Central banks across Asia are concerned and actively engaged in some kind of currency manipulation – direct intervention, quasi-capital controls, and/or public speech (I will refer to this later, but RGE published a great article to the fact) – as investors flock to global capital markets seeking the “risk-on” trade. Central banks are attempting to stem the sometimes sharp currency appreciation, however, real exchange rates remain competitive.
Over the last three months, the $USD has dropped 3.6% against the Singapore dollar, 4% against the Malaysian ringgit, 6.1% against Indonesian rupiah, 1.9% against the Thai baht, 3.6% against Indian Rupee, 6.8% against the Korean won, and 1.8% against the Taiwan dollar.
The chart illustrates the trend in key Asian (not including China, whose exchange rate is explicitly pegged at 6.83 since July 2008) nominal exchange rates (measured in local currency units per $USD) – appreciating , which has Asian export industries worried. Central banks are intervening (in some cases through direct $USD purchase), where further intervention is a near certainty as many of these countries see export growth as the impetus to recovery. As such, and according to RGE last week, Asian central bankers are faced with a dilemma:
Despite a flood of portfolio investments into many of the region’s asset markets since early 2009, Asia still needs foreign capital to stimulate investment and finance its current accounts. Therefore, facing a sluggish export recovery and a pegged Chinese renminbi, most countries have opted to contain currency appreciation via verbal and actual interventions to avoid losing competitiveness. Intervention in the foreign exchange market has led to record reserve growth of over US$70 billion in Q3 alone in emerging Asia ex-China. Although most Asian countries are expected to keep intervening amid some currency appreciation, several countries may impose restrictions on foreign currency transactions. Given buoyant equity markets, attractive carry trades and the U.S. dollar weakness, policy measures will not contain the impact of capital inflows on Asian currencies, meaning that some appreciation from the least trade-dependent countries is to be expected. Taiwan is the country where capital controls or new restrictions are most likely to be implemented.
True, Asian nominal exchange rates are appreciating (sharply in some cases); but what one needs to consider is the real effective exchange rate. Actually, real effective exchange rates (taking also into account relative prices) remain rather competitive. In fact, only Indonesia and South Korea are experiencing any substantial real appreciation, and South Korea’s coming off of a very low base.
The chart above illustrates the real exchange rate: the nominal exchange rate defined in units of home currency per unit of foreign currency * (foreign price level)/(home price level). A movement up indicates a real appreciation of the local currency against the country’s trading partners.
Real exchange rates in Malaysia, Thailand, Taiwan, and India fell in the latest monthly data point; and furthermore, some are seeing the downward trend intact. Indonesian policymakers are worried – the sharp appreciation of its currency is growing the real exchange rate quickly.
It’s a complicated policy world out there – a hodgepodge of monetary stimulus, capital controls, and fiscal deficits. Something’s gotta give; and my bet’s that it will not be the currency. Direct intervention and further capital controls are on the way in Asia in spite of the need for foreign-sponsored domestic investment.