The Indian Rupee (INR) is gaining ground against US$ and against its emerging market peers.

Last month, the INR reached a 20-month high against US$. It has raced 5% over the greenback already since the beginning of 2017.
 

A sharp Jump in INR against US$

Data as on May 02, 2017
Source: ACE MF, PersonalFN Research)

Usually, the strength of any domestic currency highlights the underlying strengths of the economy.

But, this baffling rise in the value of INR may look more worrying when the economy is struggling to grow and create more jobs.

Well, some of the factors responsible for the unique strength of the INR have to do with developments in India, while others pertain to external events.

Global Factors...
 

• Recently, the U.S. President Mr Donald Trump expressed concerns about the unprecedented strength of US$ as it may hurt the business interest of U.S. corporation overseas. As a result, the US$ lost momentum against some of the world’s major currencies, leading in the flow of capital to the emerging markets.
   
• As the chances of Mr Emmanuel Macron as the next president of France brightened, concerns over the disintegration of the Euro have receded remarkably. This has further fueled the weakness in US$. In the last week of April 2017, Euro rose to its 5-month high.
   
• On the back of Mr Trump-suggested tax reform, the strength of US$ will be tested.

Domestic factors...
 

• As per the RBI estimates The Current Account Deficit (CAD) for the Financial Year (FY) 2016-17 is likely to remain subdued at less than 1% of GDP. In the first three-quarters of FY 2016-17, the CAD narrowed to 0.7% of GDP. Lower current account deficit bodes well for INR. Even in FY 2017-18, it is expected that CAD will stay within the comfort zone.
   
• After the landslide victory of BJP in India’s biggest state assembly elections in Uttar Pradesh, Foreign Institutional Investors (FIIs) poured in money hoping that this will help in better policy integration.
    How a strong rupee is good and bad for your investments...
  
  (Source: NSDL)
   
• Post RBI shifting its monetary policy stance from “accommodative” to “neutral”. This has resulted in a hardening of bond yields from their December lows. FIIs seem to have chased the rising yields.
   
• India has managed to meet its inflation target for 2 consecutive financial years. In the Q1 of FY 2016-17 the average retail inflation, measured by the movement of Consumer Price Index (CPI) was 5.64% and the average food price inflation during this specific period was 7.19%. Compared to that, the full-year average dropped to 4.53% and 4.26% respectively.
   
• The rally in crude oil prices have lost steam in February and March 2017. India being the net importer of crude oil, decline in price was a positive development.
   
• As India is heading closer to implementing GST, perception about India’s growth potential among FIIs has started building up. This has kept INR on a firm footing.

Impact on asset classes...

Impact on equity:

Sectors that depend on imports stand to gain through the INR strength, while exporters stand to lose. The country by and large benefits when the INR is strong since our dependence on crude oil imports is high—a prime source of non-food inflation. If the global economy recovers in FY 2017-18, export volumes may revive minimising the adverse impact of appreciating INR.

Nonetheless, FII inflows are likely to improve if earnings recovery maintains the same pace or improves in FY 2017-18. As per the Business Standard Database, the sample of 2010 companies posted 18.4% sales growth in Q4 FY 2016-17, and the net profit grew at 7.56%. A sharp jump in the passenger vehicle segment recorded by some leading companies in April 2017 highlights that there’s a pent-up demand for autos, as a consequence of demonetisation and the consumer sentiment is upbeat. Albeit, less steady, industrial growth seems to be recovering. All these factors may boost the investors’ confidence. It’s true that market valuations appear very expensive, especially in the mid and small cap segment, but higher earnings growth may eventually make them look cheaper. The stock-specific approach will work well as against taking sector bets.

Having said that, investors shouldn’t try their hand at investing directly in equity unless they are seasoned players and have time and expertise not only to pick stocks, but to monitor them meticulously.

Naïve investors would be better off investing in promising diversified equity mutual funds. If you are unable to figure out mutual funds that have a good chance of outperforming benchmark indices and most of their peers, don’t forget to check the latest offering of PersonalFN.

As far as the international funds are concerned, you should avoid investing in them. Although the strong INR would support investing outside since over medium to long term such strength of INR may not sustain. But, there are two downsides to investing outside India.
 

• Markets in other nations may not be supportive and may erase all the gains you might make of the currency movement.
• Tax treatment for international funds is unattractive in India as gains are not exempt.

Impact on Debt:

Investors would be better-off if they don’t try to speculate on the moment of interest rates. Investing in long-term debt funds appears risky at this juncture as there’s little chance that, RBI may cut policy rates in the foreseeable future. Ample liquidity available in the system may keep short-term yields also under pressure. The forecast of a normal monsoon this season will keep speculative price rises of food articles under control, leaving an overall positive impact on the inflation expectation—a key factor that affects the actual inflation numbers. Strong Rupee, lower CAD, and lower inflation would restrict the upside in the bond yields.  In a nutshell, the best for debt funds might be behind us.

You shouldn’t invest more than 20% of your fixed income portfolio in long-term debt funds and do not forget to check your time horizon before betting on debt funds. Please don’t forget they are not risk-free. PersonalFN’s specialised debt mutual fund research service-Debt Select will guide you on which funds are better placed to deal with the tricky situations.

Impact on Gold:

Internationally, gold is priced in US$. Therefore, it shares an inverse correlation with the real interest rates in the U.S. and US$. Rising INR negates the positive movement experienced in the gold internally, when the US$ is falling. That being said, you shouldn’t invest in gold with the aim of making huge returns. Rather you should look at it as a portfolio diversifier. You should hold 10% to 15% of your portfolio in gold.

Currency movements can be extreme in the short term, but eventually, they balance out. Therefore, you shouldn’t speculate on them. Rather, focus on your financial goals. Your investments should be in line with your financial objectives and your risk appetite.

In case you seek an expert opinion on your finances, don’t forget to get in contact with a Certified Financial Guardian based in your city.

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