By Amit Pabari
The Covid-19 pandemic and the global lockdown are truly historic events. Never before has the global economy been deliberately put into an induced coma. Whenever an undue pandemic occurs, central banks and regulators will need to work closely with finance ministries to limit the damage to the real economy. Across the advanced economies, so far the central banks have rightly prioritized maintaining financial stability and supporting the economy over fighting inflation with delayed interest-rate hikes. But with financial fragility and inflation at all-time highs, let us check what could be the next big test coming for emerging markets.
To begin with, let’s understand the story so far with the performance of emerging markets equity and currencies. So far, the gains from the Indian stock markets outpaced emerging markets (EMs) in the first three quarters of 2021, despite the uncertainties amid the third wave of covid infections. The benchmark Nifty has gained nearly 26%, giving the best returns amongst headline EM indices.
The Risk-on Mode
The turning point for risk-on assets was the US Fed chief’s speech at the Jackson Hole Symposium which was ‘dovish’ and expressed hope that the Fed will keep supporting the market with low-interest rates leading to a weaker dollar. This had led to gains in other peer currencies. The gains in the rupee, particularly in August, were the result of heavy buying in domestic equities and weakness in the safe-haven demand. Fresh foreign capital inflows on account of the flurry of IPOs and stake sales into the Indian equity markets also bolstered the rupee. This drove the Indian rupee to be among the top-performing currencies among other emerging Asian currencies as shown below.
*Data indicating the performance of past 9 months for emerging markets
Downfall of Chinese markets
However, the story didn’t last long after an impending collapse of China’s biggest real estate company that had a serious knock-on effect on the entire economy and dragging receding effects on emerging financial markets. It started back then from July, after China’s antitrust regulator ordered Tencent to give up its exclusive music licensing rights and levied a fine on it for anti-competitive behaviour unfolding kind of another ‘Tech-Bubble’. That apart, the widening power crisis is still threatening growth and further tangles already affected global supply chains.
However, taking India specifically into consideration, in the near term, there may be minor outflows from the Indian markets as global investors having exposure to Chinese developers seek to rebalance their portfolios due to losses. But over the mid to long term, this could result in the higher allocation of flows back to India during the risk-on mode.
Countdown to taper
Moving ahead, with one more fear factor looming over the emerging markets is the likelihood of the Federal Reserve opting for a hike in interest rates considering the surge in energy prices and persistent inflationary pressures. High US Treasury yields have added another layer of pressure to emerging market currencies, as investors bet that elevated U.S. inflation could lead the Federal Reserve to tighten policy sooner than signalled overall benefitting dollar demand. In emerging markets, South Korea, Mexico, Brazil, Russia, Argentina were amongst those who hiked their rates amid rising inflation. Surprisingly, the Turkish Central Bank cut by 100 bps to 18%. Market participants judge this move after president Erdogan’s interference behind easing.
The flow story
Coming back to the rupee, analyzing all factors so far, it has remained the best performing currency among its peers in the Asian belt. Consistent FII flows on account of various IPO’s, stake sales, and diverted flows amid tighter regulations in China had kept the rupee supportive. This was clearly visible as FII continued its buying spree with close to Rs 96,644 crs for the calendar year 2021. However, being a banker’s bank- RBI didn’t want to tolerate rupee appreciation only on the basis of mere inflows. Thus RBI was seen piling up its FX reserves to prevent the economy from undue external shocks. Despite the equity market’s outperformance, Rupee has been in the range of 72.30-75.50 zone over the last few months. Also, the rupee has felt the prick of pins and needles right from the soaring trade deficit, a steady dollar rebound, and a 7-year high moving crude oil prices. After OPEC+ decided to continue with the same output, despite pressure from countries to add more oil to stabilize prices has hurt oil-importing nations badly.
Overall, on the positive side, the flow spree shall continue with the upcoming IPO and bond raises. On the flip side, higher US bond yields pushing for more dollar demand amid likely tapering announcements could cap appreciation thereof. Additionally, as per latest RBI policy, announcements were made for more VRR auctions thereby pointing towards the upcoming reverse repo rate hike. Considering the rising inflationary pressures due to spike in energy prices RBI may change the forward guidance from being accommodative to neutral tilting rupee towards depreciation.
In a nutshell, expectations are high that the Fed will upgrade its tightening policy sooner due to the recovery in labour market and rising inflationary pressures. This could keep dollar stronger, thereby limiting gains for other emerging currencies in final quarter for 2021. Rupee shall also feel a hit from negative EM FX and but intensity could be slower as RBI could possibly intervene. Technically, the roof of 75.50-75.60 is acting as a stiff resistance, if broken then we could see a move towards the first target towards 76.00 levels over the near term and then one can set second and third target of 76.50 and 77.00 levels in the medium term.
(Amit Pabari is the Managing Director of CR Forex Advisors. Views expressed are the author’s own.)