How major EM currencies fared in last 7-8 months: CARE

CARE Ratings' study report on currency movements

The emerging markets were most affected the announcement made by the Federal Reserve in May 2013 which indicated that there would be a tapering of the QE programme which entailed buyback of USD 85 bn of bonds per month from the market. Investors began moving their funds out of the emerging markets which was reflected in a decline in inflows or net outflows from the debt segment of these countries. In fact, investors also moved out of equities and the implication was that as QE tapering meant higher interest rates in the USA, funds would prefer to stay invested there. The result was a panic fall in currencies which was arrested in September 2013, when the Federal Reserve went against market expectations and held on to its stance to retain its QE programme until such time that conditions improved. The target was the unemployment rate which would have two triggers, 7 percent for a QE taper and 6.5 percent for a hike in interest rates. However, there have been developments in October 2013 such as the shutdown in the US and intense debate on the raising of the debt ceiling which in turn casts some doubt on how the government will behave with respect to its expenditure. While these two issues have been deferred, though not sorted out, as the world will confront them again in January and February of 2014, the Federal Reserve will have to keep this in mind when it deliberates the tapering programme. Any resolution of the twin issues of shutdown and debt ceiling would necessarily mean cuts in expenditure which will impact the pace of growth and hence employment situation in the USA. This would be counter to what the Fed has been doing to prop up the economy. Therefore, markets believe that the tapering will not commence any time soon and conjectures are that it would be possible only after the first quarter of 2014. The curious part of the currency story everywhere is that the dollar per se has been weakening versus the Euro over time as shown in Chart 1. On a point to point basis, the dollar has declined by 4.8 percent between April 2013 and October 2013. Typically this should have led to strengthening of other currencies. But on account of the Fed announcement, the fundamentals of balance of payments across the emerging markets were affected with capital outflows leading to currency weakening. Future direction for the rupee
With the global conditions based on Fed action being deferred for the time being, the global influence on the exchange rate would tend to be limited. Hence, FII funds could come in bigger numbers though presently it is positive in equities and negative in debt. If the USA recovery is still some distance away, then there is reason to believe that support will come from here. Also with the trade deficit coming under control, and severe curbs being placed on gold, the rupee may be expected to remain stable in the Rs 60-62/USD bracket, though stronger fundamentals can take it into the fifties. But that will depend on whether more FDI and ECBs come in and how the NRI funds behave after the November time line is crossed for the swap window. There could be an extension of these facilities if the RBI is convinced that it would help. Disclaimer: The views and investment tips expressed by investment experts/broking houses/rating agencies on moneycontrol.com are their own, and not that of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.

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