A plunging rupee may have scared foreign investors away from India's equity markets, but local institutions scent a buying opportunity.
The rupee has been one of Asia’s worst-performing currencies this year, losing about 12% against the US dollar by October 15. It hit a fresh low of 74.48 against the greenback on October 11.
The plunge has been driven by a rising current account deficit, climbing oil prices (India imports nearly 80% of the oil it uses), rising interest rates in the US and overall emerging market (EM) weakness, which has seen dollars flow back home, strengthening the greenback against most EM currencies.
Foreign investors have pulled a net $3.8 billion out of Indian stocks this year through October 12, as part of a global equity sell-off.
However, some local insurers argue this means it's time to jump in.
“We have actually been expecting a rupee depreciation on the back of rising crude [prices], a current account deficit, a strengthening US economy and rising interest rates from the Federal Reserve,” Sampath Reddy, chief investment officer of Bajal Allianz Life Insurance, told AsianInvestor late last month. "Hence we have been overweight on export-oriented companies and sectors."
Indian insurers don’t have direct foreign currency exposure in their portfolios, as they cannot invest overseas. However, it can still affect them through their equity exposure to Indian companies that earn some portion of their revenues offshore.
Reddy said the insurer had been recently buying company stocks of export-oriented sectors such as pharmaceuticals, IT services and other firms that export ancillary products to the US.
“They will likely surprise investors on quarterly earnings,” he noted, adding that the rupee movement has been an important consideration in making investment decisions recently.
About 20% of the insurer’s Rs519.7 billion ($7 billion) in assets under management is invested in equities. Bajaj Allianz is a joint venture between India's Bajaj group and Germany's Allianz.
It is estimated that exports of India’s IT services accounted for 83% of the industry’s revenues in 2017, while 50% of the revenue of the domestic pharmaceuticals industry come from overseas sales. A falling rupee will boost the local currency value of overseas sales for these companies, improving total revenues in rupee terms.
Sudhakar Shanbhag, CIO of Kotak Mahindra Life Insurance, shares Reddy’s views. “From a portfolio construction perspective, we have reasonable exposure to outsourcing themes like IT and pharma, which are based on the fundamentals of each business in addition to the currency risk/benefit these businesses carry,” he told AsianInvestor in late August.
In theory, the expected change in the exchange rate between two countries should equal the difference between interest rates in those two countries.Given the interest rate differentials between the US and India, most financial experts believe the Indian currency has to fall a few percentage points every year. The benchmark short-term interest rate (repo rate) in the US is below 1%, while in India it is 6.5%.
However, in reality, several other factors – such as rate of inflation, monetary policy expectations in both countries and geopolitics – tend to intervene, so the correlation between interest rates and foreign exchange rates is not always perfect.
Since the economic reforms of 1991, the rupee has weakened against the dollar at a compound annual growth rate of about 5%, noted Shanbhag. This sort of depreciation is not necessarily linear and must be considered in portfolio construction, he added.
The rupee’s sharp decline also prompted a raft of measures by the government on September 14 to encourage foreign investment in Indian bond markets and to make it less expensive for companies to borrow abroad.
But as a Moody’s report on September 24 noted, these measures are only likely to slow, not reverse, the Indian currency’s depreciation. For now, the rupee's slide is expected to continue.