How to protect your investments in a currency war

In case of a looming currency war, Modi feels investors should have negligible exposure to equity as defensive sectors are already quite overvalued

Last week, Reserve Bank of India Governor Urjit Patel said, “A few months of turbulence are already behind us. It looks like this is going to continue, but for how long I do not know. Trade conflicts have evolved into tariff wars and now we are possibly at the beginning of a currency war.”

The central bank’s latest move of increasing interest rates validates the threat of currency war to our economy. Let’s understand what a currency war means, its impact on investors, where you should invest and ways to protect your investment portfolio in this situation.

What is a currency war?

A currency war is when a nation deliberately devalues its currency and joins other countries to compete with them. Jimeet Modi, CEO and Founder at Samco Securities & StockNote, said, “When a series of countries one after the other deploy the same strategy of depreciating their domestic currency to boost their economy, currency wars occur. The deliberate depreciation in the domestic currency will stimulate the economy by making their exports more competitive in global markets.” Imports will in-turn become more expensive and these factors will spur growth as consumers will opt for local substitutes to imported products.

For instance, a person goes out to buy a particular grocery or item which is available at hundreds of shop but would prefer to buy it from a store that offers the same product at a lower rate. The devalued store (currency) will sell more of the same item as compared to other stores in the locality. That will, in turn, improve sales (exports) and decrease costs (imports).

Your portfolio could be deeply impacted in currency war

Modi sees investor portfolios deeply impacted as the rupee’s devaluation to the dollar will erode profits as "most sectors in some way or other would have an exposure to the global markets. In the event of a trade war, the onset of a currency war would be inevitable.”

As seen from the Asian currency crises of 1997-98, global equity markets had undergone a massive fall due to panic selling and this translated to Indian markets as well. “Companies like Hindustan Unilever, Tata Steel, and Reliance Industries had all experienced a fall of 20 percent during the  July 1997 to March 1998 period. None of the sectors escaped the Asian currency crises and investors were crying under the burden of rising losses.” Financial analysts believe historical trends are more likely to repeat if such an event does occur in the future.

Where should one invest in this situation?

In case of a looming currency war, Modi feels investors should have negligible exposure to equity as defensive sectors are already quite overvalued. "Putting fresh money at this point would not help in making exceptional returns.”

Also, the Asian currency crises of 1997-98 gave investors enough reason to believe equity markets have a higher probability to tank if the event were to occur again.

“Park money in short-term money market funds, some part in bonds and partially in gold. However, when the effect of currency wars starts to fade away, investors must swiftly begin investing in the markets at the bottom to profit from a consequent rally," Modi advised.

In case you are keen to invest in equities despite the currency war risk, Anand James, Chief Market Strategist at Geojit Financial Services suggests that one invest in sectors that have forex exposure through exports like information technology, pharmaceutical, textiles etc. He recommends investing in consumption-themed stocks when the market corrects since at present these stocks are a bit expensive.

Manish Goel, Director and Co-Founder of Research & Ranking, said: “Equity investors need to follow a cautionary approach while selecting sectors. We are quite optimistic on manufacturing, infrastructure and automobiles in the long run due to government’s revolutionary reform.”

Ways to protect your portfolio in a currency war

Goel feels investors need to be more careful than ever while picking up stocks in the current situation. "One should look out for companies with strong cash flows with unique competitive advantage to absorb the adverse effects of a currency war.”