The main idea of the trade is to buy IND and sell USD, implementing what in jargon is called a carry trade.


In the chart above we can see the 3-month trend of this risky pair, which has actually been under the spotlight in the past couple of months since Raghuram Rajan was appointed Governor of the bank of India in August. His mission -he said- was to do whatever it takes to stabilize the currency, and prevent further inflation. Since his appointment, the Rupee has gained 11 % on the dollar, from a 28th August low of 68.845 to a 61.535 on Thursday, now trading around the 61 mark, and we believe that there is still space for a downward movement in the pair. Raghuram Rajan certainly has the credibility, and on the US side a relaxation of the pressure in the rates should make the depreciation easier, now that the shutdown in the States has been resolved. At present (Friday, October 18th, 06:00 GMT), eight hours have passed since President Obama signed the bill extending the nation’s borrowing authority through February 7th.

With regards to India, the two principal markets, Sensex and Nifty are very strongly correlated with the currency. In the chart below, we can observe how INR moves accordingly with the gains in the Nifty index. The Nifty and the Sensex have gained year-to date 4.58% and 7.28 %.

We believe that India’s recovery, though slow, will be strong, and thus we think there may be room for good profit here.


As to Rajan’s view on the economy, he thinks it will pick up by year-end thanks to the start-up of billions of dollars worth of stalled resource projects and a good monsoon season that will bolster agricultural production. As to Moody’s analytics, the current economic slowdown is about to bottom out and a recovery is in sight. The Reserve Bank of India is due to review monetary policy on Oct. 29th, with a rising pace of inflation bolstering the odds of another central bank interest rate hike even as the economy stumbles through its worst crisis since 1991. Rajan already surprised the markets last month with an interest increase of 25 basis points, and we believe this could happen once more. If this were to happen, our trade would definitely be rewarding.

The right time horizon would be around 3 weeks, we would suggest to take profit once satisfied with the gain. Some of the momentum has already been lost in the first hours of the opening of the Federal Government (USDINR:-0.61%), but we suggest to enter around the 61.2 mark.
The trade is similar to that of a typical carry trade: enter an emerging market that shows good signs of recovery and an undervalued currency, keep the burden while it re-appreciates, and take profit accordingly.


Leonardo Pisano · 21 October 2013 at 23:30

Dear BSIC,
the pair you have chosen this time is fairly dangerous!

I would like to put into perspective my idea of how this trade might turn out.
India has huge problems!

1. Almost double digit consumer price index rise (food prices up by 18.4% in september) — remember the gold rush to India? That’s right, everybody was hedging against inflation — This has been mainly caused by rural subsidies, in the amount of 2.7% of GDP, which have pushed up wages. You have used this to make your case for a rate hike of another 25bp on Oct 29th. I share that opinion with you.

2. India is a double deficit country. It has 9% fiscal deficit and about 5% current account deficit.

Now, what has been happening is that investors have calmed down after QE taper talk stopped, and the current account deficit has a lower weight when it comes to the probability of causing a massive capital outflow. They are however worried about rampant inflation. So the way I see it is that Rajan has two options:
1. Increase rates in order to control inflation. A credit tightening might risk damaging an already fragile economy. On the other hand this may help the appreciation of the Rupee which is still down about 10% this year compared to the dollar. Also, at the same time, this will make oil, edible oil and fertilizer cheaper, thus aiding growth. Furthermore, your trade might just prove to be correct! That’s what they call killing three birds with one stone.
2. No increase in rates – This means Rajan would expect inflation to slowly come down as demand driven pressure cools off. And he would also be trying to do the economy a favor by not tightening anymore.

I would pick 1.

Yours truly,

ps. I hardly think anyone could be so naive as to believe that what stopped the Rupee from further depreciation was the credibility of the new governor. In fact, I am sure that Raghuram Rajan was on anti-depression pills as he stared hopelessly at the fall of its currency. Make no mistake, it was the end of taper talk what restored all emerging market currencies (to be more precise, the expectation of ‘only a small reduction’ in QE after disappointing data on US economy came to light).

    BSIC · 22 October 2013 at 10:19

    Hi Leonardo
    Thank you very much for your comment and we are impressed for the quality of your answers. If you are a Bocconi student, we strongly encourage you to apply to our club (visit the “join us” section of this website). Sorry if we do not reply promptly but we are now really busy with midterms.

    With regard to the trade, clearly we believe that the main rationale for the appreciation was the missed tapering of the FED and so the new weakness of the USD and a trading environment similar to that of this spring.
    The article mainly focuses on India situation because we want to justify why the current trend should continue as the INR has already significantly. I am sure that the author of the article, once he has finished his exams, will write an exhaustive answer about the research he has done.
    I agree with your analysis and I believe that another source of risk might come from the macro scenario. Indeed, now we are in a different environment compared to this spring. In that period the situation was straightforward: Strong QE from central banks, weak recovery in the economy of developed markets, emerging markets looked an attractive investment especially in the bonds space.
    Now, the situation is not so clear: central banks’ support may reduce in future, economies in the developed markets are recovering, although the US that has slightly disappointed recently, and EM have showed their fragility in the summer sell-off. Therefore, the starting risk-on trend may be short lived.
    I believe that, given the current scenario, the trade has room to be successful but a careful risk management of the position is required.

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