India:Revisiting risk

• The INR has been fairly robust to the turbulence in Europe and China. However, the bigger risk to the currency is likely to come from the more broad-based and global external shock from monetary policy normalization in the US later this year.

• While conventional vulnerability indicators like the current account deficit indicate reducing sensitivity to external headwinds, these can be misleading. New risks—rising foreign investor participation in local currency debt, increasing corporate indebtedness and a growing reliance of the domestic banking sector on external and wholesale funding-- have emerged that need to be accounted for in gauging India’s vulnerability to external risk.

• Taking cognizance of these risks, we believe that the volatility and re-allocation of foreign funds that could follow monetary policy normalization in the US is unlikely to leave the INR unscathed. Our bet is that the USD/INR pair could settle in the 65.50-66.50 range by the end of the 2015.

• That said, there are several other EM currencies that are more susceptible to rising interest rates in the US—the Thai Baht, Indonesia Rupiah, Malaysian ringgit and Turkish Lira to name a few. Thus, even  in a period of adjustment and depreciation the INR could out-perform some of its peers and emerge as a “safe haven” of sorts among EM currencies.

( From our latest report)