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US Federal Reserve and effects on the emerging markets

Today we at Bourse review the impact of the policies undertaken by the US Federal Reserve, in light of a seemingly improving American economy, and its effects on the currencies of the emerging markets.
Emerging Markets
Since the somewhat surprising announcement by Federal Reserve chairman Ben Bernanke in mid-2013 that tapering was on its way, Emerging Markets experienced considerable turbulence.
As a result of this, emerging equity markets and currencies all weakened. The impact of fund outflows from emerging markets has weighed on emerging market currencies, including major EM currencies like the Indian rupee, Indonesian rupiah, Brazilian real, Turkish lira and Russian ruble. As observed in Exhibit 1, EM currencies—while broadly lower in 2013, have generated mixed performances in 2014 year-to-date.
Emerging markets current account deficits have inevitably widened as governments try to contain the weakening currencies and the consequent rising inflation. In response to fund outflows, developing markets have used higher interest rates to encourage investors to remain invested.
Exhibit 2 illustrates a correction in excess of 10 per cent following the news of tapering in June 2013, as measured by an Emerging Market index capturing large and middle cap equities across 21 emerging markets.
USD/Rupee
The year 2013 was a volatile year for the rupee, when it touched its all-time low of INR68.80 to the US dollar. News of tapering of the US quantitative easing programme in mid-2013 elicited an outflow of foreign institutional investor funds from the Indian capital markets, negatively affecting the rupee. By December 2013, the rupee had recovered 8.8 per cent, attributable to a very active response by the Indian government, to end the year at INR61.80. In the short term, a falling rupee may erode purchasing power and possibly trigger inflation as imports become more expensive. On the other hand, the depreciation of the rupee may have had some benefits to export oriented sectors such as the tourism and tech industries and in the longer term this depreciation can narrow the economy’s current account deficit.
Equity funds with investments in Indian equities will be impacted by the rupee movements. The Savinvest India Asia Fund (SIAF) managed by Bourse is one such fund. With approximately 60 per cent of the SIAF exposed to the rupee currency, a 1 per cent appreciation in the currency will be reflected by an increase in the fund’s NAV of approximately 60bps (0.6 per cent) and vice versa. As at 18th March, 2014, the rupee was INR61.20, up from INR 61.80 at the beginning of 2014, a 20bps appreciation.
Looking ahead, broader market expectations are for the rupee to be range bound, trading between INR59 at the lower end and INR 63 at the higher end in the short term.
BRL/USD
The Brazilian real has shed 4 per cent in value against the USD in the past six months, moving from BRL2.2398 to BRL2.3325 on the concern that sluggish growth and a widening budget deficit will lead to a lower credit rating.
The Real hit a year-to-date low of BRL2.4403 in February, before strengthening to its opening 2014 value. In similar fashion to India, Central Bank activity (such as foreign exchange swaps implemented to support the currency and reduce import price increases) has helped the currency rebound. The spot rate for the Real was BRL2.3325 as at 19-Mar-2014, corresponding to an appreciation of 1.25 per cent. This compares favourably to the currencies of Mexico, Peru and Colombia, which have all depreciated. The Bourse Brazil Latin Fund, like the Savinvest India Asia Fund, maintains some exposure to EM currencies. In total, it is approximately 12 per cent directly exposed to the Real, therefore facing controlled risk to currency volatility.
Since April 2013, Brazil’s Central Bank has raised the Selic rate—Brazil’s benchmark interest rate—by 350 basis points (3.5 per cent) as a measure to curb inflation and retain foreign investor interest. At the February monetary policy meeting, the Selic rate was raised by 25 basis points from 10.50 per cent to 10.75 per cent. The Central Bank forecasts that the rate could be raised to 11 per cent by the end of the year.
Investor Implications
In Bourse’s 2014 Themes for the Trinidad and Tobago Investor, we suggested that diversifying across currencies is one way an investor can mitigate risk while seeking more attractive returns. While many investors would not directly acquire exposure to EM currencies (by say, purchasing stocks in Brazil), more adventurous investors gain exposure to EM currencies through investment vehicles such as mutual funds or Exchange Traded Funds (ETFs). For the investor interested in gaining exposure to Emerging market equities while minimising currency risk, it makes sense then to hold a diversified portfolio of mutual funds or ETFs. Investors looking for the higher bond yields as offered in several Emerging Markets, without currency risk, should consider investing in USD-denominated EM bonds. In this low interest environment, investing internationally would be a viable option for those seeking high level of returns. When looking to diversify across currencies, look for a reputable and long standing investment house such as Bourse, who has access to reliable international research pertaining to equities and currencies. One should, as always, bear in mind the risks associated with investing outside of their home currency such as political risk, regulatory issues, and of course foreign exchange risk.

This document has been prepared by Bourse Securities Limited, (“Bourse”), for information purposes only. Any trade in securities recommended herein is done subject to the fact that Bourse, its subsidiaries and/or affiliates have or may have specific or potential conflicts of interest in respect of the security or the issuer of the security, including those arising from (i) trading or dealing in certain securities and acting as an investment advisor; (ii) holding of securities of the issuer as beneficial owner; (iii) having benefitted, benefitting or to benefit from compensation arrangements; (iv) acting as underwriter in any distribution of securities of the issuer in the three years immediately preceding this document; or (v) having direct or indirect financial or other interest in the security or the issuer of the security. Investors are advised accordingly. Neither Bourse nor any of its subsidiaries, affiliates directors, officers, employees, representatives or agents, accepts any liability whatsoever for any direct, indirect or consequential losses arising from the use of this document or its contents or reliance on the information contained herein. Bourse does not guarantee the accuracy or completeness of the information in this document, which may have been obtained from or is based upon trade and statistical services or other third party sources. The information in this document is not intended to predict actual results and no assurances are given with respect thereto.
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