A better probability of Prime Minister Narendra Modi getting a second term after an escalation in tensions between India and Pakistan has had an unlikely gainer — rupee. In a matter of five weeks, the rupee has made a dramatic turnaround to become Asia's best-performing currency from its worst. The optimism after several exit polls showed a spike in approval ratings of the prime minister has led to robust flows into local shares and debt, turning the carry-trade returns on the rupee to the highest in the world in the past month.
The currency is set to rally further if PM Modi wins a second term, Gao Qi, a currency strategist at Scotiabank in Singapore told Bloomberg. A dovish tilt by major central banks across the world amid weakening growth could also lead to investors chasing high returns in emerging economies. Around 11 central banks have eased monetary policy this year, while just three have tightened policy. Qi expects the rupee to strengthen to around 67 per dollar by June-end.
A sudden surge in the inflow of dollars has sent the rupee to its highest level since August, prompting profit booking that led to the currency witnessing a drop on Tuesday after six trading sessions of continuous gains. In the year-to-date, foreigners bought a net $3.3 billion of shares, accounting for over half of total inflows of $5.6 billion in the period. Foreign investors have also raised holdings of bonds by $1.4 billion this month. According to data compiled by Bloomberg, borrowing in dollars to purchase rupee assets has earned 3.8 per cent over the past one month, the best carry-trade return in the world.
"The market is pricing in a Modi victory as there are no other factors that explain the sudden change of mood," Anindya Banerjee, an analyst at Kotak Securities told the media agency.
Several opinion polls show the ruling coalition-led by PM Modi may get over 272 seats in the Lok Sabha needed to form the next government. Polling will start on April 11 and results are slated to come out on May 23. Besides improved sentiments, carry traders are eager to long rupee and short other low-yielding currencies, including the dollar.
Investor optimism on rupee is also reflected in the derivatives market, where one-month options conferring the right to sell the rupee now cost 19 basis points more than those to buy. "Global conditions -- dovish Fed and ECB -- have turned more supportive and domestically, increased confidence in the BJP's prospects and a recovery in portfolio flows have been the key driver for the rupee," said Dushyant Padmanabhan, a currency strategist at Nomura Holdings Inc. in Singapore.
Other indicators such as three-month implied volatility, which is used to gauge expected swings used to price options, too point towards a stronger rupee. The volatility gauge fell to 5.87 per cent on Friday, the lowest level since August.