Weekly Review 34/2013

The past week of trading was all about emerging market (EM) currencies. Following the US Federal Reserve's announcement in May that it would soon begin tapering its bond purchases and thereby exit the phase of extremely low US yields, EM currencies have come under pressure as investors started to move capital back into US securities. That capital had originally been invested outside the US in search of higher returns. Now that yields in developed countries are expected to slowly increase again, many investors have begun to repatriate their holdings. This development accelerated this calendar week after the release of the latest FOMC minutes, which included further hints at Fed tapering.

Several countries' currencies were hit particularly hard: The Indian rupee (INR) fell to record-low levels. It currently trades just below Rs65 to the US dollar (USD), significantly above levels of Rs55 from the beginning of the year. The depreciation of the INR gained momentum when the Reserve Bank of India (RBI) introduced capital controls on August 14th to prevent local investors from moving money out of the country -- a decision that worried foreign investors, who in turn exchanged more of their INR holdings into USD and other developed countries' currencies. The Indian finance minister, Palaniappan Chidambaram, has since ruled out further capital controls in an attempt to calm the markets and remove volatility.

The Brazilian real (BRL) also continued to depreciate in the past week and now trades at around BRL 2.40 per USD. Brazil's currency is now close to the high values of roughly BRL 2.57 it reached in late 2008. Alexandre Tombini, Brazil's central banker, acted more decidedly to stop the BRL's depreciation than his colleagues from other EM countries. First of all, he decided not to attend the annual conference of central bankers in Jackson Hole to be able to monitor his country's currency. In addtion, Mr Tombini announced a $60bn intervention programme, which includes one auction of currency swaps per day and the sale of repurchase agreements every Friday until the end of 2013. The programme sends a strong signal to investors that Brazil is not going to run out of US dollar reserves and will be able to intervene to stop its currency from falling. In a first success, the real gained back some of its losses by falling from its high of BRL 2.45 to the Friday "close" of BRL ~2.40. However, taking the big hedge funds' and investment banks' capitalizations into account, the intervention programme still looks small in size and it is questionable whether Mr Tombini's promise is actually believable over a horizon of more than a few days or weeks. While he may have won this one battle, the war is certainly not over so-to-speak.

Indonesia also intervened, albeit less ambitiously, by announcing the increase of import taxes on luxury cars and tax incentives for companies investing in agriculture.  This move was aimed at reducing the oil imports, but it is unlikely to stop the devaluation of the rupiah (IDR), which was particularly sharp. As of this writing, the IDR trades at 10,775 per USD, more than 10% above its level from January. Other EM currencies, such as the Turkish lira (TRY) and the South African rand (ZAR) have also been under increased pressure. Emerging market countries can expect to struggle during the remainder of this year and most likely also in 2014 not just due to the United States exiting its monetary easing programmes, but also because of internal issues, such as high inflation rates, slowing growth rates and large account deficits.