US Fed’s interest rate hike has made the dollar appreciate against every currency including the rupee
The US Fed’s interest rate hike has made the dollar appreciate against every currency including the rupee. The rising rates are making US treasuries more attractive, thus leading to investors fleeing emerging markets to the perceived safety and attractiveness of US ‘fixed income’. The withdrawal of ₹6,400 crore by foreign institutional investors (FIIs) from Indian markets in May alone highlights the trend.
In such a risk-off mode, when investments are primarily in debt and looking towards the West, the equity component has to ensure that its businesses have positive cash flows, high pricing power and zero debt on the balance sheet. Considering the dollar is the most-sought-after currency globally, investors need to create a dollar asset for current and future dollar liabilities like international vacations and foreign education. This translates into continuous dollar expenses.
Also, on an average, the rupee has depreciated by about 4% compounded over the long term. The depreciation is not always linear, but the trend is likely to continue. So, having a meaningful diversification to dollar investments insures against rupee depreciation to some extent.
A presence in the US also allows exposure to companies that represent niche businesses like space technology, SaaS (software as a service) and chip manufacturing that are inclined to get listed on US markets. The returns in dollars also help with diversification. With geopolitical issues swirling, investors must have access to offshore dollar assets.
The appreciation of the dollar against all currencies is indeed making it attractive to invest in US markets. But in the case of India, the Liberalised Remittances Scheme (LRS) appears to be the only option available for some time to come. Many Indian mutual fund (MF) schemes invest in internationally listed companies. Some are feeder funds, collecting from Indian investors and simply buying units of an actively managed fund domiciled outside India. Currently, this option isn’t available as the Indian MF industry has reached the Sebi-prescribed limit of $7 billion.
Another category of Indian MFs, which invests in exchange-traded funds (ETFs) listed internationally, has a Sebi-capped limit of $1 billion, which is also likely to be reached in due course, making it not a viable option. Also, as this investment mode is still a rupee-denominated one, while it does serve the diversification benefit, it does not offer access to dollar currency.
RBI allows to remit up to $250,000 per person in a financial year. This remittance is towards all foreign currency expenses, including Investments outside India. These investments can be made in ETFs, stocks and actively managed funds. Money can also be deployed through some boutique investment managers who run niche concentrated strategies focusing on growth companies with high returns on equity (ROEs) and free cash flows.
The advantage of the LRS route is that the accumulated investments can be sold or redeemed at any point in time to generate a large dollar balance, which can be used for any expenses or investments without any limits. We have seen that high networth individuals (HNIs) are increasingly utilising these limits to remit monies outside India and gradually building a corpus of offshore assets.
With Sebi limits on Indian funds investing internationally, investors are resorting to increased LRS where the limit is not on the fund but rather is applied individually, which in turn resets every financial year.