Forex trading and carry trade go hand in hand. A few years back it was USD against JPY, then the turn came for AUD against USD and recently people have been talking about EUR against USD on the prospects of US interests remaining low and Euro zone increasing rates to reign in inflation.
The key in all scenarios being large interest rate differentials that allow cheap borrowing in one currency and invetsing in the other. The usual trend is that the currency with the higher interest yield slowly gains against the lower interest rate currency.
AUD-USD moved from lows of 0.80 to 1.05 range gaining whopping 25%, the theme was similar for USD-JPY or EUR-USD.
The Reserve Bank of India has gradually raised interest rates to 7.5% from lows of 3.5% over past 2 years and US still is at lows of below 0.5%. USD INR on the other hand has fluctuated between 44 – 47 in the same time with the
Now given that the interest rate differential is 7% and how other currencies have gained with the carry trade there is no reason why something similar would not happen with USD – INR. Indian Rupee should be strengthening against USD in line with how other currencies have performed.
Yes INR is a currency of a developing country and uses USD to pay for the Oil that it imports but that still does not completely negate the interest rate differential.
Using a simple calculation 1USD invested in India @ Rs.45 would grow to Rs48.37 in one year and seeing the trend of USD-INR fluctuating in a close 3% range there is every reason to enter the USD-INR carry trade.
What does this mean in layman terms?
1. It makes sense to borrow in US and invest in India
2. If you are earning in USD and do not have any need to hold US dollars its beneficial to remit to India and invest
3. If you want to trade then a USD INR carry looks like a low risk trade
Aditya Ladia 
Hi Nirav,
Doing a carry trade from India is operationally not feasible unless you are looking at large quantities. The only operator I know provides the pair is oanda.com. The mechanism is basically a NDF to enter into the trade.
The gains would be taxed in India at regular income tax rates as this would not qualify for short term or long term capital gains (I am assuming you are looking at trading).
Hope than helps
Thanks
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Hi Adiyta,
Thanks for informative article. I would like to do USD/INR carry trade. But how can an Indian resident do that? How is it operationally possible and what all are the tax implications?
Can you plz update about that?
Thanks.
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Sorry, forgot the link 🙂 !
http://www.bogleheads.org/forum/viewtopic.php?f=10&t=85635
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Thanks for your response Aditya.
Here is something I had asked on Bogleheads on same lines months ago, altho I did not particularly mention carry-trade, I was only asking whether it would be better to get a “risk free” return of 8% of more by converting my US dollars (idling in the US) into rupees. The response are interesting (as always, on that forum).
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Hi,
These are all valid questions and lets try and tackle them one by one. Assuming the conversion was done in 2007 @ 39 and invested at 8% the money would have grown to a equivalent of Rs.57.30 exchange rate in 5 years. With the current exchange rate of Rs.54.5 there is still a gain to be made. The risk free interest in US has stayed well below 1% so comparing investments which have equal risk the converted investment has not made a loss.
A currency paying high interest does not neccesarily mean high inflation. lets take example of Singapore where the interest rates are low ~ 1%, but inflation averages 3-5%. Even in US in 2006-2007 the interest rates were 4-5% but the inflation was below the 4-5% mark.
What i would like to highlight is that spiralling inflation and depreciating currency is not a one way road. if that would to be the case INR would continue weakening against the USD forever.
A good example would be to see what happened with Yen it moved from 123 against the $ in 2007 to 77 in 2012, the interest rate in Japan remained low and US joined the ranks with regular rate cuts. Now with inflation lower than US Yen has still been depreciating against the dollar and has lost close to 15% from the lows.
To sum up a simple answer would be that yes in the short term high inflation might result in currency weakness for a country which has a net imports economy but in the medium to long term as exports become cheaper due to falling currency the economy should swing back to have stronger currency with increasing demand.
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I cannot stomach the risks of investing using leverage. All I did was convert my USD savings to INR over last several years. I had significant dollar savings and way back in Dec 2007, rupee was gaining every day, so I started converting USD to INR when it was around 39 Rs to the dollar. I converted chunks of dollars at various price points : 39, 41, 44, 47 etc. Yes I am earning close to 9% on the rupee, because I transferred the money to my parents’ accounts, but where am I now ? Rupee is now 54, and in spite of the 9% returns, I am still losing.
I might have as well kept the money in USD and invested it in a “bogleheads”-style “passive investing” portfolio (including emerging markets). Read Paul Merriman’s best articles on asset allocation and model portfolios using very low cost index funds like Vanguard, ETFs etc. The beauty about the USA is that you can get access to asset classes all over the world using simple very low cost index funds from the likes of Vanguard and DFA (Dimensional Funds, by Eugene Fama, of Chicago Booth school of business) for those with more money. After I left the USA, I realized that this type of DIY low-cost investing option is not quite there in other countries.
Anyway, I dont know the sophistication of carry trade but I am pretty sure that professionals with access to milli-second information get involved in these types of activities. But leaving the sophistication of carry-trade out for the moment, let me ask a simple question : If currency B pays lot more interest than currency A, isnt it mainly because there is lot of inflation in B, meaning it costs more and more of B to buy the same good, and so, eventually the value of B must depreciate versus A, not the other way round ? I mean from a pure purchasing power parity standpoint ?
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Am I missing something, or did this prediction for a rupee carry trade work out spectacularly badly? If I’m reading the chart correctly, which I may not be, anyone who got in on a carry trade at the time this post was written more than likely got margin called, and even if not, lost a huge percentage of funds. But what about now? I’m thinking about getting in on this carry trade now, and I’m curious what people think about its future prospects. Also, who would be a good broker, preferably offshore from the USA, and with 200:1 leverage, and most importantly, trustworthy? Thanks for any input! – sean
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Trades are for a definete period and direction changes with market conditions. The trade made money with dollar cost avg as rupee rose to 56 and then fell back to 50 in Dec 2011 Feb 2012 time frame.
If you want try oanda.com they are the only ones who offer the pair and Max leverage is 50:1
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While i agree with your suggestion of earning in USD and investing in INR….yet I would caution against the tax reporting hassles….and tax laws are getting tight in US. There is no guarantee of how much tax you would have to pay when you repatriate money back to US in the future. Just a word of caution.
But you have hit the nail on the head. Interest rates in US vs. India difference is stark : 0.2% vs. 10%.
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The centrals bank increase benchmark interest rate to suck out the money supply in the economy which inturn helps controlling inflation.
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Could you explain the following?
Euro zone increasing rates to reign in inflation.
I don’t get the meaning. Thanks
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