Business Times

Where to from here for NRFC account holders?

Hindsight is one amongst a host of cognitive abilities unique to humans. Hindsight can be painful for an investor. NRFC account holders are perhaps suffering an acute and prolonged period of pain. Savers working in the Gulf Arab states should be the most aggrieved. Not only has the firm peg to the US$ of local currencies imported runaway inflation, but the sustained depreciation of the greenback along with negative real interest rates for most of the last decade has dwindled the real value of savings.
As a starting point, no currency offers prospective positive real rates of returns across all time periods. As savers you are paying the country of your choice for the luxury of holding their currency. While the irrationality of this exercise is in no doubt, the illusion of safety offered by an unchanging nominal value of savings has appealed to many people who seek the freedom from the fear of poverty.

If the last decade can be explained away as mere muddle through, the next is set for pandemonium. Dysfunctional politics in Europe is a staple, but the Europeans have to look like fine upstanding citizens in comparison to the extremist on display in Washington DC. The current run of global market volatility is driven by people losing confidence in the liberal democratic political order in advanced countries. This is why the most plausible outlook is for a continuing weakening of the US$ against most currencies, while the yields will remain low (theoretically translating to low rates of returns on US$ NRFC accounts for some time).

It is tempting to think that the intractability of the fiscal problem in the US makes higher inflation inevitable. Inflation is a very efficient way to transfer wealth from savers to debtors and might seem to be more attractive than trying to impose unpopular austerity measures. Even if the Federal Reserve in the US were tempted to monetize away the debt, it is hard to imagine global markets would remain quiet in such a scenario. The most likely scenario if markets felt that US debt obligations are being inflated away is for a rapid fall of the US$. That would set off a vicious cycle which would undoubtedly cause a severe US recession.

Luckily for most investors, such a scenario is at least a decade away. For all its faults the political system can still get ahead of this problem and tackle it in a sensible manner. Fears of a looming US fiscal crisis are overblown in the short and even medium term. But NRFC holders will be a lot poorer for simply holding on to US$ at low rates for the next half decade.

Meanwhile Japan offers no meaningful alternative, and China continues to be focused on export-oriented industries creating vast employment opportunities but actively devalues the renminbi. The Australian and Canadian dollars remain pillars of strength off the back of strong commodity prices, which should hold steady over the next few years. Expect more upside for the Canadian dollar as a more hawkish BoC (Bank of Ceylon) stance would lead to higher policy rates. Other large Asian currencies including the Singapore Dollar, Malaysian Ringgit and Thai Baht should gradually appreciate over time, as investors look for alternatives to the US$.

It is in this backdrop that the recent visit to Hong Kong by China’s Vice Premier Li Keqiang (who many expect to be the next Premier) takes importance. Developing HK as an offshore financial hub has long been part of Beijing’s strategy to internationalise the RMB. In a US$-centric trading world where a liquidity freeze can mean a halt to world trade, Beijing thinks it vital to establish a viable mechanism to settle trade in RMB. This requires a large and active pool of RMB offshore, which is where Hong Kong comes in to play. This measure highlights the overall shift towards domestic consumption in China, as outlined in their five-year strategic plan and confirms Beijing’s intention to continue to foster the international use of the RMB. While investors should not expect anything dramatic in the short term, a gradual rise and internationalisation of the RMB is underway.

Fixed deposits aren't a sound investment strategy (in Rupees or any other currency) for investors with a time horizon of more than ten years. Timing is everything and I do not recommend hiding in an extremely defensive investment strategy in fear of a looming U.S. fiscal catastrophe. The current cyclical environment of moderate economic growth in the older economies and extremely low interest rates is likely to persist for at least another year. While that is hardly a perfect environment for risk assets, equities and corporate bonds should outperform term deposits in any currency. With no confidence in the political order, the time to run for cover will come soon enough.

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