The BRICS are emerging economies and the markets. It has gained significant importance recently as an important trade block. Its markets i.e. stock and currency are linked with the global financial markets. Due to globalization the market volatilities are linked with each other and BRICS are no exception. In order to have sustainable growth it is important that BRICS manage their currency market properly. The paper made an attempt to study the volatility of the currency markets of the BRICS by estimating the Value at Risk- VaR for their currencies at different time horizon and analyzed the correlation amongst these currencies.
Currency Markets, BRICS and Value at Risk-VaR
Goldman Sachs economist Jim O’Neill (2001) coined the term BRIC in the year 2001. O’Neill was the one of the first person to realize the importance of BRIC and he stressed the need for the re-organization of world policy making forum and G-7 should be adjusted to incorporate BRIC representatives. The South Africa was added to the original BRIC group in 2010, thus making it as BRICS. Since last three decades the markets in the BRICS have expanded in a rapid manner simultaneously with Economic Growth. During the 6th BRICS which was held in Brazil during 14th-16th July,2014, the BRICS head signed a document to set up a New Development Bank of USD 100 billion with a reserve pool of another USD 100 billions. Such bank will boost the infrastructure development and stimulate the growth further in the BRICS region.
The BRICS today attained the socio-economic and geopolitical importance due to its 3 billion people which are 40 per cent of the world population, with a combined GDP of USD 16.039 trillion that is roughly 20 per cent of the world GDP. The stock market capitalization of BRICS is almost US$ 7000 billion. The combined GDP increase of BRICS was more than twice that of the United States and it was equivalent to the creation of another new Japan plus one Germany or five United Kingdom’s in the space of a single decade. (O’Neill, 2011).
According to the Triennial Central Bank Survey conducted by Bank for International Settlements in 2013, The BRICS was having a negligible presence in World Foreign Exchange markets in 1998. The global foreign exchange turn over daily average in 2013 was around US$ 6671 billion and out of which US$ 174 billion were attributed to BRICS currency markets.1
Currently BRICS block also emerges as a Major Player in the world currency market with their respective currencies are ranked in first twenty top traded currencies of the world.
|
|
1998 |
2001 |
2004 |
2007 |
2010 |
2013 |
|
Brazil |
5 |
6 |
4 |
6 |
14 |
17 |
|
Russia |
7 |
10 |
30 |
50 |
42 |
61 |
|
India |
2 |
3 |
7 |
38 |
27 |
31 |
|
China |
0 |
- |
1 |
9 |
20 |
44 |
|
South Africa |
9 |
10 |
10 |
14 |
14 |
21 |
|
Total of BRICS |
23 |
29 |
52 |
117 |
117 |
174 |
|
World Daily Average |
2,099 |
1,705 |
2,608 |
4,281 |
5,043 |
6671 |
|
BRICS as a % of the World Daily Average* |
1.09 |
1.7 |
2.00 |
2.73 |
2.32 |
2.60 |
Source: Triennial Central Bank Survey (2013)conducted by Bank for International Settlements
*Authors calculations
The Table 2 lists some of the important indicators of the BRICS. Comparisons of these Indicators reveal that China is way ahead in many parameters, followed by Brazil, India, Russia and South Africa. The size of South African economy is relatively small when it is compared with the remaining BRICS nations.
The Table 2 also indicates the some of the parameters which has a direct impact on the currency value. China has foreign exchange reserves of US$ 3880.37 billion which is around 40 per cent of its GDP. The same ratio stands for India and Brazil at 16 per cent, for South Africa 14.5 per cent and for Russia around
24.30 per cent. The China also has an advantage over other BRICS in terms of lower external debt as a percentage as GDP. The China and Russia are also having an advantage over others as they both have a current account surplus.
