The Indian sharp weakness this year has triggered growing anxiety across financial markets. Foreign investors have continued to pull money out of Indian equities, crude oil prices remain elevated, and concerns around the country’s balance of payments have intensified after the rupee crossed the 96 mark against the U.S. dollar. For many investors, the instinctive reaction has been to look outward — toward dollar assets, gold or overseas markets.
But DSP Mutual Fund is making a contrarian call.
In a recent note titled “This Is The Time To Buy Rupee Assets, Not Bet Against Them,” DSP argued that several macroeconomic indicators suggest the rupee may actually be significantly undervalued at current levels and that the risk-reward now favours Indian assets across equities and bonds.
The note highlighted five major reasons behind its constructive stance on India, ranging from real effective exchange rate (REER) levels and inflation trends to balance of payments resilience, equity valuations and the cyclical nature of forex reserves.
“Currencies, interest rates, and flows are inherently cyclical. Betting against the Rupee at these depressed REER levels and tight inflation differentials is a low-probability trade,” DSP said.
1. Rupee’s REER levels are near historic stress zones
DSP said the rupee’s Real Effective Exchange Rate (REER) had fallen to highly competitive levels rarely seen outside periods of major structural crises. According to the note, the rupee’s REER stood at 89.7 at the end of April 2026 based on BIS data and was estimated to have slipped below 88 after USDINR crossed 96.9 on May 20, 2026.
“To put this in perspective, this is the most competitive the currency has been outside of two major structural crises: the 2013 twin deficit crisis and the 2008 Global Financial Crisis,” DSP said.
The fund house argued that on a trade-weighted basis, the rupee now appears fundamentally undervalued, creating what it described as a strong “margin of safety” for investors allocating toward rupee-denominated assets.
2. India’s inflation differential with the U.S. has narrowed sharply
DSP also highlighted that India’s differential with the U.S. has compressed significantly compared to historical averages, which could reduce long-term depreciation pressure on the rupee.
Historically, the inflation gap between India and the U.S. averaged around 3.5%-4%. However, the note stated that the spread between India’s core CPI and U.S. core PCE has now narrowed sharply to around 1%-2%.
“Over the last 12 months, US CPI has averaged 2.8% while India’s CPI has averaged 2.3%, a gap favouring India by 50bps,” DSP said.
According to the fund house, a structurally lower inflation differential mathematically implies that the long-term pace of rupee depreciation against the U.S. dollar should slow down rather than accelerate.
3. India’s invisible surplus is cushioning external stress
One of the strongest arguments in the note revolved around India’s balance of payments resilience.
DSP said current concerns around India’s external position are being driven more by fears of permanently elevated crude oil prices above $120 per barrel rather than actual realised stress. The note added that only a prolonged period of staying above $120 for more than 12 months could meaningfully worsen India’s current account deficit toward 2.5%-3% of GDP.
DSP also noted that , historically a major pressure point for India’s current account, may become less problematic because record-high prices have triggered sharp demand destruction.
“Gold has historically been a massive detractor for the Rupee. However, record-high prices have triggered severe demand destruction, with domestic jewellery volumes contracting by nearly 25%,” DSP said.
4. Large-cap Indian equities are no longer expensive
DSP argued that while headline market continue to appear elevated, the large-cap segment has quietly become far more attractive.
The note stated that muted FPI and FDI flows were partly a consequence of historically expensive Indian equity valuations. However, several heavyweight large-cap companies are now trading below long-term average valuation multiples.
According to DSP, select segments are currently available below 15 times forward earnings, with some valuations approaching levels last seen during the COVID-19 crash or the Global Financial Crisis.
“Generating Return on Equity (ROE) upwards of 18% to 20% is a rarity in emerging markets, yet top-tier Indian businesses continue to deliver it,” DSP said.
The fund house believes these valuation levels could help place a floor under further selling, especially because the underlying quality of Indian businesses remains strong.
5. FX reserves and capital flows are cyclical
DSP also sought to calm fears around India’s declining foreign exchange reserves and the RBI’s forward book position.
The note stated that RBI’s headline FX reserves have declined by $29 billion this year, while the outstanding USD forward book currently stands at nearly 13% of total reserves. However, DSP argued that such levels are not unusual in historical context.
The fund house pointed out that the RBI’s forward book stood at 14% in March 2025 and 11% in March 2013, while the central bank had even maintained a net forward purchase position of 11% back in March 2022.
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