Rupee Undervalued, Inflation Gap at Record Low, Time to Turn Constructive on Indian Assets: DSP Mutual Fund

Why It Matters

The convergence of a cheap rupee, tight inflation gap and attractive equity valuations could spark renewed foreign inflows, supporting Indian growth and stabilizing the currency.

Key Takeaways

• Rupee REER around 89, lowest since 2008 crisis
• India‑US inflation gap compressed to 1‑2% range
• Services surplus and remittances create $349 bn invisible buffer
• Large‑cap Indian stocks now trading below 15× forward earnings
• FX reserves fell $29 bn, forward book stays around 13%

Pulse Analysis

The Indian rupee’s Real Effective Exchange Rate (REER) slipped to 89.7 at the end of April and is projected to breach the 88‑point threshold as the USD‑INR pair nudged past 96.9 in May. Such a level, unseen outside the twin‑deficit crisis of 2013 and the global financial crisis of 2008, signals a deep valuation discount relative to trade‑weighted peers. At the same time, the inflation differential with the United States—traditionally a 3.5‑4% spread—has tightened to a historic 1‑2% range, implying that the rupee’s long‑run depreciation pressure is easing.

Beyond the headline exchange rate, India’s external position is buttressed by a sizable invisible surplus. Annual services exports now run close to $447 bn, generating a $214 bn surplus, while remittances add another $135 bn, together forming roughly $349 bn of net foreign earnings. This cushion more than offsets the FY‑26 merchandise trade deficit of about $333 bn and would absorb a potential current‑account gap of 2.5‑3% of GDP even if crude oil were to linger at $120 per barrel. Consequently, balance‑of‑payments stress remains limited unless oil prices stay elevated for an extended period.

Equity valuations add another layer of appeal. The large‑cap segment, which captures two‑thirds of foreign portfolio inflows, has quietly de‑rated, with several heavyweight stocks trading below 15× forward earnings—levels reminiscent of the COVID‑19 and GFC troughs. Coupled with robust return on equity figures of 18‑20%, the pricing floor offers protection against further foreign‑portfolio outflows, which have totaled $34 bn over the past two fiscal years. For investors seeking yield and growth, the combination of a fundamentally cheap rupee, narrowing inflation gap, and attractive equity multiples makes a constructive stance on Indian assets a compelling proposition.