How currency fluctuations impact your financial plan ?

How currency fluctuations impact your financial plan ?

If someone was to come and tell you that the movements of dollars and pounds would impact your financial plan, then you would surely be amused. How your personal financial plan buying Indian assets even could be influenced by global exchange rates. The surprising fact is that currency fluctuations do influence your portfolio either directly or indirectly. Remember, currencies are always traded in pairs. That means for every base currency there is a value currency. What is good for one currency is bad for the other currency. And that can impact your personal financial plan in a variety of ways. Here are 5 ways your financial plan will be influenced by currency fluctuations...

The dollar defensives and the dollar aggressive stocks...

There are certain industry groups that are predominantly dependent on export markets. Sectors like IT, pharmaceuticals, auto ancillaries, gems & jeweller etc are all impacted by the fluctuations of the currency. Then there are scores of Indian companies who have raised money through ECBs and FCCBs by borrowing in dollars. These dollar borrowers will be worrying about their payables rising in rupee terms if the dollar appreciates. Similarly, IT and pharma will benefit from a strong dollar. When you invest in equity mutual funds then a good proportion of your portfolio will consist of stocks that are either dollar defensives or dollar aggressive stocks. Any fluctuations in the price of the dollar will substantially modify the fortunes of these companies who have dollar businesses or dollar borrowings. It is estimated that such stocks will contribute 50-60% of any diversified equity portfolio.

Impacts the landed cost of crude oil...

Now you may obviously wonder why the price of crude oil really impacts your financial plan. Here again, the relationship is slightly circuitous. Let us assume that you hold a mutual fund that has a portfolio of mid-cap and large cap stocks. For many sectors like paints, tyres and petrochemicals, crude oil is an important input. For sectors like oil extraction and oil refining, crude oil becomes an output and hence benefits from higher oil prices. If you add up the universe of stocks then the overall population of crude oil sensitive stocks will be quite large. The reason crude oil is so important is that India imports nearly 80% of its daily crude oil needs and that situation is unlikely to change in the short to medium term. Also, if you were holding mid-cap funds, then these funds would have been the biggest beneficiaries of lower crude oil prices and that would impact your portfolio performance. And the strength of the dollar plays an important role in raising the landed cost of imported crude oil.

Have you heard of imported inflation...?

Imported inflation is an interesting term. When you import from countries with a strong currency, then you tend to import inflation from these countries. That raises the level of inflation in India. For example, if we import oil from the US which has a strong currency, then the strong dollar will constantly result in India importing inflation from the US. You may wonder that notwithstanding the impact of currency on inflation, how is this relevant to your financial plan? Remember, your financial plan is based on inflation assumptions. When you import inflation then your future inflation projections will change. That means you will require a bigger corpus in the future compared to your original assumptions. That means, you either increase your allocation today or deploy money in more risky assets. Either way, it is likely to have a deep impact on your financial plan.

What if your portfolio has an allocation to gold and global funds?

This is another interesting scenario. Why should you worry about your gold when the currency is fluctuating? The reason is that gold moves inversely with the dollar value. That means a strong dollar will mean weaker gold prices. That will impact the value of gold in your portfolio. Secondly, there are many global funds offered by domestic mutual funds. These typically operate as fund-of-funds. They collect money in India and invest in their parent abroad. The advantage for you is that your financial plan gets de-risked due to a global exposure. The challenge is that if you own funds based in the US then you are automatically exposed to the value of the dollar and other currencies. If you are diversifying into gold or global assets, then currency fluctuations can have a serious impact.

Currency fluctuations impact the composition of your debt portfolio...

What if the dollar appreciates and the rupee weakens? The RBI is normally worried that debt investments may suddenly turn risk-off and shifts out of India as we saw in 2013. To pre-empt this situation the RBI may hike the rates of interest in the economy. Now debt funds react negatively to a rise in interest rates as the NAVs of these debt funds will come down. This impact will be more pronounced in long dated securities and therefore you will have to tweak your debt portfolio more in favour of shorter-term instruments to avoid capital loss.

The moral of the story is that currency fluctuations may appear to be a remote event but they have serious repercussions for your financial plan. In fact, the actual impact can be much bigger than you can imagine!

Source: Motilaloswal