Forecasting Exchange Rates of the Mauritian Rupee to March 2015
A J Khadaroo
October 2014
1. Introduction
Using a model I have developed, this paper produces forecasts of the exchange rate of the rupee against the dollar, euro and pound from October 2014 to March 2015. The forecasts are derived on the basis of postulated trajectories for the globally determined dollar/euro and dollar/pound exchange rates over the forecast period Oct 2014 – Mar 2015. An examination of the previous set of forecasts (contained in Khadaroo, July 2014) made in June 2014 for the period July to October 2014 is undertaken.
2. Forecast Performance July to mid-October 2014
Forecast (ex-ante) values of the rupee produced by Khadaroo (July 2014) for the period July to mid-October 2014 are compared with actual (ex-post) values.
Figure 1: Forecast (Ex-Ante) and Actual (Ex-Post) Rs/USD Buying Exchange Rate 30 June - 17 October 2014 (Including 50% Confidence Band)
31.2
30.8
30.4
30.0
29.6
29.2 30 7 14 21 28 4 11 18 25 1 8 15 22 29 6 13 M6 M7 M8 M9 M10
Actual Mean Forecast Lower Bound Upper Bound
The actual values are consistent with the upward trend in the forecasts denoting a depreciating rupee against the dollar.1 The confidence band comfortably contains the actual values. In addition the actual values remained close to the mean (central) forecasts up to the third week of August but thereafter transited to end up near the upper quartile as from first week of September. The fact that the actual values have most of the time been above the mean forecasts indicates the dominance of upside risks in value of dollar against rupee over the last three and a half months.
Figure 2: Forecast (Ex-Ante) and Actual (Ex-Post) Rs/EUR Buying Exchange Rate 30 June - 17 October 2014 (Including 50% Confidence Band)
40.8
40.4
40.0
39.6
39.2
38.8
38.4 30 7 14 21 28 4 11 18 25 1 8 15 22 29 6 13 M6 M7 M8 M9 M10
Actual Mean Forecast Lower Bound Upper Bound
The actual rupee/euro exchange rates are consistent with the declining trend in forecast values and are well contained within the confidence band. The actual values were in the vicinity of the upper quartile up to mid-July, stayed close to the mean forecast up to end-August and thereafter fell further. This implies a weakening euro and denotes that downside risks have lately been more important.
1 The Buying exchange rate is here defined as the average of the T.T and D.D. rates. Figure 3: Forecast (Ex-Ante) and Actual (Ex-Post) Rs/GBP Buying Exchange Rate 30 June - 17 October 2014 (Including 50% Confidence Band)
54
53
52
51
50
49 30 7 14 21 28 4 11 18 25 1 8 15 22 29 6 13 M6 M7 M8 M9 M10
Actual Mean Forecast Lower Bound Upper Bound
Forecasts of the rupee/pound exchange rate turned out to be less accurate, indicating a strengthening pound while actual values have been on the decline. Consequently, the confidence band does not adequately contain the actual values. An analysis of the postulated and actual trajectories for the dollar/euro and dollar/pound exchange rates leads to an explanation for such inaccuracy.
Figure 4: Scenario (Ex-Ante) and Actual (Ex-Post) USD/EUR Buying Exchange Rate 30 June - 17 October 2014
1.50
1.45
1.40
1.35
1.30
1.25
1.20 I II III IV I II III IV I II III IV I II III IV 2011 2012 2013 2014
Actual Scenario
Figure 5: Scenario (Ex-Ante) and Actual (Ex-Post) USD/GBP Buying Exchange Rate 30 June - 17 October 2014
1.75
1.70
1.65
1.60
1.55
1.50
1.45 I II III IV I II III IV I II III IV I II III IV 2011 2012 2013 2014
Actual Scenario
Figure 4 and Figure 5 show the postulated (scenario) and actual trajectories for the dollar/euro and dollar/pound exchange rates from July to mid-October 2014. The postulated and actual trajectories for the dollar/euro rates both imply a weakening euro against the dollar, with a steeper decline in the actual rate. However, the expectation of a stronger pound against the dollar turned out to be less accurate. The Scottish Referendum held in September 2014 may, inter alia, have contributed to a reversal in the pound as from July.
Inaccurate expectation of the evolution of the dollar/pound exchange rate made in June 2014 has resulted into off-target forecasts of the rupee/pound rate (Figure 3). Nevertheless, forecasts of the rupee against the dollar and euro have been on-target and within confidence bounds (Figure 1 and Figure 2).
