International funds can provide protection against rupee depreciation

When remitting money abroad, go with the player that offers the most attractive exchange rate

The rupee has been weakening in recent times against the dollar. On Wednesday, it closed at 76.23, a level it had last seen on April 27, 2020 (more than 19 months earlier). Its depreciation against the dollar and other hard currencies has assumed greater significance in recent years because more Indians now wish to educate their children in foreign universities. Indians also holiday abroad and hold destination weddings at foreign locales in greater numbers. Ultra-high net worth individuals purchase real estate in foreign cities. When the rupee weakens, they have to shell out more for these foreign-currency denominated goals.

Fund outflows causing weakness

Two factors are responsible for the current bout of depreciation. One is the steady pull out of funds by foreign institutional investors (FIIs) from the equity markets over the past couple of months. “With the Western central banks, led by the US Federal Reserve, withdrawing their ultra-loose monetary policies, the amount of money floating around in the system is reducing. FIIs are getting choosier and exiting markets where valuations are on the higher side,” says Abheek Barua, chief economist, HDFC Bank.  

With the domestic economy reviving, import growth has been strong across categories. High commodity and crude oil prices have also led to bloating of the import bill. Exports, which had been doing well, have slowed down a little over the past couple of months, causing widening of the trade deficit. The higher demand for dollars owing to these two factors is also causing the rupee to depreciate.

The rupee has depreciated against the dollar over the past 10 years at an annualised rate of 3.58 per cent. “Even in the past, we have tended to import more and export less, so the rupee depreciates against the dollar,” says Joseph Thomas, head of research, Emkay Wealth Management.

How to hedge

When planning for longer-term goals, investors can safeguard themselves against the rupee’s tendency to depreciate by taking exposure to the international mutual funds available in India. Besides currency hedge, exposure to international funds offers several other benefits as well. “Diversifying internationally helps investors safeguard themselves against the risks that arise due to exposure to a single market,” says Avinash Luthria, a Sebi-registered investment advisor and founder, Fiduciaries. Investors also get the benefit of exposure to sectors and themes not available in the domestic equity market.

“If a goal like your child’s foreign education is seven years or more away, you can take exposure to international funds to the extent of 20 to 50 per cent of your equity allocation, depending on your comfort level,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors.  He suggests using passive funds based on broad-based indexes, such as the MSCI World Index or the S&P 500 index, or an active fund with a sound track record.  

Gold, too, can provide a hedge against currency depreciation. Gold prices are determined abroad in dollar terms and we in India are price takers (adjusted for exchange rate). However, financial planners feel gold is an imperfect hedge as it can witness prolonged downturns. “The price of gold in dollar terms fell 60 per cent between 1980 and 2001,” says Luthria. Dhawan suggests taking an exposure of 5-10 per cent to gold only for goals that are more than seven years away due to its negative correlation with equities.

Hunt for the best rate

Those who have long-term dollar-denominated goals must factor rupee depreciation into their calculations. When trying to estimate the corpus that will be required for, say, your child’s foreign education, factor in the target country’s education inflation (say, 5-6 per cent) and add another 3-4 per cent for currency depreciation.

The remittance market in India has become very competitive. “When purchasing dollars, go with a player that charges you the lowest premium,” says Barua.