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 $ 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% for a QE taper and 6.5% 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. On a point to point basis, the dollar has declined by 4.8% 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.
Some interesting points that emerge are:
8 of the 12 currencies witnessed depreciation in each of the months between May and August.
Korean won was probably the exception which appreciated in 3 of the 4 months.
In case of the South African rand, Malaysian ringgit and Mexican peso, there was depreciation in 3 of the 4 months.
The rupee and the real of Brazil were probably the most affected by currency developments and registered relatively higher rates of depreciation. In the Indian case, a contributing factor was an adverse balance of payments which exacerbated the situation. The Turkish lira also declined continuously though the rate of decline has been relatively more moderate.
The rupiah took the biggest hit in September by 7.6% when other currencies either appreciated or declined at relatively low rates after the Fed announcement in the middle of the month.
There has been a change in currency movements in the month of October where currencies have regained lost ground. 10 of the 12 currencies have strengthened with the exceptions being Indonesia and Argentina. The rupee, real and ringgit witnessed relatively stronger recoveries in October after the Fed had announced that it would not be tapering the QE programme and would take a review in October (where it has been decided to further wait for strengthening economic signs before taking a decision).
For the entire period, Indonesia, Argentina, India and Turkey were most affected by currency volatility with depreciation of over 10%. South Africa and Brazil followed them with a fall of around 9%, while Thailand witnessed a decline of a little over 7%.
What can the rupee bounce back be attributed to?
While it will be difficult to apportion the strengthening of the rupee to different factors, some of the positive developments were as under.
1. Trade deficit has improved from a high of $ 20.7 bn in May to $ 6.6 bn in September, which has been due to a combination of rise in exports (which has come over a low base) and control in growth in imports with gold imports coming down.
2. RBI opened the swap window for NRI deposits for banks which has caused inflows of over $ 10 bn. Further, there is separate window for OMCs (oil marketing companies), which has lowered demand for dollars in the market.
3. FIIs have tuned positive in net terms, which can be attributed more to global factors. After being in the negative territory with outflows of $ 7.1 bn, $ 3.1 bn and $ 2.35 bn in June, July and August, it turned positive to $ 734 mn in September and further to $ 586 mn up to October 29th.
4. The fact that the RBI has started reversing some of its earlier imposed measures that targeted speculative activity in the market is indicative that these influences have been negated to a large extent.
5. The RBI has been selling dollars in the market to steady the rupee. Our forex reserves have come down by around $ 11 bn between March end and October 18th.
6. While higher interest rates could be a reason, the fact that FII flows into the debt segment are still negative indicates that this effect would be at best marginal.
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/$ 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.
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