India’s Rupee Has Best Week in Two Months on Inflow Optimism

India’s rupee completed its biggest weekly gain since January on speculation foreign investors will boost purchases of the nation’s assets to benefit from relatively stronger growth and returns.

The European Central Bank kept its benchmark rate at a record low yesterday and Federal Reserve Vice Chairman Janet Yellen said March 4 the U.S. central bank should press on with $85 billion of monthly debt purchases that depress yields. Morgan Stanley is bullish on the rupee and predicts India’s economy will expand 6.3 percent in the year through March 2014, following estimated growth of around 5 percent in the current period, as the government looks to attract foreign investment and improve public finances.

“Ongoing efforts at structural reform are a medium-term supportive factor, as is the high carry,” Kritika Kashyap, a Hong Kong-based analyst at Morgan Stanley, wrote in a report received today, referring to the practice of borrowing in a low-yield currency to invest in one with a higher interest rate. “Prospective monetary policy easing over the first quarter is likely to be positive for growth expectations and support the currency.”

The rupee advanced 1.1 percent this week to 54.2925 per dollar in Mumbai, the biggest gain since the five days through Jan. 18, according to data compiled by Bloomberg. One-month implied volatility, a gauge of expected moves in the exchange rate used to price options, dropped 54 basis points, or 0.54 percentage point, this week to 9.22 percent. The rate fell five basis points today.

Current Account

The currency may weaken to 55.5 in the “next few months” due to uncertainties over U.S. spending cuts and Europe’s debt crisis, according to Morgan Stanley, which predicts subsequent gains.

The shortfall in India’s current account, the broadest measure of trade, is a “greater worry” than the nation’s fiscal deficit, Finance Minister Palaniappan Chidambaram said in his Feb. 28 budget speech. The gap, a record 4.2 percent of gross domestic product in the 12 months through March 2012, is expected to be “significantly higher” this year, central bank Governor Duvvuri Subbarao said Feb. 11. Morgan Stanley predicts the shortfall will narrow to 3.9 percent of GDP in the coming fiscal year.

Rate Cut

The monetary authority lowered its benchmark repurchase rate by 25 basis points to 7.75 percent on Jan. 29, and said slowing inflation gives some room for more easing. A further reduction in borrowing costs will encourage foreign direct investment and purchases of Indian stocks, strengthening the rupee even as the currency loses some of its yield support, according to Morgan Stanley.

Euro-based investors will earn 12.1 percent including interest, the most in Asia, by holding rupees until the end of this year, based on currency forecasts and deposit rates compiled by Bloomberg. Dollars will earn 10.2 percent.

Three-month onshore rupee forwards traded at 55.34 per dollar, compared with 55.66 yesterday, according to data compiled by Bloomberg. Offshore non-deliverable contracts were at 55.37 versus 55.48. Forwards are agreements to buy or sell assets at a set price and date. Non-deliverable contracts are settled in dollars.

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