History is a strong guide of how one after another emerging market has failed to curb foreign exchange volatility, by hiking interest rates. Interest rates are blunt tool and fail to produce any good, rather cause further harm, as chief causes remain un-addressed. Last year, India and Indonesia, both tried to stop depreciation of their currencies and both failed. We fear that, after Turkey's sharp increase in interest rates, there can be case of peer pressure to build on fragile EM nations, like Indonesia, Brazil and South Africa. In such a scenario, if US Fed decides to taper liquidity by USD 10 billion, it can add fuel to the EM contagion. On the other hand, if US Fed decides not to taper or announces a taper-lite, it can be seen as a serious moral hazard and undermine their credibility, but EM currencies can see a few days of gains against the US dollar.
Over the near-term, we continue to expect volatility to remain high, as market digest the outcome of the US FOMC meeting and the EM monetary policies. We are looking for a range of 62.00/62.10 and 63.10/63.40 on spot, with interim resistance around 62.50/55.
By Anindya Banerjee, currency analyst, Kotak Securities
NOTE: The views are those of the author