Moderating global growth, sticky inflation and political stagnation negatively impacted the Indian economy in 2012.
Growth decelerated to under 4% while above-trend inflation effectively tied the hands of the RBI.1 The rupee sharply declined against the U.S. dollar last year.
However, in February 2013, we mentioned that the Indian economy may be turning the corner.
As a result of recently announced tax reforms and a fresh round of interest rate cuts from the central bank, we are bullish on the Indian rupee in 2013.
Lower Oil and Gold Permits Easier Monetary Policy
Key commodities that account for a large percentage of the average Indian citizen’s spending have fallen significantly. So far this year, oil is down nearly 6.5% while gold has fallen 12%.2 With lower inflation being reported via the Wholesale Price Index (WPI), the Reserve Bank of India recently cut interest rates to help get economic growth back on track. In fact, the International Monetary Fund (IMF) forecasts that the Indian economy will grow by 5.7% in 2013.3 As a result of lowered borrowing costs and rebounding growth, we believe money may continue to flow into the Indian economy through accelerating foreign direct investment (FDI).
Lower Taxes, More Flows
On April 30, 2013, the Indian Ministry of Finance announced that withholding taxes on government and corporate debt would be cut from 20% to 5% effective June 1. Through lower taxes, the Indian government is attempting to make Indian debt more attractive to foreign investors. Flows from abroad could then give a lift to the rupee, a currency we believe to be undervalued compared to the U.S. dollar. According to the IMF, the Indian rupee is currently undervalued by nearly 62% versus the U.S. dollar.4
Next page: Even with Rate Cuts, Carry Still Attractive