Of late, currencies have increasingly become part of the global monetary policy debate. The Japanese yen (JPY) would be the most obvious case and the sharp weakening of the JPY could have broader global policy implications. The new Japanese government looks committed to propel the economy out of deflation, given the range and extent of measures employed. A weaker yen is a key strategy to revive its export oriented economy.
Japan has fired the first round of shots on this front, which could result in a major confrontation from other countries as well. The Fed, ECB and BoE (which have their own QE programs to stimulate growth), along with other emerging markets could follow with verbal interventions, capital controls and interest rate cuts. Finally if a weaker yen remains core of Japan's plans to revive its export market, risk of currency war looms higher. With anemic global growth and sluggish demand, any revival of Japan's export market would be at the loss of market share for other countries.
I have written about the risk of looming currency war in my previous article "Is Japan Prompting A 1930s-Like Currency War?"
However, Ridham Desai of Morgan Stanley (MS) argues that the best option for a country like India where the Central Bank is already on an easing path is to ease more aggressively. In this article we will look into reasons why India looks well positioned to benefit from the currency war.
1. India runs a current account deficit (CAD) with ample room to absorb foreign exchange inflows: Import substitution (high inflation and domestic supply-side bottlenecks), slow growth in services sector, inelastic energy demand and anemic global demand would lead to CAD remaining above sustainable levels in 2013.
2. FX Decline Creates Room for more FX absorption: India's Import cover of foreign currency reserves has gone down below six months for the first time since 1997, which stresses the growing external vulnerability.
3. INR Undervalued on REER basis: In my previous article "Emerging market currencies," I have written how the Indian rupee is undervalued on a real effective basis.
4. The starting point of nominal rates is high relative to history both on an absolute as well as relative basis. Equities also look undervalued relative to emerging markets allowing for flows without causing a bubble, at least for now.
- The trend augurs well for cyclical companies in the auto, banking and industrial space serving the domestic market. Investors can get exposure by investing in stocks of ICICI Bank (IBN), HDFC Bank (HDB), State Bank of India (SBKJY), Sterlite (SLT) and Tata Motors (TTM). General Motors (GM) and Ford (F) would also be good bets given their strong presence in the subcontinent, which is also its small car hub.
- However, exporters would be affected on a relative basis. This would be disadvantageous for software companies like WNS (WNS), Wipro (WIT), Sathyam (SAY), Sify (SIFY), Rediff (REDF), Cognizant (CTSH) and Infosys (INFY).
- Investors can also get broad-based exposure to the Indian market using the following ETFs: First Trust ISE Chindia ETF (FIN), India Fund (IFN), WisdomTree India Earnings Fund (EPI), PowerShares India Portfolio (PIN), iShares S&P India Index Fund (INDY) and iPath MSCI India ETN (INP)
- Readers who wish to play Japan reflation theme can refer to my previous articles "Asia And Japan's Reflation Game" and "Marc Faber: Get Ready For Decade-Long Low Interest Rates."