled State Bank of India, considered a proxy for the sovereign by some investors. The cost of insuring the Mumbai-based lender’s debt for five years against non-payment using credit-default swaps has dropped 121 basis points from a five-month high of 389 in June, according to data provider CMA, which is owned by McGraw- Hill Cos. The contracts pay the buyer face value in exchange for the underlying securities or the cash equivalent should the borrower fail to adhere to its debt agreements.

Nordea Bank AB (NDA), the largest Nordic lender and the third- most accurate rupee forecaster, predicts India’s currency will strengthen to 48 against the dollar in 12 months as investors buy more of the nation’s bonds. The benchmark 10-year note offers an extra 651 basis points over similar-maturity U.S. Treasuries, data compiled by Bloomberg show. Rupee-denominated debt returned 7.5 percent this year, the best performance among 10 Asian markets monitored by HSBC Holdings Plc.

Yield, Volatility

The yield on the 8.15 percent note due June 2022 fell one basis point today to 8.14 percent. The rupee’s one-month implied volatility has fallen 95 basis points in 2012 and touched 8.5 percent on Sept. 13, the lowest level in a year, reducing the risk that currency swings will wipe out profits.

Dollar-based investors who buy rupee-denominated assets will earn 7.7 percent in a year, including interest, according to data compiled by Bloomberg, the best gain among the 11 most- traded Asian currencies.

“The rupee is one of the highest yielding currencies in the emerging-market universe, and in this low volatility environment investors are chasing the yield,” Aurelija Augulyte, an emerging-market analyst at Nordea in Copenhagen, said by e-mail yesterday. “The rupee was one of the most harshly punished over the past few years, and has room to recover.”

To contact the reporters on this story: Jeanette Rodrigues in Mumbai at jrodrigues26@bloomberg.net; David Yong in Singapore at dyong@bloomberg.net

To contact the editor responsible for this story: James Regan at jregan19@bloomberg.net

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