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What is Currency Risk when you invest outside India?

There are many risks in investing. Some of the key risks that can affect our investments include default risk, market risk, interest rate risk and liquidity risk.

As I mentioned in an earlier post 'Should you invest in Global/International Funds?' investing abroad comes with one more risk...Currency Risk.

Currency risk is the increase or decrease in the value of your investments due to change in the value of the rupee vis-a-vis the currency of the country where you make your investment. 

If the rupee depreciates, it will add to your returns. But if rupee appreciates, it could potentially wipe out all your gains and you could end up with losses in your portfolio.  

A simple example will illustrate this currency risk.
rupee-dollar rates
Dollar-Rupee Chart for last 10 years

Let's say you have Rs.1 lakh to invest, with which you buy stocks in say the US. Assuming the rupee-dollar rate at 50, you can buy stocks worth US$ 2,000. One year later, if you make a profit of 10%, your investment in US would be valued at US$ 2,200.

Now let us now see how the rupee movement can affect your returns.

Scenario 1 : The Rupee depreciates
Suppose, the rupee-dollar rate goes to 56. Hence, if you sell your investment, you will get back Rs.1,23,200 (=2200 * 56). But you invested only Rs.1 lakh. So, your total profit is Rs.23,200. So your effective returns - after rupee depreciation - works out to 23.20%. In fact, even if you had made no gains on your investment, you would still make a profit of 12%, merely on account of rupee depreciation (i.e. 2000 * 56 = 1,12,000).      

Scenario 2 : The Rupee appreciates
But what if rupee turns stronger? Say the rupee-dollar rate moves to 48. Then you will get back only Rs.1,05,600 (=2200 * 48) and hence your effective returns would work out to just 5.6%. In fact, if rupee appreciates to 45, you will get back only Rs.99,000. Thus, despite making 10% profit on investment, you will finally end up with a loss of 1%.

I know, historically rupee has generally depreciated. But, one should not forget that around 2006-2008 and again during 2009-2011 the rupee was appreciating. Logically, if India gets its economic policies right, rupee can turn stronger. Therefore, it would be prudent, not to ignore the currency risk when making any investments outside India.

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