Rajan Hailed as Swings Drop Amid Gundlach Warning: India Credit

Traders are rewarding India’s new central bank chief with the biggest drop in currency swings among emerging markets, even as fund manager Jeffrey Gundlach says the nation could trigger the next major financial crisis.

The rupee’s one-month implied volatility versus the dollar, a gauge of expected fluctuations used to price options, has fallen 446 basis points to 17.78 percent since Aug. 28, when the currency touched an all-time low of 68.845 against the greenback, data compiled by Bloomberg show. The measure dropped 254 basis points for Brazil’s real and was little changed for Russia’s ruble and China’s yuan.

The decline suggests more traders are betting the rupee will sustain its 7.4 percent rebound from the record-low as Governor Raghuram Rajan builds the Reserve Bank of India’s defenses with concessional swaps for lenders’ foreign-currency deposits and vows to rein in inflation. Gundlach, manager of the $36 billion DoubleLine Total Return Bond Fund, said this week India is most vulnerable among emerging economies as it relies too much on outside capital to finance its deficit.

“There is less uncertainty in the rupee after the RBI delivered its message, and people have started unwinding their bearish positions,” Unnikrishnan K, a Mumbai-based options and rates trader at IndusInd Bank Ltd., said in an interview yesterday. “Sentiment has improved, but nothing has changed on the fundamentals,” he said, adding that Gundlach’s warning is “scary” and shouldn’t be dismissed.

Rajan Measures

Rajan, 50, began his three-year term on Sept. 4 with measures to stem the rupee’s worst crisis since 1992. The currency slumped 14 percent in the three months through Aug. 31 as investors pulled $12.6 billion from local bonds and stocks amid capital flight from emerging markets triggered by prospects of the Federal Reserve reducing its record stimulus.

The new governor pledged to maintain monetary stability and announced a window for banks to swap new foreign-currency deposits by non-resident Indians at 3.5 percent, a move that Bank of America Merrill Lynch estimates will add $10 billion to India’s reserves.

JPMorgan Chase & Co. closed its bet against the rupee on Sept. 9 and Elara Securities Pvt. predicts it will climb to 62 per dollar by March. The rupee’s gain since Aug. 28 is the biggest among 24 emerging-market currencies tracked by Bloomberg. It fell 0.9 percent to 64.09 in Mumbai today.

Rupee Bets

“The central bank’s moves have prompted funds not to bet against the rupee,” Lutz Roehmeyer, who helps manage 600 million euros ($798 million) including Indian assets as a director at Landesbank Berlin Investment, said in a Sept. 11 telephone interview. “We are waiting for India to further open its markets, particularly the government bond market.”

The yield on India’s 7.16 percent rupee-denominated bond due May 2023 rose two basis points, or 0.02 percentage point, to 8.52 percent today, according to central bank prices. It reached a three-year high of 9.24 percent on Aug. 19.

The nation’s sovereign bonds handed investors a 1.6 percent gain this month though yesterday, Asia’s best performance, according to indexes compiled by HSBC Holdings Plc.

Credit-default swaps insuring the bonds of State Bank of India against non-payment for five years have fallen 40 basis points from a 14-month high of 372 touched on Aug. 20, according to data provider CMA. The contracts climbed 106 basis points last month in the biggest surge since October 2008.

Rebound Temporary

The rupee’s rebound may be temporary as currency strategists predicted further weakness in the months ahead amid speculation the Fed will start reducing its unprecedented stimulus as early as next week, when the Federal Open Market Committee meets Sept. 17-18.

Credit Agricole CIB forecasts the rupee will reach 75 per dollar by end-2014. Nomura Holdings Inc. said in a Sept. 5 report that India’s weak economic growth and deficits in its budget and current account will result in more rupee weakness.

Gross domestic product expanded 4.4 percent last quarter from a year earlier, the least since the three months ended March 2009, as investment and consumer spending slowed. The shortfall in India’s current account, the broadest measure of trade, widened to a record 4.8 percent of GDP in the year ended March 31, official data show. The RBI considers the gap the biggest risk to Asia’s third-largest economy.

Crisis Warning

Los Angeles-based Gundlach, citing comments by Ray Dalio, founder of $145 billion hedge-fund firm Bridgewater Associates LP, that the next major financial crisis may come from an emerging-market country, said India is the most likely candidate to trigger such a crisis because of its excessive reliance on outside capital to finance its deficit. China and Russia, by contrast, are relatively insulated, Gundlach said.

“Non-stable flows,” including purchases of Indian stocks and bonds by foreign institutional investors and short-term credit, comprised more than half of total capital inflows in the last fiscal year, compared with one-third in the previous period, according to the RBI’s annual report released Aug. 22.

Foreign funds are returning to India after the recent market rout, exchange data show, helping the rupee rebound. Overseas investors have bought $70 million of Indian debt more than they sold since Rajan took over as RBI governor on Sept. 4. They also added a net $883 million of equities.

Any slide in the rupee toward 65 per dollar is excessive, Ashish Kumar, an economist at Elara Securities in Mumbai, said by telephone on Sept. 11.

Rajan’s “arrival has given India a temporary but deserved bounce,” Neeraj Seth, Singapore-based head of Asian credit at BlackRock Inc., the world’s biggest asset manager with $4 trillion, said in a Sept. 10 e-mailed statement. “Rajan has the experience and, according to his first statements, the will to take tactical and specific measures.”

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