Go long on the rupee to target Indian growth

WITH the Indian government finally adopting a standardised symbol for the rupee last month, there are ever more signs that the currency is going to become more accessible to investors. Given its persistent weakness against the dollar in recent times – out of line with other Asian currencies, as the chart on the right shows – traders should look to the rupee both for near-term rallies and long-run appreciation.

Despite its growing availability to forex traders, the rupee is still far from a freely traded currency. It is easy to buy for long bets, but the Reserve Bank of India (RBI) makes it difficult to sell the currency, so short trades require the purchase of a non-deliverable forward (NDF). Given that a NDF on unusual currency pairs is likely to have a wide spread, in practice, shorting the rupee is only worth it for large institutions.

Fortunately, traders should currently be going long on the rupee. Although the rupee has rallied in the last week from a high around R46.8 to around R46 per dollar, most analysts think it will rise further this year. One of the primary drivers of rupee appreciation is likely to be a steady rise in Indian interest rates – or repurchase rates – throughout the rest of the year.

With non-food inflation at 10.6 per cent and growth projected to be 8.5 per cent, the RBI hiked repurchase rates by 0.25 up to 5.75 per cent and reverse repurchase rates by 0.5 to 4.5 per cent. Because of the lack of a developed credit market, the RBI uses repurchase rates to influence money supply: the “repo rate” is the interest rate the RBI gives on deposits, while the reverse repurchase rate is the rate it pays on loans. And the Bank has signalled that it is likely to raise both rates further to combat inflation, which has become even more challenging in light of this week’s 38 per cent spike in the wheat price.

Yet, as analysts at Deutsche Bank highlighted last week, the rupee has not yet strengthened on the back of this signal. In a note entitled “Why is the rupee so weak?”, DB speculated that increased gold imports for the festival season, greater oil imports to meet new clean diesel regulations, and a combination of foreign direct investment and defence imports could be behind Indian demand for the dollar. Combined, the cyclical nature of these factors have convince analysts that we could be in for a rising rupee in the fourth quarter.

Standard Charter’s Callum Henderson and Thomas Harr agree, citing India’s strong economic outlook and the possibility of higher-than-expected capital inflows as drivers of rupee appreciation. They target a rate of R45.5 to the dollar by the end of the year.

The long-term outlook is similarly rosy with the rupee likely to offer growth alongside Indian equities. So with more “exotic” currency products coming out all the time and spread betting providers expanding their coverage, forex traders should keep an eye on India.