RBI Cut Seen Adding Fuel to Rupee Rally as Two-Year High Reached

There’s no stopping the rupee. Strategists say Asia’s best-performing currency of the past six months could climb further as the Reserve Bank of India’s interest-rate cut lures more inflows into local shares.

Benchmark borrowing costs in Asia’s third-largest economy stand at the lowest since 2010, which could spur growth, boost earnings and encourage foreigners to add to $8.8 billion of local stock purchases this year. The rupee reached a two-year high after the RBI’s decision Wednesday, and Bloomberg Intelligence predicts the currency to further strengthen to 61 per dollar by March next year.

“The break in USD/INR below 64 suggests that the RBI will not be standing in the way of any increase in inflows, which could lead to some further near-term rupee appreciation,” said Khoon Goh, Singapore-based head of Asia research at Australia & New Zealand Banking Group Ltd. “Interest in the Indian economy will continue to be strong.”

ANZ is one of at least three global banks to have recently raised their year-end forecasts for the rupee, which has rallied 5.8 percent over six months. While India’s improving finances, higher real rates and rising foreign-exchange reserves have played a part in the rupee’s strong showing, the currency has also benefited from a weak dollar.

The rupee gained 0.1 percent to 63.6425 on Friday, set for the biggest weekly climb since April.

Foreign holdings of rupee-denominated government and corporate debt have surged by 1.39 trillion rupees ($21.8 billion) so far this year. While the RBI’s easing will narrow the spread Indian notes offer over Treasuries, strategists say the Asian nation’s yields, still the highest among major regional markets after Indonesia, keep the allure of rupee debt intact.

“Economic and political stability and reform momentum are attracting strong inflows, which will mean the rupee is set to continue appreciating,” said Abhishek Gupta, India economist at Bloomberg Intelligence in Mumbai. “Attraction for India’s debt market is based on factors such as a higher risk-free rate of return, a strong currency and possibility for further rate cuts.”

That said, some investors are growing skeptical about the outlook for foreign flows, arguing that equity valuations look expensive after benchmark indexes surged to record levels. At the same time, global funds have almost exhausted their purchase limits for Indian bonds, leaving little scope for them to add to their holdings of rupee debt in a substantial manner.

Read: HSBC Sees Rupee Drop as Foreigners Put Brakes on India Flows

“Much of the capital inflow into India this year has come from foreign investment into Indian local currency debt,” said Ray Farris, Singapore-based head of fixed-income research and economics for Asia Pacific at Credit Suisse Group AG. “This flow is now running up against regulatory limits and is likely to moderate sharply over the coming months.”

Farris, however, said his firm expects India’s government to increase limits on global funds’ holdings of bonds, which should prevent flows from “stopping outright.” The limits on foreign ownership have been a sore point with fund managers chasing returns in one of the world’s fastest-growing economy.

Below are year-end rupee forecasts and comments from strategists:

• Kritika Kashyap, rates strategist at Morgan Stanley in Hong Kong, wrote in report:
  • Stay bullish INR; rate cut should support further inflows in equities
  • USD/INR broke below the key support at 64, opening room for further downside interest in the pair, both from carry-seekers as well as exporters’ hedging demand
  • Continue to position for INR carry via short PHP/INR 3-month NDF
• Cristian Maggio, head of emerging markets strategy at TD Securities in London:
  • In India, where lower rates usually support stock prices, RBI’s move “could be marginally positive for INR"
  • Valuations look stretched after Sensex’s rally this year. The INR will correct if the market starts shunning Indian stocks. The rate cut will help delay this scenario, but may still fail to prevent it
• Credit Suisse raised its year-end rupee forecast to 63.72 per dollar versus an earlier estimate of 65.37
• Oversea-Chinese Banking Corp. raised its forecast to 63.18 from 65.67
• Barclays Plc sees the rupee ending 2017 at 63.30 versus previous forecast of 64
• ANZ has changed its call to 65 from 66