FxWirePro: Bullish/bearish INR scenarios in H1’2018 – NDFs to provide positive carry

Amid our largely constructive assessment for EM Asia FX, it is shifted more vigilant thought on the INR outlook. The currency now exceeds the +5% threshold across our fair value metrics.

To be sure, the mean-reversion to fair value is not an instantaneous process (rather a multiyear process), and our ex-ante assumption is for a 2% capital loss in the INR FX over the next 12 months.

This is counter-balanced by the fact that INR NDF provides a prospective real positive carry of 1.50%-1.75%, such that total expected returns are marginally negative. There is clearly no longer the buffer of a year ago when the INR was 0.6% below fair value.

Asia yielders IDR and INR are unlikely to experience much spot appreciation even in a risk-on environment (central banks will limit the gains). But on a carry-to-vol perspective, they continue to screen well. Additionally, with rising FX reserves, there is plenty of scopes to limit any damage from flare-ups in risk aversion.

Bearish INR risk scenarios:

1) Crude oil price gains accelerate;

2) The fiscal position deteriorates;

3) Exports continue to underperform.

Bullish INR risk scenarios: Reform process accelerates; India exports play catch up with the regional trend.