Investing strategies for a weak rupee

How you can plan asset allocation to hedge rupee depreciation

Indian corporates reported strong earnings in Q1FY19, and continue to gain traction. Both the Nifty and the Sensex have also attained life-time highs. However, the global macro backdrop for India is becoming cloudy due to sharp rupee depreciation and rising oil prices.

Although the rupee had been stable for a long period of time, year-to-date it has depreciated more than 13 per cent against the US dollar, and breached 72 to the dollar for the first time. In comparison, while the Chinese renminbi has depreciated 5 per cent, currencies of other emerging markets (EMs) such as South Africa, Russia and Brazil have depreciated 15-20 per cent against the dollar

The primary reason is that US GDP growth has been strong, boosting the odds of further rate hikes by the US Federal Reserve. The fact that this will lead to continuing strength in the dollar is weighing on EM currencies including the rupee.

In addition, Brent crude price has rallied more than 10 per cent over the past month, and crossed $80 a barrel. Consequently, India’s trade deficit has surged to a five-year high. Q1FY19 current account deficit (CAD) also widened and is projected to increase to around 3 per cent of GDP by March 2019.

Capital flows which had offset CAD in the past have not sustained this year. Foreign direct investment (FDI) has been dropping year-on-year. Fiscal deficit concerns and an increase in bond yields have seen a reversal of flows from foreign portfolio investors.

In response, the RBI has deployed $30 billion of its reserve buffer, and still has sufficient forex reserves of $400 billion. The RBI can also consider additional measures such as raising interest rates, issuing a foreign currency bond, or raising NRI deposits, amongst others.

There is a view that on a trade-weighted basis, the INR was over-valued, and that it is now moving towards its fair value. If Brent crude prices continue to rise and the RBI doesn’t intervene, more weakness is likely. But INR depreciation becomes a political issue in the run-up to the general elections. The government has already announced some remedial measures, and we can expect further measures.

Sectoral impact

Sharp rupee depreciation has a positive impact on the demand for Indian goods and services abroad. With many Indian companies importing raw material which is getting costlier, the end product is either exported with better profits due to INR depreciation, or domestically consumed at an increased price. The margins will depend on the ability of companies to pass on increased costs to the customer. Overall, analysts estimate that INR depreciation is marginally positive for Nifty earnings.

Sectors which will be impacted positively include: IT, as its service exports become more competitive; pharma, as most companies export generics; metals and mining, which will see better returns through exports despite costlier raw-material imports; and auto ancillaries, as most companies are net exporters.

Sectors that will be affected negatively include: oil marketing companies (OMCs), as forex cost is likely to get hurt; industrials and consumer, as net importers with dollar-denominated input costs are likely to suffer; and NBFCs, as the rise in benchmark 10-year yields impacts their margins, tightening liquidity.

In addition, companies with foreign debt, mainly in the infrastructure and energy sectors, will also be adversely impacted.

Options for investors

From an investor’s point of view, as rupee depreciates, it erodes their purchasing power. But they can evaluate options to hedge rupee depreciation.

Investors can consider international funds with large exposure to developed markets, especially the US. Not only will it enable them to achieve portfolio diversification, but also give them exposure to high-growth areas such as technology. Also, the underlying currency exposure can prove beneficial to those who expect to incur some dollar-based expenditure, such as children’s higher studies.

Just to give a perspective, over a 10-year period, the S&P 500 index in the US has given a compounded annual return of 9 per cent vs the Nifty 50’s compounded annual returns of 6 per cent, in US dollar terms.

Investors can also look at thematic funds focussed on export-oriented sectors such as IT which benefit from rupee depreciation. For example, year-to-date, the Nifty IT index has given a return of 38 per cent vs the Nifty 50’s 9 per cent, in INR terms. In addition, some domestic funds, for example, dividend yield funds, have a provision for fund managers to invest in international stocks. .

Investors can allocate 15-20 per cent of their portfolio across international equity funds, thematic export-oriented funds, and dividend yield funds to hedge rupee depreciation. A longer time horizon of three years is advisable for the international funds from a tax-efficiency standpoint.

The writer is Co-CIO,

Aditya Birla Sun Life AMC

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