The actual performance of key emerging market currencies was much more diverse in 2013 than is often assumed. Second quarter depreciation was the norm, and QE taper talk from Fed Chair Ben Bernanke got most of the blame. For the second half of 2013, emerging market currencies differentiated themselves, with relative stability for the Mexican peso contrasted against further weakness for the Brazilian real and Indian rupee.
For example, the Mexican peso lost a little less than 5 percent against the U.S. dollar in the second quarter, lost another 1 percent against USD in the third quarter, and gained a small fraction in the fourth quarter, despite the official QE taper decision. The Indian rupee lost much more in the second quarter, almost 9 percent against the U.S. dollar, and lost more again in the third quarter, down another 5 percent, yet also was just barely positive in the fourth quarter. While following the same pattern in the second quarter, losing about 9.5 percent versus the USD, the Brazilian real stabilized in the third quarter and then dropped another 6 percent in the fourth quarter. Putting the performance of these three currencies in the lens of the ranges through which they traded, the high-low range for the Mexican peso (against USD) was 12 percent in 2013, which was just barely 1 percent higher than the range for the British pound and the Swiss franc against the U.S. dollar. By sharp contrast, there was a very wide range for the Brazilian real of 26 percent, and for the Indian rupee of almost 30 percent, as these currencies faced much more severe risks and difficult long-term challenges.
The initial depreciation of emerging market currencies in the second quarter of 2013 coincided with Fed Chair Ben Bernanke’s QE taper talk, but there was much more going on in the world. The Syrian civil war was in the daily headlines, the middle class in Brazil and Turkey went to the streets to protest economic policy priorities, etc. Given the strong performance of the U.S. stock market, despite QE taper talk, some asset allocation shifts away from emerging market equities and currencies and into the U.S. and other mature industrial nations was only natural.
After the initial downward currency move for emerging markets in the second quarter, however, the general pattern disappeared and markets became much more mixed. In the second half of 2013 there was much more focus on the specific situations and policies of each country relative to the others.
Emerging market currencies with comparatively large depreciations for the year as whole, such as the Brazilian real and the Indian rupee, both had country-specific issues, and different timing patterns. Attention in Brazil focused on the growing middle class as an active political force for improving government services. The middle class protests have come during the infrastructure building for the World Cup and Olympics, and the currency markets have reflected that considerable policy uncertainty.
In India, which has highly restrictive capital controls, a growing current account deficit has been part of the problem. India is a big importer of gold, and they have raised taxes and tariffs to curb gold imports. Perhaps more importantly, India provides huge subsidies for energy and food that further exacerbate the current account situation. India’s currency weakness, however, was arrested in the fourth quarter, in no small part due to a change of leadership at the central bank and a strongly signaled desire for financial and market reforms. Brazil’s currency weakness, by contrast, took a break in the third quarter, and then resumed in the fourth quarter.
The possibility of occasional bouts of “contagion” when emerging markets in general face perceptions of higher risk is nothing new at all. And, once the short contagion period has passed, the large and considerable individual difference among countries come to the fore to drive exchange rates and also equity markets for emerging market countries.
Prospects for G7 Currencies
Trading in the USD, GBP, and EUR has been dominated since the financial panic of 2008 by the simultaneous adoption of near-zero short-term interest rate policies. QE makes virtually no difference here. So long as short-term interest rate differentials among USD, GBP, and EUR are very close to zero, it is highly unlikely to see persistent trends, although plenty of volatility is likely due to swings in the political winds.
Japan is the outlier here, in that Japan actively promoted a weaker yen in coordination with the initiation of Abenomics in early 2013. The yen versus the USD then stabilized until recently, when some additional weakness has been observed. The yen’s fate in 2014 will probably hang on how much additional stimulus Prime Minister Abe and the Bank of Japan provide to counter the depressing effects of the national sales tax rise coming in April 2014.
Why the Demand for Emerging Currencies?
Emerging market currencies (and equity markets), one by one, are becoming more liquid and they are finding a place in the longer-term portfolios of global investors. It is not a new class of investors, it is the natural progression and increasing attraction of maturing countries, with growing middle classes, and evolving national policies – all while coping with the strains of promoting economic growth in a rather volatile world climate dominated by the zero rate policies of the major central banks.