Over the past couple of months, sovereign risk has dominated the headlines in the foreign exchange markets. Financially strapped countries like Greece have put the euro on its longest losing streak against the dollar since November 2008. Debt investors have also grown concerned about budget deficits in other euro-region countries such as Spain and Ireland. The USD is has risen nearly 10 percent from its lows against the EUR from just two months ago. From my perspective, the entire episode confirms the dollar's status is still the world's only reserve currency. However, not all currencies are being punished. The Indian rupee (INR) is one of the exceptions to this trend. Today, the INR closed near 46 per USD. The INR has only changed modestly in the past few months and is actually 6 percent higher against the USD since October, making it one of the best performing currencies. The reasons for its strength are a classic example of supply and demand.
Despite the global economic woes, India continues to grow at a better than average rate. India's government has set a goal of becoming the world's fastest-growing economy within four years, counting on an expanding pool of savings to help finance the nation's development. India's growth rate will likely accelerate to 8.2 percent in the financial year beginning April 1, a government report recently showed. India has averaged GDP growth of 7.1 percent over the past decade. It's also predicted that Western companies will continue outsourcing to India for information technology and business processing. Even Harley-Davidson plans to begin sales in India this year, while the world's largest retailer, Wal-Mart Stores Inc., is expanding to tap into an economy. As India grows, Goldman Sachs estimates India will need an investment of $1.7 trillion over the next decade to build roads, utilities, railways and other infrastructure.
The Indian stock market will continue to attract overseas investors. The prospect of faster economic growth attracted $17.5 billion of overseas investments into stocks in 2009, resulting in the benchmark stock index rallying to its highest level in 18 years. If you were fortunate to invest in the Bombay Stock Exchange Sensitive Index (SENSEX) in early 2009, you would have experienced a 120 percent appreciation. India's Finance Minister has said, "The rupee appreciation is because of the large inflow of capital." With this robust performance and predicted growth, the demand for the INR should remain strong.
On the other hand, inflation, if left unchecked, has raised fears it could dampen economic growth. Many analysts think that from a medium- to long-term perspective, a growth rate near 7.5.percent with inflation down to about 5 percent would be healthier for the Indian economy. The present consumer price index is rising nearly 15 percent annually. The country's poor are the hardest hit by the rising price of staple foods and fuel. The country's per capita GDP was $2,300 in 2008, almost half of China's $5,900, according to the World Bank data. Let's not forget, 50 percent of India's 1.2 billion citizens live on a meager 100 INR — little more than two dollars a day. The Reserve Bank of India (RBI) direction seems clear: to keep inflation low while allowing economic expansion to continue. The longer-term effect should further limit the supply of INR. The RBI will most likely raise interest rates. December industrial production grew an astounding 16 percent, the quickest pace since 1994. Inflation is expected to ramp up quickly due to the current easy monetary environment. A 300 basis point increase in interest rates from the current 3.25 percent this year will not be unreasonable given the expected strong growth for 2010.
India has also pledged to act on one of the largest budget deficit reduction schemes in 20 years. The finance minister recently unveiled plans to cut the deficit from 6.9 percent of gross domestic product to "only" 5.5 percent in the next fiscal year ending March 2011 and 4.1 percent in two years. "We want to make this recovery broad-based," the finance minister said as he announced increased spending for education, health, rural and urban infrastructure and farmer assistance. The effort will rely mostly on tax increases. The excise tax on most products was raised to 10 percent from the current 8 percent. In addition, India plans to raise almost $9 billion by accelerating sales of its many state-owned assets. If these projections become reality, there is a good chance the major credit rating could improve India's debt rating.
As long as these positive trends continue to exist, the INR will most likely remain a top performer. There is enough demand on a strong growth outlook from overseas investors, ample demand for India's skilled labor and a central bank that will control the supply of cash to keep inflation from spinning out of control. In addition, there is a central government that appears to be taking its deficit seriously. Most forecasts, including mine, have the INR stronger for the remainder of 2010. Buying INR non-deliverable forwards (NDF) may be the call. The one-year NDF is currently priced near 47, while the average forecast from Bloomberg is 43 INR per USD.
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