3. Forecast Exchange Rates July to mid-October 2014 under Perfect Expectations
An experiment is carried out to assess the forecast accuracy of the model under perfect expectations of the dollar/euro and dollar/pound exchange rates, that is, when the postulated (ex- ante) trajectory matches the actual (ex-post) trajectory exactly. Figure 6: Forecast Rs/USD Buying Exchange Rate 30 June - 17 October 2014 Conditional on Perfect USD/EUR and USD/GBP Expectations (Including 50% Confidence Band)
32.0
31.5
31.0
30.5
30.0
29.5 30 7 14 21 28 4 11 18 25 1 8 15 22 29 6 13 M6 M7 M8 M9 M10
Actual Forecast
Figure 7: Forecast Rs/EUR Buying Exchange Rate 30 June - 17 October 2014 Conditional on Perfect USD/EUR and USD/GBP Expectations (Including 50% Confidence Band)
40.8
40.4
40.0
39.6
39.2
38.8
38.4
38.0 30 7 14 21 28 4 11 18 25 1 8 15 22 29 6 13 M6 M7 M8 M9 M10
Actual Forecast
Figure 8: Forecast Rs/GBP Buying Exchange Rate 30 June - 17 October 2014 Conditional on Perfect USD/EUR and USD/GBP Expectations (Including 50% Confidence Band)
52.0
51.5
51.0
50.5
50.0
49.5
49.0
48.5
48.0 30 7 14 21 28 4 11 18 25 1 8 15 22 29 6 13 M6 M7 M8 M9 M10
Actual Forecast
Assuming the postulated trajectories for the dollar/euro and dollar/pound exchange rates from July to mid-October 2014 match the actual paths shown in Figure 4 and Figure 5 exactly, the dynamic model forecasts for domestic exchange rates over this period are graphed above. Figure 6, Figure 7 and Figure 8 show that forecasts of the rupee exchange rates against the dollar, euro and pound closely track the corresponding actual values, especially up to mid-September. This experiment confirms that the model is reliable for forecasting rupee exchange rates. The user (policymaker, investor, banker or trader) basically needs to develop the acumen of forming sound expectations for the dollar/euro and dollar/pound rates over the ensuing three-to-six months. The volume and quality of economic information available on the US, Euro zone and UK far exceed available information on a small economy like Mauritius, so that it is more reasonable and sensible to form expectations on the exchange rates of advanced economies. The model forecasts may be conveniently updated whenever these expectations change.
4. Forecast Exchange Rates October 2014 to March 2015
In order to compute the model forecasts of rupee exchange rates over the next six-month period, expectations of the dollar/euro and dollar/pound rates are first formed.
Figure 9: Scenario USD/EUR Buying Exchange Rate October 2014 - March 2015
1.6
1.5
1.4
1.3
1.2
1.1
1.0
0.9 02 03 04 05 06 07 08 09 10 11 12 13 14 15
Historical Postulated
Figure 9 shows the historical evolution of daily dollar/euro exchange rate from June 2002 to mid October 2014 as well as the postulated trajectory thereafter up to March 2015. The euro is here assumed to continue its recent decline that started in June 2014 so that by end-March 2015 it reaches a value of 1.1700 dollars, almost equal to the ten-year low observed in November 2005. The loose policy stance of the European Central Bank resulting from low inflation and growth outlook in the Euro zone is reasonably consistent with a falling euro exchange value.
Figure 10: Scenario USD/GBP Buying Exchange Rate October 2014 - March 2015
2.2
2.0
1.8
1.6
1.4
1.2 02 03 04 05 06 07 08 09 10 11 12 13 14 15
Historical Postulated
Figure 10 shows the historical evolution of daily dollar/pound exchange rate from June 2002 to mid October 2014 as well as the postulated trajectory up to March 2015. The pound is here assumed to continue its recent decline that started in July 2014 so that by end-March 2015 it reaches a value of 1.4800 dollars, almost equal to the recent low observed in July 2013. The accommodative policy stance of the Bank of England resulting from subdued inflation and growth outlook in the UK is reasonably consistent with a weakening pound exchange value.
