The suggestion the Federal Reserve would start tapering its massive bond buying programme has disproportionately affected emerging markets (EMs). As the dollar appreciated, the purchasing power for countries like India has significantly diminished. Between 22 May and 19 September, the cost of oil in dollar terms rose 8.25% from $102.29/barrel (bbl) to $110.73/bbl. The impact of currency fluctuations has seen a much steeper increase in the oil price in India. The cost of a barrel of Brent in rupee rose nearly 30% from INR5294/bbl to INR6824/bbl over the same period.
The value of the rupee fell 15% between 21 May and 19 September from INR55.10/$ to INR63.58/$. Other EMs have seen similar effects as mini-crises erupted in currencies from Brazil to South Africa, Turkey and Indonesia. The effect is like adding a relatively massive and broad-reaching tax on goods, including food, being consumed in EMs. It has also woken investors up to the considerable structural problems that cheap borrowing has allowed many EM governments to largely ignore. Tapering by the Fed is a question of when rather than if and, as the Bank of England has already done, shows the period of quantitative easing that has pumped excess liquidity into markets and inflated risk asset prices will be gradually withdrawn over the medium term. The sharp correction seen over the summer reveal a potentially worrying medium to long-term trend for EMs unless they can get debt levels down and implement much-needed structural reforms.
The implications for investors are manifold, especially given the exposures built up in recent years. EMs have already underperformed developed markets. The magnified effect on commodity prices of a stronger dollar will create a significant drag on growth of emerging economies. Higher food and energy prices also increase tensions within countries, leading to civil unrest, which in turn contributes to uncertainty and volatility across many asset classes.
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