India has been in the eye of the emerging market (EM) storm in the middle of 2013. Among EM economies, India has one of the largest current account deficits—at -5% of gross domestic product (GDP)—which is driven primarily by its trade deficit. As we mentioned in a previous blog post, in today’s market environment, countries with large external vulnerabilities have come under pressure. Given that India’s principal imports are oil and gold, the trade balance is particularly sensitive to rises in commodity prices.
However, the Indian rupee’s recent performance has not been driven solely by domestic factors. Speculation that the U.S. Federal Reserve (Fed) would begin tapering its bond-buying programs caused interest rates to rise for a four-to-five-month period from early May to September 18—the day the Fed decided to delay its tapering decision. Coinciding with a global rise in interest rates, the Indian rupee declined by over 15% from the beginning of May up until September 181. With the Fed surprising markets, we believe the India rupee may be undervalued at current levels.
Fed’s Inaction Delivers a Reprieve to India
The Fed’s decision not to taper, announced in its September 17/18 Federal Open Market Committee (FOMC) meeting, has supported prices in both equities and currency in India. In September, the MSCI India Index appreciated approximately 6.5%, while the Indian rupee appreciated over 4%.