Figure 11: Forecast Rs/USD Buying Exchange Rate October 2014 - March 2015 (Including 50% Confidence Band)
34
32
30
28
26
24 02 03 04 05 06 07 08 09 10 11 12 13 14 15
Mean (Lower Bound,Upper Bound)
Figure 12: Forecast Rs/USD Buying Exchange Rate October 2014 - March 2015 (Including 50% Confidence Band)
33.5
33.0
32.5
32.0
31.5
31.0
30.5 20 27 3 10 17 24 1 8 15 22 29 5 12 19 26 2 9 16 23 2 9 16 23 30 M10 M11 M12 M1 M2 M3
Mean (Lower Bound,Upper Bound)
Given the postulated trajectories for the dollar/euro and dollar/pound rates in Figure 9 and Figure 10, Figure 11 and Figure 12 show that the dollar is forecast to appreciate over the next six months, from a central forecast of Rs 30.75 late October 2014 to Rs 32.40 by end-March 2015 – this implies a forecast point-to-point rupee depreciation of between 2% and 8% centered around 5%. By end-March 2015 the dollar is forecast to be near its 10-year peak against the rupee.
Figure 13: Forecast Rs/EUR Buying Exchange Rate October 2014 - March 2015 (Including 50% Confidence Band)
48
44
40
36
32
28 02 03 04 05 06 07 08 09 10 11 12 13 14 15
Mean (Lower Bound,Upper Bound)
Figure 14: Forecast Rs/EUR Buying Exchange Rate October 2014 - March 2015 (Including 50% Confidence Band)
39.5
39.0
38.5
38.0
37.5
37.0
36.5 20 27 3 10 17 24 1 8 15 22 29 5 12 19 26 2 9 16 23 2 9 16 23 30 M10 M11 M12 M1 M2 M3
Mean (Lower Bound,Upper Bound)
The euro is forecast to fall against the rupee, from Rs 39.35 late October 2014 to a central value of Rs 37.95 end-March 2015 with corresponding lower and upper bounds of Rs 36.75 and Rs 39.10. As expected, the confidence band (here constructed from 1,000 residual bootstrap replications) widens as the forecast horizon increases.
Figure 15: Forecast Rs/GBP Buying Exchange Rate October 2014 - March 2015 (Including 50% Confidence Band)
65
60
55
50
45
40 02 03 04 05 06 07 08 09 10 11 12 13 14 15
Mean (Lower Bound,Upper Bound)
Figure 16: Forecast Rs/GBP Buying Exchange Rate October 2014 - March 2015 (Including 50% Confidence Band)
50.0
49.6
49.2
48.8
48.4
48.0
47.6
47.2
46.8
46.4 20 27 3 10 17 24 1 8 15 22 29 5 12 19 26 2 9 16 23 2 9 16 23 30 M10 M11 M12 M1 M2 M3
Mean (Lower Bound,Upper Bound)
Figure 15 and Figure 16 show that the pound is forecast to depreciate against the rupee over the next six months, from Rs 49.50 late October 2014 to a central value of Rs 48.00 by end-March 2015 with corresponding lower and upper bounds of Rs 46.45 and Rs 49.45.
5. Conclusion
This paper applies a model I have developed for forecasting rupee exchange rates on the basis of postulated trajectories for two global exchange rates, namely dollar/euro and dollar/pound. The second set of forecasts, pertaining to period Oct 2014 – Mar 2015, has been presented after an ex-post evaluation of the first set of forecasts ranging from July to mid Oct 2014. The model forecasts are highly accurate when postulated trajectories of the two global exchange rates closely match their actual paths.
Policymakers, international investors, bankers or traders may use such forecasts as a benchmark while formulating strategic decisions involving currency exchange and risk. They may also be interested in uncovering the likely rupee exchange rate path in response to a stressful episode on the global foreign exchange market. The model forecasts may conveniently be revised or updated as and when required, e.g. following a change in expectations regarding future global foreign exchange rates.
Forecasts for the next six months essentially point to rupee depreciation against the dollar but rupee appreciation against the euro and pound. On this basis, Mauritius is likely to experience higher imported inflation with a stronger dollar in the near-future. Given a subdued economic growth environment and outlook, the monetary authorities should as far as possible avoid a hike in the Key Repo Rate or even mention thereof.
References
Khadaroo, A J (2014), Exchange Rate Forecasting in Small Open Economies
Khadaroo, A J (July 2014), Forecasting Exchange Rates of the Mauritian Rupee to Dec 2014