Morgan Stanley has said that investor concern over INR is overblown and a cheap but stable currency benefits both equities and exports.
While fundamentals remain strong, the RBI should keep INR competitive, it said.
“The long INR consensus has reversed recently after USD/INR broke above 83.50: Investors voice concerns that INR depreciation could accelerate post-elections. We disagree. We expect India’s balance of payments to improve going forward, and the RBI could lean against inflows by keeping INR stable,” the brokerage said in a note.
A combination of an improving balance of payments and stable real effective exchange rate (REER) makes INR cheap, supporting India to increase its export market share and benefit the stock market: A virtuous cycle of higher capital flows and a more stable INR on the back of rising share prices should ensue, it said. “Our INR call favors sectors such as financials, consumer discretionary and industrials. A break could come from growth disappointing (not our base case) or valuation excesses (still not evident),” it said.
India’s fundamentals suggest a stronger exchange rate… India normally runs a current account deficit and a financial account surplus, making it sensitive to global oil prices and global capital flows. The good news is that oil prices are likely to stabilise, India’s exports could strengthen and global capital inflows to India should continue in the next 6-12 months.
“All this implies a stronger currency, in real if not nominal terms. …but RBI management aims for REER stability: The RBI, on the other hand, would like to keep the real exchange rate stable by increasing its FX reserves. Higher reserves could serve India well, reducing its external vulnerability. They keep INR competitive to support exports while lowering the private sector’s cost of capital. Killing three birds with one stone, the RBI is unlikely to change course in the near term.
CNH/INR trade
It has recommended short CNH/INR as a structural trade and expect a 10% return over the next 12 months, stating, “Given the structural improvements in inflation and the balance of payments, we expect INR’s NEER to depreciate by 1% per year, an improvement from the 2% per year seen between 2016 and 2022.”
It expects USD/INR to be in the range of 93 to 98 by 2035 should USD be stable over the period. “Our detailed comparison indicates that India’s balance of payments is improving while China’s is worsening, anchoring our short CNH/INR trade,” it said.
For context, India’s macroeconomic fundamentals have transformed in the past 10 years: The current account deficit has hovered around or below 2% of GDP since F2014 while growth has averaged 8.3%Y in F2022-24. Inflation has tracked at or below 6%Y since F2016. We see a continued monetary and fiscal policy focus on macro stability, implying sustained macro balance sheet strength.
“We expect the current account deficit to narrow to 0.5% of GDP in F2029 and to 0.2% in F2034 in our base case, on the back of improving export competitiveness and further energy transition. Our bull case sees India achieving a surplus of 0.3% of GDP in F2029 and improving to 0.8% in F2034. The overall balance of payments should be in a comfortable surplus in the next few years, it said.
REER stability
REER stability should grow exports market share and equities: We expect India’s NEER to depreciate by 1% per year, an improvement from 2% per year in 2016-22. Under those circumstances, INR’s REER should remain stable. The combination of an improving balance of payments and rising productivity growth could lead to an increasingly undervalued REER, supporting an increase in export market share and buoying the stock market.
Investors remember when high inflation led INR to depreciate in decent size. However, India’s macro fundamentals have transformed in the past 10 years. Inflation has tracked at or below 6%Y over seven years since F2016, and the current account deficit has hovered around or below 2% of GDP since F2014.
We expect the current account deficit to narrow to 0.5% of GDP in F2029 and to 0.2% in F2034 in our base case, on the back of improving export competitiveness and the continuing energy transition. Our bull case sees India achieving a surplus of 0.3% of GDP
in F2029, improving to 0.8% in F2034. The overall balance of payments should be in a comfortable surplus over the next few years.
A virtuous cycle of higher capital flows, a more stable INR and rising share prices should ensue.
A break could come from growth disappointing (not our base case) or valuation excesses (still not evident). Our INR call favours sectors such as financials, consumer discretionary and industrials. We also recommend short CNH/INR as a structural trade and expect a 10% return over the next 12 months.
The brokerage sees 2032 being the more likely time for India to join should it continue to promote internationalization of INR via trade settlement and capital market, it said, adding India is unlikely to be labelled a currency manipulator as its current account doesn’t meet the US Treasury’s criteria.
