Choosing the right currencies to boost your income

It looks like the Indian rupee's spectacular appreciation in January flattered to deceive.

It was the worst performing Asian currency in 2011. However, at the start of 2012 it became the best performing among the emerging markets along with the Mexican peso. In January, both rose seven per cent against the US dollar. Then since February, the rupee has lost 2.88 per cent from this year's high of 48.60.

The Mexican peso has continued to appreciate and is a favourite of foreign exchange strategists and analysts for this year. With risk appetite returning, the peso is among a few currencies that are expected to do well this year. So, given the range of currencies, it is wise to invest, with a professional adviser's help, through a fund or a basket of currencies.

"The Mexican peso and the Russian rouble are our top two picks in the emerging market space in the first half of 2012," said Audrey Childe-Freeman, global head of currency strategy for JP Morgan Private Bank, in an email.

Besides appealing fundamentals, two specific factors justify the bullish view on the two currencies.

"As far as the Mexican peso is concerned, the strong exposure to the US is highly supportive at a time when the US economy is gaining upward momentum," says Childe-Freeman. "The US is Mexico's main export destination, with over 70 per cent of Mexican exports going to the US."

As the Latin American foreign exchange and interest rate strategist at BNP Paribas, Diego Donadio shares a similar view on the Mexican peso.

"The Mexican peso is very much a function of US economic growth and it would benefit from the improving economy," Donadio told Gulf News in a phone interview from Sao Paulo. "Our model suggests that the Mexican peso should move to 11 by year end. We forecast 11.4. It is currently trading close to 13 and so that means a very sharp and aggressive appreciation."

Bullishness on the rouble comes from the prevailing high oil prices. Revenue from oil, said Childe-Freeman, would likely "benefit the economy substantially, which will improve the overall fundamentals — including strong growth, healthy current account and fiscal positions, highly appealing yields and a favourable rating outlook."

The Mexican peso and Russian rouble also figure on the list of Mark McFarland, emerging markets economist at Emirates NBD. The other currencies he likes are Korean won, Taiwan dollar, Indonesian rupiah and Mongolian tugrik and even African commodity currencies "as all are key currencies attached to Bric (Brazil, Russia, India and China)-driven global growth."

Higher rate of returns

Generally upbeat about the emerging market currencies, McFarland said that it's an opportune time to invest in them as interest rates in G7 (Group of seven wealthy countries) countries are much lower. "Investors in developed nations, particularly investment funds, are sending increasingly large quantities of savings into emerging markets where rates of returns are higher."

However, he points out that currencies where governments have a tendency to intervene suddenly to push them lower or to make them more expensive to trade better be avoided.

The Brazilian real is an example of this, which has declined since the highs of January. Both McFarland and Donadio believes the Brazilian real will not appreciate much and is bearish on the currency.

For the long term, Asian currencies would do quite well, says Singapore-based Chin Loo Thio, foreign exchange and interest rate strategist at BNP Paribas, Asia.

"The reason for that is the credit upgrade in Asia story vis-à-vis downgrade in the developed world," she told Gulf News over the phone.

The bullishness towards selective emerging market currencies also arises from the expected liquidity from central banks in the developed world. The liquidity will be looking for yields and part of it will go to emerging countries.

"As developed economies print more money, international investors will be looking abroad for greater investment opportunities," said Michael Hasenstab, senior vice-president and portfolio manager of international bond at Franklin Templeton Investments Fixed Income Group. And those lie, in the long term, in those emerging markets that are showing strong growth and have been fiscally responsible.

The long-term investment perspective cannot be overemphasised though. As Mark Watts, head of fixed income at National Bank of Abu Dhabi, reiterates: "I consider an allocation to emerging market local currency exposure as natural for a large diversified investor, but it pays to keep a long-term view as short-term moves can leave you feeling far from happy." Also, as Watts pointed out, through emerging currencies investors can get access to growing economies with different drivers to developed markets. Emerging markets also often have higher interest rate structures which provides a risk premium.

"Add to this the ability to participate in currency appreciation and this is a good recipe for positive returns," he said.

Bullish sentiment

As of January 31, the currency weightings of the Templeton Global Bond Fund, managed by Hasenstab, were as follows: among the top three allocations within Asia, excluding Japan, were South Korean won and Malaysian Ringgit; in non-US America, Mexican peso and Chilean peso were the top two currencies; and finally in peripheral or emerging Europe, Polish zloty was the second-highest allocated currency.

Currencies do well when free from an intervention by the country's central bank. And this is why Donadio, like Hasenstab, favours Chilean peso.

"The bar for intervention especially in the case of Chilean peso is very high," said Doandio. "We hope, in the months to come, all the noise out of Europe that is affecting the growth outlook will be [eliminated] and then the liquidity injected by the central banks will start to play a bullish sentiment on commodities. The Chilean peso will perform well based on the move on copper prices," despite the fact that they are a bit dependent on China's growth.

When it comes specifically to search for higher yields in the Asian region, Chin cited Indonesia and the Philippines. However, she added that the Indonesian rupiah may not benefit on the back of fresh liquidity from central banks of Europe, Japan and US because foreign participation in Indonesian bonds is already quite high at 32 per cent. "But foreign participation in the vicinity, like in Thailand and [South] Korea, does have some room to increase," pointed out Chin.

"The Philippines as well, as it moves into investment grade and I think these countries will be looked at quite closely. We do think that the [Filipino] peso would do quite well. The Korean won we think is currently undervalued and it should appreciate over time."

In general though, for the smaller export dependent emerging countries, external risk factors are still the most prevalent. "So it is the growth stories or lack thereof in the US and Eurozone, it is oil, commodity price inflation and the impact that it has on domestic inflation, and the lack of flexibility therefore on monetary policy supporting growth," Chin said.

"Fiscally, most of these countries are fine, except for India. And may be, while it's true Malaysia and Taiwan are running larger fiscal deficit, but both the countries have also large current account surpluses that buffer them against fiscal deterioration."

What's in store

With state election politics out of the picture, currency analysts will be watching the budget next Friday. The government doesn't have enough fiscal flexibility to undertake populist measures. India has a large current account as well as large fiscal deficit and the room for flexibility is curtailed by their high structural inflation. India is probably most at risk of higher inflation as well as rising oil prices.

Also, as Mark McFarland, emerging markets economist at Emirates NBD, points out, Europe's debt problems are far from over and Indian equities are expensive relative to their peers in emerging markets, both factors which make him cautious on the Indian rupee. "It may well outperform, but its risk profile [at the present moment] is not appealing." Chin Loo Thio, foreign exchange strategist of BNP Paribas, Asia, says much would depend on how much the government is willing to stick to fiscal consolidation. Otherwise it risks a credit downgrade. "We also have to watch fuel price as well as stock market behaviour," she said. "We are not looking for a sharp rally in the Sensex. So I think the Indian rupee will be range bound, probably within 48 to 51 to a dollar."