DSP Mutual Fund Predicts Undervaluation of Indian Rupee, Citing Five Key Factors

Indian Rupee's Sharp Weakness Triggers Contrarian Call from DSP Mutual Fund

The Indian rupee's 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. However, DSP Mutual Fund is making a contrarian call, arguing that several macroeconomic indicators suggest the rupee may actually be significantly undervalued at current levels.

In a recent note titled "This Is The Time To Buy Rupee Assets, Not Bet Against Them," DSP highlighted five major reasons behind its constructive stance on India. The note cited the rupee's Real Effective Exchange Rate (REER) levels, inflation trends, balance of payments resilience, equity valuations, and the cyclical nature of forex reserves as evidence that the risk-reward now favors Indian assets.

DSP's Key Arguments

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1. Rupee's REER Levels are Near Historic Stress Zones DSP noted that the rupee's 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. This level is comparable to the 2013 twin deficit crisis and the 2008 Global Financial Crisis.

2. India's Inflation Differential with the U.S. has Narrowed Sharply DSP highlighted that India's inflation 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%.

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3. India's Invisible Surplus is Cushioning External Stress DSP argued that 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 crude oil prices staying above $120 for more than 12 months could meaningfully worsen India's current account deficit toward 2.5%-3% of GDP.

4. Large-cap Indian Equities are No Longer Expensive DSP argued that while headline market valuations 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.

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.

By highlighting these key arguments, DSP Mutual Fund is making a contrarian call, arguing that the risk-reward now favors Indian assets across equities and bonds.