What’s Next for the Indian Rupee?

On September 30, 2014, Indian prime minister Narendra Modi met with President Obama during his first official visit to the U.S. since he was sworn in as prime minister four months ago. For Modi, this meeting marks the end of an ambitious foreign policy schedule that included meetings with leaders from nearly every major economy around the world. While the details of these discussions were not made public, the message from Modi’s public speeches has been clear: India is open for business. In advance of any formal changes in policy, we highlight a way to position for a resurgence in Indian growth through investments in the Indian rupee.

Even before the election results were fully counted in May, Indian currency and equity markets were reacting. After touching all-time lows last year, the rupee surged on the optimism that the reform-minded Modi would push through an agenda to improve Indian economic competitiveness. Today, Indian equity markets remain near their recent highs, up nearly 30% year-to-date. However, recent concerns about changes in Federal Reserve (Fed) policy and a general increase in risk aversion have seen the rupee fall back to pre-election levels. In our view, the rupee represents an attractive way to play Modi’s turnaround story in India. It also offers high short-term interest rates (8% implied yield for one month forward), specifically in relation to perceived risk in the currency. The rupee’s carry per unit of volatility is one of the highest among EM currencies (only China and Peru are higher). As we detail below, we believe the recent positive developments could support continued rupee appreciation through year-end.

Indian Rupee, 12/31/13-9/30/14

For definitions of terms and Indexes in the chart, visit our glossary.

#1: All Emerging Markets Are Not Created Equal

As our equity team noted in a recent blog post, India has been a bright spot for emerging market investors so far this year. As the market began pricing in the prospect of a Modi victory, equity markets rallied in anticipation. Although equity markets are up nearly 30% year-to-date, we believe that positive economic momentum could continue to push markets higher. As we noted in previous pieces, foreign investor flows into the Indian equity market can have a significant impact on the value of the rupee. Should these flows persist, we believe that they could support rupee appreciation.

#2: Credit Rating Agencies Are Taking Notice

On September 26, 2014, the credit rating agency Standard & Poor’s revised its outlook from negative to neutral. In their report, analysts noted that the political environment had shown a marked improvement. This could potentially support the government’s ability to implement reforms, spur growth and improve its fiscal performance.1 From the currency’s perspective, we believe that improved investor sentiment could support foreign investment. Longer term, S&P noted that, should per capita GDP increase to 5.5%, this increase could support a credit rating upgrade from BBB-.