Rupee Return Seen Best in Emerging Markets as Growth Beats China

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RBI Governor Raghuram Rajan
Raghuram Rajan, governor of the Reserve Bank of India. Photographer: Kuni Takahashi/Bloomberg

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 percent 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 3.5 percent for Mexico’s peso and 2.1 percent for China’s yuan. India’s currency has lost 2.5 percent since March 31, wiping out the first quarter’s 0.9 percent advance.

Growth looks set to accelerate as Prime Minister Narendra Modi opens more industries to foreign investment and central bank 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 5.8 percent compared with 3.1 percent on Chinese notes and 2 percent on Indonesian securities, indexes compiled by Bloomberg show. Indian 10-year notes pay 553 basis points more than similar-maturity U.S. Treasuries.

Investors borrowing in dollars to purchase rupee fixed-income assets earned 1.4 percent this year, the third-best carry-trade return in Asia. Global funds have increased their holdings of Indian government and corporate debt by $6 billion this year after a record $26 billion of inflows in 2014. The rupee has climbed 7 percent 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 percent in the three months to December, compared with 7.3 percent growth in China. The International Monetary Fund predicts India’s gross domestic product will increase 7.5 percent in 2015, the most in five years, while China’s expansion will slow to 6.8 percent from 7.4 percent 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 May 15. That along with faster growth and reduced twin deficits provide India with layers of defense to tackle any volatility in fund flows, Reserve Bank of India’s Rajan said May 22.

ABN Amro Bank NV said the rupee will still weaken when the Fed starts raising rates later this year. The Dutch lender on May 19 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 0.3 percent to 64.1350 as of 9:31 a.m. in Mumbai Wednesday.

“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 $1.4 billion from Indian bonds this month as a 19 percent 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 225 basis points to 6.54 percent from a one-year high reached on May 11.

“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.

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