Photographer: Dhiraj Singh/Bloomberg

HSBC Sees Rupee Drop as Foreigners Put Brakes on India Flows

  • INR could fall to as low as 65.25/USD over two months: Khanna
  • Remains constructive on the rupee from a carry perspective

The Indian rupee may weaken as global funds start to hit buying limits for the nation’s debt and valuations for equities look expensive, according to HSBC Holdings Plc.

“I won’t be surprised if we drift down to 65-65.25 to the dollar over the next two months,” Pradeep Khanna, HSBC’s head of global markets trading for India in Mumbai, said in an interview. “Equity valuations are stretched in India as company earnings haven’t changed much in the past two years while the market is much higher.”

While the benchmark S&P BSE Sensex index closed at a record high on Tuesday, foreign investors have turned net sellers of local shares in July for the first time in three months. The withdrawals come as hawkish comments from major central banks cloud the outlook for flows to emerging markets. Overseas purchases of Indian bonds too have slowed this month.

“Clearly, a slowdown is expected over there,” Khanna said, noting that global funds, whose access to Indian debt is restricted, have “utilized about 90 percent” of their investment limits. He also cited a seasonal increase in India’s trade deficit among the reasons for the rupee’s potential depreciation.

The Indian currency capped a fourth straight week of declines on Friday. It rallied 5.2 percent in the six months ended June 30, and was up 0.1 percent at 64.5150 per dollar in Mumbai on Wednesday.

Overseas investors have sold a net $244 million of shares this month, paring inflows for 2017 to $8.3 billion. Their holdings of rupee-denominated government and corporate bonds have risen by 71.6 billion rupees ($1.1 billion) in July, after surging 1.2 trillion rupees in the last five months.

Read: Buy India Trade Gets Hotter as RBI Dovishness Boosts Inflows

The rupee will broadly trade in a range of 64 to 66 per dollar for the rest of the year, Khanna predicts, adding that HSBC remains “constructive” on it from a carry perspective. Borrowing in dollars to purchase rupee assets has earned 8.1 percent in 2017, the highest carry returns in Asia, data compiled by Bloomberg show.

Following are Khanna’s views on the other key factors impacting the currency:

  • Trade deficit:
    • Khanna said he remains “watchful” on India’s widening trade deficit
    • “Over the last couple of months, there is a component driven by a spurt in gold demand, which could well be temporary but, to a certain extent, the trade deficit is higher than a couple of years back”
    • Also, the gap “is going up slowly without any recovery in oil prices. It is something I would think about for the medium term”
  • Reserve Bank of India’s currency management:
    • “I would tend to think they would smoothen volatility if there is a huge amount of inflow, or there is large depreciation because of seasonality factors, but on the whole, there seems to be much more comfort with regular market volatility”
    • “You tend to be more tolerant when you are operating from a position of strength”
    • NOTE: Forex reserves have jumped to a record $386.5b
  • Real rates:
    • “From a more immediate perspective, if inflation turns out to be benign at 3%-3.5%, even with a policy rate of 6%, we have 250-300bps of real rates, which isn’t too common in the world”
    • “This is very supportive for the currency”
  • Global monetary policy:
    • “The extent and the pace of monetary policy normalization undertaken by global central banks will be key”
    • “Mostly, it will be the ECB that is watched, because the Fed’s likely actions are far more telegraphed”
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