Rising hedging costs and a weaker rupee are eroding overseas investors’ returns from Indian equities and government debt, adding to record capital outflows.
Foreign investors are growing more cautious on India as the Reserve Bank of India’s efforts to steady the rupee have made currency protection more expensive, squeezing the appeal of both shares and government debt. Reuters reported that one-year hedging costs rose by more than 60 basis points this week after the central bank’s latest move, reducing the net return overseas investors can expect once exchange-rate risk is taken into account.
For global funds, the question is no longer just whether Indian assets can deliver strong local-currency gains. It is also how much of that return survives after conversion into dollars or other foreign currencies. A weaker rupee can quickly erode profits, which is why hedging is often used to lock in currency exposure. But when the cost of that protection rises, the effective yield on Indian assets falls. Ajay Marwaha, head of fixed income at Nuvama Group, told Reuters that a lack of confidence in rupee stability and the higher price of hedging would keep Indian equities relatively less attractive.
The shift comes at a time when foreign money has already been leaving the market. Reuters said overseas investors have withdrawn a record $30 billion from Indian equities this year, while debt inflows have turned negative since the start of September. The Economic Times has also reported that foreign institutional investors are becoming more wary as foreign-exchange controls pushed up hedging costs and added to concerns about corporate earnings, further dampening demand for both bonds and shares.
The bond market is feeling the strain as well. According to the Economic Times, the Reserve Bank’s sell-buy swap operations have helped slow the rupee’s decline, but they have also lifted forward premiums, making hedging more costly for investors. The one-year dollar-rupee forward premium has risen to 8.65 per cent from 7.40 per cent in less than a month, the paper said, underscoring how central bank intervention can stabilise the currency while simultaneously reducing the appeal of rupee-denominated assets for overseas holders.
Janus Henderson Investors’ Sat Dhura told Reuters that the RBI’s rate increase could help at the margin by reinforcing policy credibility, but was unlikely on its own to reverse capital outflows. Dhura said the direction of flows would continue to depend more on US yields, the dollar, oil prices, earnings and valuations than on a single 25-basis-point move. That leaves India facing a difficult mix of a softer currency, expensive hedging and elevated global yields, with the added risk that further rupee weakness could feed imported inflation and keep pressure on policymakers.
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