Fed casts shadow over India, emerging markets

NEW DELHI — Travelospin, a medium-sized travel agency, occupies a prominent spot in a large commercial complex in the central Indian city of Jaipur’s affluent shopping district of Vaishali Nagar. Surrounded by the large showrooms of international brands such as Nike and Levi’s, Travelospin is one of the thousands of small travel agencies that popped up in the past decade after India liberalized its economy.

Then, Indian middle-class families found themselves with cash to spare and a desire to travel. Firms like Travelospin rushed in to cater to them. With the recent declines in Indian rupee, though — the currency fell by nearly 20% in the past three months against the dollar — it looks like the honeymoon is over.

“We have seen business drop by nearly 20% in the leisure travel category in less than two weeks,” said Nitin Jain, the 31-year-old proprietor of Travelospin.

“When the rupee was 54 to a dollar, a visit to Malaysia cost $230 but now that the rupee is up to almost 64 to a dollar, people have to shell out nearly 2,000 rupees more.”

For Indians, the past few weeks have been a nightmare, each morning bringing with it a new “historic low” for the rupee. Last week, the rupee fell to a lifetime low of 65 to a dollar. In total, the currency has now declined nearly 40% since mid-2011. It is a long way off from a healthy 54-55 rupees to a dollar that most Indians are accustomed to.

Some economists say the decline of the rupee — as well as other emerging market currencies — was triggered by signals from the Federal Reserve that it is trying strengthen the American economy, and so will soon begin tapering U.S. monetary stimulus.

“We are noticing similar decline patterns in India, Indonesia, Brazil and other emerging economies that host sizeable foreign investments,” said N.R Bhanumurthy, professor at the National Institute of Public Finance and Policy in New Delhi.

“(Fed) Chairman (Ben) Bernanke’s announcement that the U.S. will revert quantitative easing has caused a lot of capital from emerging economies to flow to the U.S.,” he added, referring to a monetary policy initiative that governments sometimes take to expand the economy by buying up financial assets.

“Most of these economies have a high current account deficit,” Bhanumurthy said. “Foreign investors look for returns and rewards on the risk they undertake and the majority opinion for now is that returns on U.S. bonds are higher than returns on emerging market bonds.”

Leading the pack of emerging market currency decline is the Brazilian real, which has witnessed a 22% decline since May 1. The Turkish lira, the Indonesian rupiah and the South African rand have also seen a 10-15% fall in the same period.

“This is short-term volatility backed by foreign capital outflow and my guess is that it’s speculative outflow, and the market will balance itself out in the next few months, maybe even weeks,” Bhanumurthy said.

Still, some major market players such as Deutsche Bank are more pessimistic.

“We now believe that the Indian rupee could touch 70 to the U.S. dollar in a month or so, although we expect some revival of the currency by the end of the year,” said the bank in a recent statement. Referring to the decline of emerging market currencies, Deutsche said that “under a scenario of deep pessimism, currencies can overshoot (themselves) substantially and remain so for a long time. India, we fear, is entering such a zone.”

Indians, meanwhile, are already feeling the impact of this slide, most notably those who work in the manufacturing and import sectors. One industry that has already taken a hit is the diamond sector, currently valued at nearly $12.5 billion.

“Nearly 800 small- and medium-sized diamond companies have temporarily downsized leading to a loss of nearly 10,000 jobs,” said Vinoobhai Ambalia, chief accountant at Dharmanandan Diamonds, one of the largest diamond companies in India. The cost of rough diamonds has appreciated greatly, and many customers have stopped buying them, Ambalia said.

In a bid to stem the rupee’s fall, India’s Reserve Bank over the past few weeks has introduced higher import duties on gold and silver and restricted the amount that local companies can invest overseas without seeking approval. Yet, outlook on the rupee remains cautious.

Many Indians hope that Raghuram Rajan — a highly respected former professor at the University of Chicago who will take over the chairmanship at India’s Reserve Bank — will be able to reverse the tide.

However, many analysts say that any hint of aggressiveness by the Reserve Bank could result in further slowing the economy.

Brian Jackson, a global currency strategist at Coutts, a London-based wealth management firm, wrote in a research paper that it is hard to see the Reserve Bank “being able to control the rupee’s fall without further impeding growth, either by pushing up bond yields or making it more difficult to access bank financing.”

In Jaipur, Jain is a worried man.

“Never before have I seen business decline so quickly, in a matter of days, and the real fear now is that if the rupee continues to fall, even business travelers will reign in their travel expenditures,” he said. “This could prove to be fatal for small-sized businesses like mine.”