Currency of the Month: Driving Value For The Indian Rupee

Driving Value For The Indian Rupee
The Indian rupee has been on somewhat of a tear since November 2016, reversing at least some of the weakness experienced in the currency relative to the U.S. dollar over the past three years (Figure #1). Yet, unlike every other news story out these days, it seems this strength has very little to do with the new U.S. administration. In fact, it has everything to do with the Indian government’s push to position itself as the “next China” in terms of global growth and economic importance.

Fig. #1
Historical Exchange Rate INR/USD
05/2012 – 05/2017

Source: Trading Economics

(View a larger image here)

Loyal readers of the Daily Pfennig® newsletter will recall that our last COTM review of the Indian rupee highlighted the nascent economic initiatives implemented by Prime Minister Narendra Modi, whose May 2014 inauguration unveiled a series of pro-growth initiatives, including economic reforms, simplified tax codes, a reduction in corporate taxes, an easing of foreign investment restrictions, and a redistribution of government subsidies into infrastructure investment.1

Since this time, economic growth in India has rebounded from the mid-single digits to high single digit gross domestic product (GDP) growth rates (Figure #2), now representing one of the 10 fastest-growing economies in the world.2 Similarly, when Prime Minister Narendra Modi assumed office in 2014, Indian inflation was running at more than 9%3, compared to the most recent inflation rate of 5.6% in 2016.4

Fig. #2
India GDP Growth
2012 – 2022 Estimate

Source: International Monetary Fund.5

(View a larger image here)

And, with estimated GDP growth rates approaching 8% by the end of this decade, the World Bank estimates that the Indian economy has the potential to become the third largest economy in the world by 2030.6

India’s Middle-Class Economic Engine
Notwithstanding the Indian government’s successful pro-growth initiatives, the real potential within the Indian economy lay with its young, educated, and motivated labor force, which represents the second largest workforce in the world amounting to over half a billion citizens.7 Coupled with a large and growing middle class of consumers that is also expected to approach half a billion by 2030, India seems to have plenty of latent energy stored to help drive growth for decades.8

In particular, the number of Indian households with disposable income of more than $10,000 is expected to have increased from 2.5 million to nearly 50 million in 2015.9 More striking, it is predicted that by 2030, the median income per household in India is expected to exceed $10,000 USD (based on constant 2014 prices),10 placing the Indian economy within “spitting distance” of the World Bank’s $12,475 threshold of what is considered a high-income or developed economy.11

Common characteristics of high-income economies include markets with strong capital and banking formation, higher disposable income, industrialization, technological advancement, and lower rates of poverty. Even today, India is well known for its advanced technology industry, ranking as the fourth largest information technology start-up community with more than 3,100 tech start-up companies. India also has one of the world’s largest automotive production centers, ecommerce markets, and food manufacturing markets.12

Assuming growth rates for the Indian economy continue in the high single digits, and per capita income levels increase commensurately with economic growth, the Indian economy could become a global powerhouse in short order, boasting an emerging middle class in excess of 500 million individuals purchasing higher-value proteins, automobiles, electronics, cell phones, and various household consumer goods. And, just as China’s ongoing transition to a developed economy has created vast wealth for the country, India could just as quickly find itself in a similarly enviable position based on the potential of its middle class consumer.

Based on such a positive fundamental backdrop involving the emergence of a large middle-class workforce and an ongoing transition from an emerging market into developed market, the longer-term outlook for the Indian rupee seems clearly biased toward the upside. Similarly, Prime Minister Modi’s economic initiatives have been successful in spurring economic growth while controlling inflation and providing more near-term support for the rupee. And, yet, the Indian rupee continues to offer a competitive yield, allowing investors to collect a positive interest rate differential on a currency with a favorable economic narrative.

Outlook For The Rupee
But, just when you think everything is clicking on all cylinders for the Indian economy, the Indian government goes and drops a bombshell that shakes nearly all confidence in the rupee. The shock I am referencing is the November 2016 surprise announcement that, in an effort to flush out counterfeit currencies and hidden cash, the central bank would immediately replace all high-denomination banknotes with a series of new bills, in a move that placed nearly 86% of all currency in India at risk.13

The decision to withdraw legacy notes from circulation was an admirable effort to arrest the flow of counterfeit money toward terrorist activities, and to open access to the black market economy that has been estimated to represent from 30% to 75% of GDP transactions not currently taxed.14 This execution included an ill-conceived printing of replacement currency that did not fit legacy ATM machines – causing even more unnecessary anxiety for Indian citizens. The poorly planned execution to withdraw cash from an economy where 98% of transactions take place in cash caused considerable confusion and panic in the economy, and prompted the International Monetary Fund (IMF) to lower 2017 GDP growth estimates by one full percentage point to 7.2%.15 Not surprisingly, the Indian rupee declined nearly 5% during the two weeks immediately following the government’s announcement.16

The story of the Indian government’s cash replacement debacle should stand as a stark reminder to investors with positions in any emerging market currencies that investing in emerging economies is an inherently risky proposition, and should only be considered for those investors whose risk profile, capacity for risk, and time horizon is appropriate for speculative investments. Risks including market volatility, geopolitical, governance, bankruptcy, liquidity, and, of course, sovereign risks, can be amplified with investments in emerging markets, and should be strongly considered when determining exposure and position sizing for a properly diversified portfolio.17

In the end, the Indian rupee appears to have dodged the short-term cash replacement debacle, and continues to post gains against the U.S. dollar, as investors have remained focused on the favorable demographics and economic backdrop supporting the currency. This all goes to prove, once again, that it is difficult to keep a strong fundamental currency, such as the rupee, down and out for too long.

Does your portfolio contain any foreign currencies? Let us know by posting your thoughts in the Comments section of our blog.

Until the next Daily Pfennig® edition…

Chris Gaffney, CFA
EverBank World Markets, a division of EverBank






International Monetary Fund. (2017). Gross domestic product, constant prices – India [data file]. Retrieved from












16. (November 8, 2016 to November 23, 2016)


Another risk associated with the Indian rupee is that it is a Non-Deliverable Currency (“NDC”). A NDC cannot be delivered to investors due to foreign governmental controls or rules.

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