The inclusion of Indian bonds in JPMorgan’s Global Bond Index has brought optimism to the medium-term outlook for the Indian rupee. While the immediate impact is limited, the expectation is that in the near term, bond yields and the rupee may experience reversals due to global market dynamics. However, by the end of March, the trend is anticipated to favor bonds, with the 10-year yield dropping below 7%. Analysts project the rupee to trade between 82.25 and 84.25 per dollar for the remainder of the financial year ending in March, with support from the Reserve Bank of India’s intervention.
JPMorgan’s decision to include Indian government bonds in its Global Bond Index – Emerging Markets over a 10-month period is set to attract significant inflows into these bonds, thus strengthening the rupee. HSBC analysts estimate that this move will result in $30 billion of inflows into government bonds.
Despite the initial positive reaction, global factors are expected to continue influencing the Indian unit in the near term. The substantial impact of the index inclusion is anticipated in 2024-25 when Foreign Portfolio Investment (FPI) inflows related to the index become significant.
The rupee recently opened at 82.82 per dollar, above the crucial 83-dollar mark, but it retreated by the end of the day due to persistent demand for dollars from oil importers. The rupee has been trading below 83 per dollar for the past five sessions, reaching a record low of 83.2675 against the US currency due to rising crude oil prices.
The rupee faces challenges such as a strong US dollar, elevated US yields, and higher oil prices. The US Federal Reserve’s indication of prolonged higher interest rates and the likelihood of another rate hike by the end of 2023 are keeping upward pressure on the US dollar index. Additionally, crude oil prices are expected to reach $95-$100 per barrel in the near term due to supply concerns.
Market participants expect the Reserve Bank of India (RBI) to absorb the dollar inflows to stabilize the rupee. They believe that the RBI will act to prevent the rupee from appreciating beyond 82.50 per dollar to maintain a stable exchange rate.
Despite the challenges, market players are confident in the RBI’s ability to support the rupee, considering its recent efforts to prevent the currency from hitting a record low. India’s foreign exchange reserves stood at $593.90 billion as of September 8, 2023, down from the recent high of $609.02 billion on July 14.
In the near term, most market participants expect the rupee to trade in the range of 82.50 to 83.30 per dollar. The positive medium-term outlook is based on the anticipation of foreign fund inflows into Indian debt markets, along with increased clarity on the US Federal Reserve’s rate hike cycle.
The inclusion of Indian bonds in the global bond index is also expected to impact forwards premiums, with foreign funds entering the debt market. Many individuals with dollar exposure may seek to hedge long-term forwards, leading to a potential rise in one-year forward rates by approximately 30-35 basis points. This could push the premium above 2.00% from the current 1.80%.
Most market participants expect the one-year dollar/rupee forward premium to range between 1.80% and 2.10% in the near term. Exporters may take advantage of higher premiums, potentially limiting their rise. The differential between Indian and US yields may also narrow in the future.
While the inclusion of Indian bonds in the global index may not provide an immediate boost to the rupee, it has offered relief to the domestic currency market in the near to medium term. The impact of the index inclusion underscores the significance of this development for the Indian financial landscape.