Friday, October 24, 2014

Is the rupee a one-way bet?

Interesting set of graphics from Research Associates (ht: Barry Ritholtz) on real 10-year expected returns on a variety of asset classes. The one on currencies was of particular interest since unhedged returns on rupee investments (borrow abroad in dollars and invest in short-term rupee bills, and keep rolling them over) topped all other currencies.
India has one of the highest inflation rates among all emerging economies and its inflation trajectory is not expected to subside dramatically. Therefore the prospects of any sharp decline in its high interest rates is not promising. This, coupled with the liquidity trap conditions in developed economies, again likely to persist for some time, points to attractive carry trade potential from borrowing in dollars and investing in rupee assets. This short-term one-way bet and the consequent vulnerability it imposes by way of capital flows and sudden-stops makes capital account management an important macroeconomic challenge for the country.

A comparison of the cyclically adjusted PE ratios (real price divided by average of real EPS over the past ten years), CAPE, reveals that Indian equity market is among the most volatile and remunerative. 
Finally, a comparison of real 10-year expected returns indicate that among all asset categories, emerging market assets occupy the top three places - equity, local debt, and currency 
The importance of this graphic comes from the attendant capital flows related vulnerabilities that emerging markets face from cross-border capital as they search for yield in an environment of ultra-low interest rates.

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