Table 2: Overview of some indicators of the BRICS
|
Sr. Nos. |
Particulars |
Brazil |
Russia |
India |
China |
South Africa |
|
1 |
Population (2014) (millions) |
202 |
141 |
1267 |
1370 |
52.52 |
|
2 |
GDP in US $ (2013) Billions |
$2246 |
$2097 |
$1877 |
$9240 |
$350.60 |
|
3 |
Market Capitalisation US$ billions (2012) |
$1229.85 |
$874.66 |
$1263.335 |
$3697.376 |
$612.31 |
|
4 |
Foreign Exchange Reserves US$ billions |
$358.81 |
$509.692 |
$298.0925 |
$3880.37 |
$50.68 |
|
5 |
FDI-Net in US$ (billion) |
$80.843 |
$ 70.653 |
$28.153 |
$ 347.84 |
$-1.727 |
|
6 |
FPI –Net in US$ |
$11.636 |
$-7.625 |
$19.891 |
$ 32.594 |
$-6.694 |
|
7 |
Current Account Deficit per cent of GDP (2012) |
-2.41% |
3.57% |
-4.92% |
2.15% |
-5.235% |
|
8 |
External Debt as a per cent of GDP |
19.87% |
- |
20.775% |
9.50% |
36.59% |
|
9 |
Short term Debt as a per cent of Total Reserves |
8.73% |
- |
31.07% |
16.09% |
54.98% |
|
10 |
Gross Domestic Savings as a per cent of GDP (2013) |
15.41% |
28.46% |
26.42% |
51.85% |
16.55% |
|
11 |
Bank’s nonperforming loans to total gross loans |
2.9% |
6.0% |
3.8% |
1.0% |
3.6% |
Source: World Bank web site2
The good saving rate, high working age group population with growing GDP makes BRICS as a attractive destination across International Institutional Investors. Opening up of the financial sectors in the BRICS block has created a vibrant stock and currency markets in their respective economies. The Exchange rates in the BRICS are now making a transition towards a floating exchange rate mechanism which world is following since 1973. Though the foreign exchange turnover of BRICS is relatively small as compared with the world average, yet it has its presence felt in the world currency markets.
The vibrant monetary policy and exchange rate stability is an important factor for overall economic development. The demand and supply mechanism affects the value of a particular currency along with the trade imbalances. The prevailing interest rates and inflation has a direct impact on the exchange rates. The expectation of the market participants such as exporter, importers, portfolio investors, corporate and international trade partners has a significant bearing on the currency value. All such developments lead to volatility in the foreign exchange market. The volatility linkage across markets can affect the stock and currency prices higher the volatility, higher will be the perceived risk and higher would be the expected returns. The foreign exchange risk is nothing but the variability in the value of an exposure that is caused by uncertainty about exchange rate changes. (Click and Covel, 2007). In order to measure the risk and volatility a statistical technique is used known as Value at Risk or simply VaR. The concept of Value at Risk-VaR is being increasingly used by financial institutions to quantify the risk of the investment portfolio. (Apte, 2011)
The Value at Risk -VaR summarizes the worst loss over a target horizon that will not be exceeded with a given level of confidence. (Jorion, 2007). In this paper an attempt is made to measure the Value at Risk –VaR for BRICS currencies for different time horizons.
Managing a currency risk has become an important exercise for the treasury managers as the currency risk leads to exposure. Mainly there are three types of exposure, Transaction Exposure, Translation Exposure and Economic Exposure. Changes in the value of foreign currency with respective to the domestic currency affects the corporate (Lakshman, 2009) hence it is important to study the volatility of a particular currency.
The exchange rate fluctuations do not necessarily have negative effects on international trade in developing countries. The financial development has positive effects on international trade which can promote growth. (Kurihara, 2013)
The volatility in the currency not only affects the corporate but it also makes an impact on the stock markets. The return in stock market had causal influence on return in exchange rate. (Nath and Samanta ,2003). The correlation between Nifty returns taken from October 2007 to March 2009 and the exchange rates was found to be negative. Their study also highlighted unidirectional relationship between Nifty returns and Exchange Rates, running from the former towards the latter such as an increased in the Nifty caused a decline in the exchange rates but converse was not found to be true. (Agrawal, Srivastav and Srivastava 2010).
The BRICS also attracts the large chunk of global capital flows, which affects their currency market and in turns leads to currency volatility. It is evident the capital flows, stock markets, central bank actions and financial turbulences has strong effect on the currency markets. The improvement in telecommunication systems, currency trading is no longer limited to a particular market. (Rajwade, 1996). Such improvements affects the foreign exchange markets as one currency going down will have contagion effect on other currencies and their respective stock and currency markets. This leads to a currency risk. The currency risk may not be fully eliminated it can be better detected, measured priced and managed using statistical technique such as Value at Risk- VaR.
The current study explores the Value at Risk- VaR. associated with The BRICS currencies and also establishes a correlation in between them. The study is exploratory in nature and based upon the secondary data.
This study considered the data of BRICS currencies which are quoted against the United States of America’s US Dollar since January 2001 till December 2014 for the analysis. The data is collected from popular currency website oanda.com3 and analyze using Microsoft excel. The Value at Risk -VaR is estimated for BRICS currencies which are quoted against the US Dollar-USD.
The BRICS currencies which are considered for the study are Brazil- Brazilian Real, Russia- Russian Ruble, India, Indian INR, China- Yuan/CNY and South Africa- South African Rand/XAR. The VaR is estimated for duration of one day, one week, one month, six month, one year, three years, five years and ten years.
The VaR is estimated by the method suggested by Jorian (2007) with 99 % probability assuming a normal distribution. One of the important limitations of the current study is that, it is purely based upon the secondary data with limited time period post year 2000.
