October 6, 2013 4:27 am

The rupee: the Cinderella of emerging market currencies?

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The skyline over the Dharavi slum in Mumbai at twilight©AP

The skyline over the Dharavi slum in Mumbai at twilight: India’s current account deficit has been spurred by the high cost of imported oil

The Indian rupee’s plummet to record lows recently prompted one fund manager to ask whether the currency is the Cinderella of its emerging market peers – or the ugly sister.

Some investors believe the worst of the currency turmoil is over after Raghuram Rajan, India’s new central bank governor, stepped in to calm the crisis by raising interest rates to 7.5 per cent last month.

But others doubt the sustainability of the rupee’s recovery given its vulnerability to US Federal Reserve announcements on the tapering of its bond-buying programme.

This susceptibility is exacerbated by India’s large fiscal deficit, its dependence on energy imports and the political barriers to enacting desperately needed structural reforms.

Nima Tayebi, executive director of JPMorgan Asset Management’s global fixed income group, says that these “lethal and toxic” factors culminated in August to relegate the rupee to the “fragile five” band of currencies.

Other members of this unpopular club include the Turkish lira, the Indonesian rupiah, the South African rand and the Brazilian real.

Thomas Beckett, chief investment officer of Psigma Investment Management, says it is “amazing” how quickly the revered Indian rupee became a “place to flee”, while China’s renminbi experienced the reverse.

Faced by such unpredictable conditions, the main lesson for investors exposed to India is to hedge their currency exposure before it becomes too expensive to do so, according to Mr Tayebi.

He says: “[Is India] through the worst for now? Possibly, but you can’t say it won’t happen again.”

Mr Tayebi points out that the cost of hedging the rupee reached extreme heights at the peak of the crisis in August when implied interest rates on non-deliverable forward contracts hit 20 per cent. Just two months earlier, however, the same interest rates were around 8 per cent.

David Cornell, chief investment officer of Ocean Dial, an India-focused fund company, agrees that one of the most obvious lessons for investors following the summer’s turbulence is to “hedge your rupee risk”.

But he adds: “Most investors who want exposure to Indian equities also want exposure to the currency, so long-term buyers of Indian equities will probably be unhedged.

“If you hedge your returns, you might as well invest in UK gilts.”

Mr Cornell believes, therefore, that the most important message has been for policy makers, not investors who remain committed to India’s long term growth trajectory.

He says: “The lesson for Indian policy makers is to fix the roof when the sun is shining, so when it rains you don’t get soaked. Now everyone is wet, policy makers have started to do something about [the currency].”

To address India’s fiscal deficit and its susceptibility to the investment whims of foreign investors, David Sloan, director of the Asia arm for Eurasia Group, a political risk consultancy, believes that the country’s policy makers should privatise energy production. This is because the main driver of the weakening rupee is the country’s current account deficit, which is spurred by the cost of importing oil. “As long as the oil import bill remains as high as it is and India has problems with oil production, this currency problem will persist,” Mr Sloan says.

Enacting major energy reforms, however, will be a “huge task for any policy maker to chew on”, he adds, particularly in the fiercely partisan political environment in the run-up to India’s elections, which will take place in the first half of 2014. Yet despite lingering concern over India’s reliance on external financing and the central bank’s ability to shore up its currency, Psigma’s Mr Beckett believes thick-skinned investors could still stand to gain from the rupee’s crash.

He says: “The key lesson we have learnt is that you should always invest after precipitous falls and periods of underperformance. This might be wrong [over the] short term, but we expect to be well rewarded in the years to come.”

Mr Beckett’s fund house consequently plans to take on some exposure to India for the first time in early November.

Ocean Dial’s Mr Cornell agrees that the currency swings could prove advantageous for hardened investors willing to “stomach the volatility”.

He believes the main impact of the Indian interest rate change was to restore confidence among foreign investors, which in turn encouraged $2.1bn of assets back into the economy over September.

“Investors should be buying Indian currency like it is going out of fashion, because to make money in India, you have to invest when sentiment is negative,” he says.

Jan Dehn, head of research at emerging markets specialist Ashmore, goes one step further. “There is no crisis” with the Indian rupee, he believes, adding that India is simply undergoing “a standard macroeconomic adjustment following a period of excess domestic demand”.

He adds: “The cure is demand restraint and currency adjustment, [and] India is doing both.

“Its banks are healthy, it has $277bn of reserves, modest levels of government debt, plenty of policy choices, and growth is going to trough out around 4 per cent real GDP growth. Investors should not – nor will – give up on India.”

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