India is using a surge in inflows into local bonds and equities to rebuild its currency reserves, boosting its ability to avoid a junk debt rating.
The Reserve Bank of India bought $820 million more than it sold in March, the first net purchase since 2010, official data published May 13 show. The RBI has purchased $1 billion since then and will buy an additional $8 billion through March 2014, Bank of America Merrill Lynch estimated in a May 16 report. The promise of the highest returns in Asia has boosted overseas holdings of Indian debt 15 percent this year to an all-time high of $38 billion, according to data compiled by Bloomberg.
RBI Governor Duvvuri Subbarao said this month India should be prepared for the probability of outflows next year as developed economies consider withdrawing stimulus measures. Even so, Standard Chartered Plc recommends investors buy the rupee to profit from a 3.9 percent gain by the end of this year as foreigners load up on debt after the government reduced taxes on the investments.
“Given India’s foreign-exchange reserve adequacy has worsened considerably, the central bank will use capital inflows to rebuild its reserves,” said Priyanka Kishore, a strategist at Standard Chartered in Mumbai. “The RBI is likely to let the rupee strengthen once it is more comfortable with the current-account outlook.”
The rupee is little changed in 2013 after slumping 22 percent in the past two years as inflation overshot the central bank’s target and the current-account deficit widened to a record. The currency stabilized after Prime Minister Manmohan Singh’s government further opened Asia’s third-largest economy to foreign investors and price pressures eased.
The shortfall in the broadest measure of trade is “by far the biggest risk to the economy,” Subbarao said May 3, the day he cut the RBI’s benchmark repurchase rate for a third time this year to boost the slowest economic growth in a decade.
Foreign-currency reserves stood at $294 billion as of May 10, official data show, 8.4 percent lower than an all-time high of $321 billion in 2011. That’s enough to cover about seven months of imports as of end-March, the lowest level among the largest emerging markets of Brazil, Russia, India and China, according to Bank of America.
The reserves “are low but not worryingly so” as organizations such as the International Monetary Fund consider three months of import cover as adequate, according to Credit Suisse AG.
Dollar-based investors will earn 9.4 percent including interest by holding rupees until the end of 2013, compared with 4.6 percent for the Thai baht and 3.1 percent for South Korea’s won, according to data compiled by Bloomberg based on surveys and prevailing interest rates. Indian debt returned 7.4 percent this year, the second-highest gain among the 10 Asian markets monitored by HSBC Holdings Plc.
Global funds bought a net $13.5 billion of Indian equities this year through May 17, and boosted purchases of rupee-denominated bonds by $5 billion, the highest inflows for the period, exchange data show.
Total purchases of sovereign and corporate debt could rise by as much as $18 billion in the year through March 2014, Standard Chartered estimates, after the government said last month it will cut a tax on interest earned by foreigners to 5 percent from 20 percent effective June.
“Since the start of the year, we’ve seen decent inflows into Indian assets, which is naturally creating rupee demand,” Jonathan Cavenagh, a strategist at Westpac Banking Corp. in Singapore, said in a May 15 telephone interview. “The RBI is probably using that opportunity to push reserves back up.”
The central bank bought $3.2 billion in March and sold $2.3 billion, RBI data show, while its outstanding dollar sales in the forward market fell to $11 billion, the lowest since May 2012. The rupee plunged to a record 57.3275 per dollar in June last year. The currency rose 0.1 percent to 55.0450 today.
“The RBI is intervening in both directions, trying to keep the rupee in the range of around 54 to 55 per dollar,” Robert Prior-Wandesforde, an economist at Credit Suisse in Singapore, said in a May 15 telephone interview. “The effort would be symptomatic of the RBI’s belief that it would be comfortable in meeting its twin goals of keeping inflation in check and not letting growth slip too much by keeping the currency stable at these levels.”
While a stronger currency helps keep India’s import bill in check, a weaker rupee helps exports stay competitive, he said.
The nation’s current-account deficit will stay at about 4 percent of gross domestic product this fiscal year, compared with 2.5 percent considered sustainable by Indian policy makers, Standard & Poor’s said in a May 17 statement.
India’s foreign-exchange reserves support its ’BBB-’ sovereign rating, the lowest investment-grade, S&P said, even as it reiterated a one-in-three chance of downgrading the nation in the next 12 months due to the government’s budget deficit.
Bond risk in India has fallen for all but one month since September, when Prime Minister Manmohan Singh started unveiling policy changes aimed at reviving economic growth and improving public finances to ward of the threat of a downgrade. Besides lowering the levy on foreign purchases of bonds, the government has reduced energy subsidies and allowed overseas investment in industries including aviation and retail.
The cost to insure the debt of State Bank, considered a proxy for the sovereign by some investors, for five years against non-payment using credit-default swaps has fallen 49 basis points this year to 177, according to data provider CMA, which is owned by McGraw-Hill Cos. The swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.
The RBI will look to keep the rupee between 52 and 56 a dollar as long as the U.S. currency trades in a range of 1.2 to 1.3 per euro, according to Bank of America. The monetary authority will buy the greenback when $5.4 billion pours in next month as Unilever Plc increases its stake in its Indian unit, the lender predicts. The open offer may start June 21 and close July 4, according to a tentative schedule published in an advertisement in the Economic Times newspaper.
“We are relieved that the RBI has resumed buying foreign-exchange,” Indranil Sen Gupta, a Mumbai-based economist at Bank of America, wrote in the research report. The bank forecasts the rupee will strengthen to 52.50 per dollar by the end of June.