Table 3: BRICS Currencies considered for the Study
|
Country |
Currency |
Data Duration |
|
Brazil |
Brazilian Real-BRL |
January 2001 to December 2014 |
|
Russia |
Russian Ruble -RUB |
January 2001 to December 2014 |
|
India |
Indian Rupee -INR |
January 2001 to December 2014 |
|
China |
China’s Yuan Renminbi -CNY |
January 2001 to December 2014 |
|
South Africa |
South African Rand - XAR |
January 2001 to December 2014 |
VaRs are calculated for the BRICS currencies mentioned in the Table 3 for the time horizons varied from 1-day to 10-Year. The results of VaR calculated for the BRICS currencies are shown in Table 4 which indicates that the VaR for the Brazilian Real rapidly increases with increase in time horizon. The currency of China–Chinese Yuan is the most stable as it is state controlled.. The next stable currency in the lot is Indian INR, while others namely Brazilian Real, Russian Ruble and South African Rand are relatively more volatile.
Table 4: Value at Risk –VaR of BRICS Currencies
|
|
One Day |
One Week |
One Month |
Six Month |
One Year |
Three Years |
Five Years |
Ten Years |
|
Brazil |
-0.023 |
-0.047 |
-0.089 |
-0.270 |
-0.387 |
-0.537 |
-0.658 |
-0.760 |
|
Russia |
-0.014 |
-0.031 |
-0.063 |
-0.181 |
-0.230 |
-0.321 |
-0.367 |
-0.452 |
|
India |
-0.009 |
-0.021 |
-0.043 |
-0.110 |
-0.160 |
-0.238 |
-0.275 |
-0.344 |
|
China |
-0.002 |
-0.004 |
-0.009 |
-0.033 |
-0.060 |
-0.141 |
-0.203 |
-0.261 |
|
South Africa |
-0.021 |
-0.047 |
-0.096 |
-0.235 |
-0.323 |
-0.511 |
-0.602 |
-0.441 |
The VaR of South African currency as shown in Chart 1, goes southwards till 5 years period and then suddenly goes up, when 10 years horizon is considered. The VaR for the currencies of Brazil, Russia, India and China steadily increases with increase in the time horizon.
The correlation of daily returns of the currencies when they quoted against the US dollar is shown in the
|
|
Brazil |
Russia |
India |
China |
South Africa |
|
Brazil |
1.000 |
|
|
|
|
|
Russia |
.227 |
1.000 |
|
|
|
|
India |
.219 |
306 |
1.000 |
|
|
|
China |
.062 |
.163 |
.254 |
1.000 |
|
|
South Africa |
.259 |
.220 |
.351 |
.106 |
1.000 |
The Table 5 indicates Indian INR’s daily returns are correlated with Chinese Yuan and South African Rand. The correlation between Russian ruble and Chinese Yuan is nominal and less than the correlation between the Indian INR and Russian Ruble. All above correlations when tested for zero found to be significantly different from zero at 5 % and 1 % level of significance.
Table 6: Currency Correlation of BRICS
|
|
Brazil |
Russia |
India |
China |
South Africa |
|
Brazil |
1.000 |
|
|
|
|
|
Russia |
.256 |
1.000 |
|
|
|
|
India |
.090 |
.756 |
1.000 |
|
|
|
China |
.606 |
-.362 |
-.600 |
1.000 |
|
|
South Africa |
.145 |
.612 |
.731 |
-.348 |
1.000 |
The Table 6 shows that the Chinese currency Yuan is negatively correlated with Russian Ruble, Indian Rupee- INR and South Africa’s XAR. It explains whenever US Dollar appreciate against the Yuan, it depreciates with Russian Ruble, Indian INR and South African XAR. Yuan has a positive correlation with Brazilian Real, while Indian INR shows a good positive correlation with Russian Ruble and South African Rand. The currency correlation of Indian Rupee INR and Brazilian Real -BRL is very weak. The Russian Ruble shows a low positive correlation with Brazilian Real-BRL. The correlation of Brazilian Real-BRL is low with other currencies except Chinese Yuan. All above correlations when tested for zero found to be significantly different from zero at 5% and 1 % level of significance.
The BRICS are emerging as an important trade block not only on geo-political front but also on the socio- economic front. The trade and capital flows will have a strong impact on the BRICS currency markets and may lead to volatility. The global capital flow will pose a challenge to the Central Banks of BRICS in terms of managing their currencies without hampering the trade growth. In order to improve the linkages with world economy and to continue on the sustainable growth path, it is important for BRICS nations to manage the volatility of its currencies. Such efforts will not only fuel the economic and financial growth but also makes BRICS sustainable.
Authored by:
Dr. Nitin Kulkarni
Associate Professor
Prof. Sandeep Chopde
Assistant Professor
Mrs. Yashashree Gurao-Kokate
Research Assistant
MET Institute of Management, Mumbai
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