Rupee stays ahead of emerging market curve in January on FII Rush

Indian rupee was the best-performing Asian as well as emerging market (EM) currency in January following $4.2 billion worth of investments by foreign institutional investors ( FIIs) in Indian equities and debt markets. Another key reason was the changing tack of global forex market traders for base currencies to buy EM currencies, which helped the rupee.

A base currency is the one used by traders and investors while acquiring emerging market assets. Overseas forex traders have traditionally used the US dollar and the Swiss franc as the base currencies to buy the emerging market ones. They were also the most suitable base currencies to execute carry trades. Under the carry trade, the investors borrow from countries with low interest rates and invest into countries with higher ones.

The biggest catch or risk in carry trades is that the funding currency (US dollar and Swiss Franc) should not appreciate. The US dollar and the Swiss franc have appreciated by 0.67% and 4.12%, respectively, against the rupee over the last three months. This has prompted traders to use the euro and the yen as base currencies instead. This change can be gauged from the fact that the Credit Suisse Carry index that tracks return from the carry trades using the dollar and the Swiss franc has slipped 6.6%, the highest in six years.

Traders are buying EM currencies such as the rupee, Turkey’s lira, Brazilian real, South African rand and Mexican peso. The rupee and the lira are the most popular currently since both are net importers of crude oil. This has resulted in the rupee becoming the best performer among 24 emerging market currencies, up 2.5% since the beginning of the year.