Rupee Carry Magic Looks Volatility-Proof as Funds Weigh Brexit

  • Rupee Sharpe ratio is second highest among developing nations
  • Rupee ‘probably one of the safest:’ AllianceBernstein

The Indian rupee has been the best-performing carry trade in emerging markets in the past year after the Indonesian rupiah by one measure. For some investors, that’s a reason to stick with it as storm clouds gather.

Record foreign-exchange reserves, low overseas ownership of Indian debt and high yields make the rupee one of the safest currencies in emerging markets, said Brad Gibson, a Hong Kong-based portfolio manager for AllianceBernstein LP, which oversees $487 billion globally. The rupee’s Sharpe ratio -- which gauges returns from borrowing in dollars to buy the currency adjusted for price swings -- was 0.49 in the past year, the second-highest among 23 developing-nation exchange rates tracked by Bloomberg. That for Indonesia was 0.81.

“In Asia, there aren’t many currencies that offer decent carry, so we’re content to accept the volatility of the rupee for the carry on offer,” Gibson said in an interview. “While we are not strongly positive on the bond markets at these levels, the currency in terms of the carry is probably one of the safest in emerging markets.”

Investor anxiety over the U.K.’s June 23 vote on European Union membership ahead of this week’s central bank meetings in the U.S. and Japan has roiled global markets, with rising volatility spurring risk aversion. A gauge of expected swings in the rupee headed for its biggest two-day jump since August on Wednesday amid signs demand for local assets is waning.

AllianceBernstein joins Pacific Investment Management Co. in favoring the rupee as a target for carry trades, which are financed with lower-yielding currencies. The rupee is expected to remain stable and will most likely perform better than other Asian currencies, Luke Spajic, head of portfolio management for emerging Asia at Pimco, which oversees about $1.5 trillion in assets globally, said in an interview.

The Indian currency is forecast to deliver a 2.1 percent total return by end-2016, Asia’s best, estimates compiled by Bloomberg show, even as its spot rate has dropped 1.5 percent so far this year to 67.1250 a dollar in Mumbai on Wednesday. While the currency weakened 4.4 percent in the past 12 months, its total return was 3 percent. AllianceBernstein predicts it will end the year around 66-67 a dollar.

‘Shouldn’t Deserve’

India’s world-beating economic growth and improvements to its current-account and fiscal deficits have burnished the appeal of the nation’s assets. Foreign funds have poured a net $2.9 billion into local shares in 2016, a fifth straight year of inflows, while overseas holdings of rupee-denominated debt surged 2.2 trillion rupees in the last two years before falling by 99 billion rupees ($1.5 billion) in 2016. Foreign-exchange reserves soared to an unprecedented $363.5 billion last week.

“Fundamentally, India has improved immensely,” said Anthony Chan, a senior economist at AllianceBernstein. “India should do better in case of an emerging-market selloff or a big risk-off event and shouldn’t deserve the same scale of a selloff as other emerging markets may see in the region. The Reserve Bank of India has enough reserves to put to work to defend the currency.’’

The investment manager isn’t holding Indian sovereign bonds as it doesn’t see the Reserve Bank of India easing monetary policy further after five interest-rate reductions since early 2015. It is betting on rising swap rates.

The yield on benchmark 10-year government notes climbed to 7.53 percent on Monday, its highest close since March 16, before a report showed consumer inflation accelerated to a 21-month high of 5.76 percent in May. The yield was at 7.51 percent on Wednesday. Five-year offshore interest-rate swaps rose eight basis points in the last two days to 6.68 percent, the highest close since June 3. They were steady on Wednesday.

“We don’t think that bond yields in India are going to fall significantly," said Gibson. "The RBI is unlikely to cut rates so it’s more about carry and not rally.”

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