One of the most impressive changes to the global economy is the ascent of India and its growing role in international financial markets and the global economy. The size of its economy has doubled to $4 trillion over the past decade and it’s becoming a major player in the international economy.
India now has the fifth-largest stock market, and its $1.3 trillion sovereign debt market is the darling of global and institutional investors looking for solid fixed income returns and using its stable currency, the rupee, as the source of a lucrative carry trade across the $7.5 trillion daily churn in global capital markets.
Read more of RSM’s insights on the global economy and the middle market.
The rupee has been relatively stable against the dollar this year and has depreciated by only 0.26%jj, from 82.35 at the outset of the year to a low of 83.57 on June 11. On Wednesday, it stood at 85.43.
Forward pricing on the rupee implies a year-end price of 84.04 to the dollar and implies further depreciation to 94.02 over the next three years, or a 12% depreciation in the value of the rupee at a pace of 2.3% per year.
As long as the Reserve Bank of India remains committed to intervening into global currency markets to stabilize the rupee at or near current levels, international and institutional investors will continue to use the rupee as the basis of a global carry trade that then bolsters dollar-denominated assets in the U.S. and other select economies.
In fact, JPMorgan is now set to include Indian fixed income assets into its emerging market global bond index, which will stimulate demand for rupee denominated assets.
For those unfamiliar with global foreign exchange markets, the carry trade is a trading or forex management strategy that focuses on borrowing at a low interest rate and investing in an asset proving a higher rate of return.
Traditionally, this involves borrowing in a low-interest rate currency and transforming that quantity into another currency.
For the past three decades or so, this has been one of the more popular trading and hedging strategies organized around the yen-dollar carry trade. Once the funds are exchanged into the bilateral pair–for example, borrowing in yen and purchasing the U.S. dollar–it is used to purchase bonds, commodities, equities or real estate.
Today, investors, especially traders and foreign exchange managers in Asia, seek to do the same with rupee-dollar bilateral pair.
A look at what is called the one-month implied volatility–a measure of expected future volatility of the underlying asset between now and the option maturity date, which is based on the Black-Scholes option pricing model–of the dollar-rupee results in 3.55, which explains why.
This favorably compares with regional peers such as the Chinese, Thai, Korean and Philippine currencies, and that return is why the rupee is the favored regional carry trade against other local currencies even as the rupee has modestly depreciated against the greenback this year.
Over time, as the Indian economy grows and expands into the lucrative provision of global economic services, demand for rupees will expand and it will test the Reserve Bank of India’s commitment to keeping the rupee undervalued and a cheap funding currency.
For now, however, the quickly changing structure of the global economy favors the rupee-dollar carry trade as well as purchases of the rupee versus other regional currencies.
