Undervalued currency may be a magnet for returning investors
Analysts note that when a currency becomes sharply undervalued, history shows it often draws foreign investors back into local assets. That renewed demand can cushion the currency and limit further falls, even after a period of weakness.
Why undervaluation attracts capital
A deeply discounted exchange rate can create attractive entry points for foreign investors for several reasons:
- Higher potential returns: Buying local assets becomes cheaper in foreign-currency terms, raising the chance of gains if the currency rebounds.
- Valuation play: Institutional investors and funds look for mispriced opportunities; large gaps between market rates and estimated fair value signal a possible upside.
- Carry and yield advantages: If local interest rates are competitive, investors can benefit from yield differentials plus potential currency recovery.
Market and policy implications
When foreign capital flows back, it tends to drive demand for the local currency and assets, helping to stabilise prices. This dynamic can reduce pressure on central banks to intervene aggressively. On the other hand, policymakers must still monitor inflation, capital flow volatility and any structural risks that could deter lasting inflows.
Risks still remain
While undervaluation can limit further downside, it is not a guaranteed floor. Key risks include:
- Global risk-off episodes that push investors into safe-haven currencies.
- Unexpected domestic political or economic shocks.
- Policy changes such as capital controls or sudden rate shifts.
What investors should watch
- Exchange rate trends: Signs of stabilisation or renewed depreciation.
- Capital flow data: Net foreign purchases of bonds and equities.
- Monetary policy signals: Central bank guidance on rates and FX intervention.
- Macro indicators: Inflation, growth and fiscal health that affect long-term returns.
In short, deep undervaluation often acts like a pull factor for foreign investors, which can help cap further currency losses. Still, investors and policymakers need to balance that historical tendency against present risks and changing global conditions.