The Case for the Rupee: Currently at a Significant Discount
On a long-term basis, the Indian rupee is an emerging market currency selling at the greatest discount to purchasing power parity of all emerging market currencies. Some of this discount is warranted—the high inflation levels in India will likely be a headwind for the currency, as it erodes India’s purchasing power over time. But the convergence of India’s demographics and income growth potential with those of the rest of the world argues the long-term fundamental case for the country’s ability to catch up as money flows into its economy.
India’s Central Bank Establishing Credibility
There is no question India’s currency has been volatile. But the new head of its central bank, Raghuram Rajan, has been a very positive influence. By hiking interest rates during his early days in office, he made it more expensive for speculators and hedgers to short the rupee. He also re-established the inflation-fighting credibility of the central bank in the eyes of many investors. This has made it more attractive to get exposure to the rupee via a fund, such as ICN, that seeks to collect the interest rate differential after expenses.
Macroeconomic Tide May Be Turning
Additionally, India has been proactive in addressing its external vulnerabilities and fiscal corruption concerns. Its current account position has improved considerably, inflation has slowed— even though it remains high, specifically for core consumer prices—and slow but encouraging progress on fiscal reforms has been made.
There is also an emerging consensus that the opposing Bharatiya Janata Party (BJP) and its coalition for the upcoming national elections will have the potential to provide a boost for investor confidence in India.
From a valuation standpoint, long positions in the rupee against the dollar offer a high level of carry or potential interest return per unit of risk. The rupee ranks third in its measure of carry to its volatility amongst other emerging market currencies, behind the Peruvian new sol and the Brazilian real.4
Conclusion: Portfolio Perspective on the Rupee
If one is looking to get access to emerging markets, the high interest rates in India are an interesting way to achieve that exposure. We think allocations to ICN have broad applications within client portfolios, such as:
1) Augmenting emerging market fixed income portfolios: For many investors, assessing the pros and cons of exposure to rupee debt can be challenging; ICN can facilitate access to the Indian currency and its local short-term rates.
2) Blending in with Indian equities to help mitigate the risk profile of one’s overall Indian investments.
1Refers to the S&P BSE SENSEX Index hitting 21,934 as of 3/10/2014.
2Refers to the WisdomTree India Earnings Index and the Indian rupee’s cumulative returns from 12/3/2007 to 2/28/2014.
3Source: Bloomberg, as of 2/26/2014, effectively the last day of the month with viable data.
4Source: Bloomberg, as of 02/28/2014.
Important Risks Related to this Article
There are risks associated with investing, including possible loss of principal. Foreign investing involves special risks, such as risk of loss from currency fluctuation or political or economic uncertainty. This Fund focuses its investments in India, thereby increasing the impact of events and developments associated with the region, which can adversely affect performance. Investments in emerging or frontier markets are generally less liquid and less efficient than investments in developed markets and are subject to additional risks, such as risks of adverse governmental regulation and intervention or political developments.
WisdomTree Head of Fixed Income & Currency Rick Harper contributed to this piece.