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Currency Markets Brace Up for Any Fed-led Turbulence

Published: 18th March 2015 06:10 AM  |   Last Updated: 18th March 2015 06:10 AM   |  A+A-

Currency

MUMBAI: The US Fed Chief Janet Yellen’s statement after the US Federal Reserve’s meetings on March 17 and 18 will be a crucial time for India to examine the outlook of its currency, reserves, exports, and inflation.

Yellen is widely expected to tighten the US monetary policy beginning June. The mere talk of ending quantitative easing in June 2013 triggered an outflow of $5 billion from India, and sent rupee crashing to 68 to a dollar.

“If the pull back is violent then emerging economies like India could get hurt as there could be pullout from stock markets with a potential negative impact on currency markets,’’ said K Harihar, the treasurer at First Rand Bank.

Jamal Mecklai, the chief executive at Mecklai Financial terms it a tricky situation and says there could a lot of volatility in the coming months with the rupee potentially swinging between 65 and 60 per dollar.

On the exports front, February exports fell 15 per cent, the third straight month of decline even as trade deficit narrowed to 17 month low because of falling prices of crude oil and other commodities. The rupee has held around 62-63 past few months.

So, is the currency level good  enough to support exports denominated in dollar? Consider the real effective exchange rate (REER) data, which reflects the weighted average of the currency relative to an index or basket of other major currencies after adjusting for inflation.

Reserve Bank of India’s March 10 data shows that 36-currency export and trade based weights real effective exchange rate rose to 112.70 in February 2015, indicating any depreciation of the rupee would help improve India’s export competitiveness. Real effective exchange rate in February 2014 was 101.97. What’s disconcerting is that February exports declined on a low base of a year earlier.

What is of equal concern but got left out is that Euro-denominated exports are worse hit as the dollar gained sharply against the Euro, as also other major currencies. About two-thirds of India’s exports are invoiced in the US dollar while Euro gets a share of 15-20 per cent.

As the dollar index, a measure of the value of US dollar relative to majority of its most significant trading partners, rose to 100, the highest level in a decade, the euro weakened further and could soon test the parity level (see chart).

“For exporters in euro it’s a tough situation because not many expected it, and hence remained un-hedged,’’ says Mecklai.

Federation of Indian Export Organization has represented to the government for support as exports to Europe include traditional items such as textile, leather, foods, fruit, marine products and flower which also provides large employment, says Ajay Sahai, director general and Chief Executive Officer at Indian Export Organization.

The Reserve Bank, which typically irons out volatility, has been mopping up foreign currency inflows over the past few months to prevent the rupee from appreciating. Should it go a step further to depreciate the currency, analysts ponder.

The central bank also faces the dilemma that a weaker rupee may help exports but could end up importing inflation.  Actions of the Fed will be keenly watched.

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