International | Aug 04 2006
By Chris Shaw
In the first few months of this year Asian currencies generally rallied strongly against the US dollar and other major currencies, but in recent months this rally has begun to run out of puff.
As Danske Bank points out this in part reflects the global trend of the last few months towards a tightening in monetary conditions, such an environment being bearish for Asian currencies given the US Federal Reserve will potentially out-hike many Asian central banks. It also notes the world is becoming more risk averse as volatility in markets increases, which reduces the attraction of investing in the emerging Asian economies.
Danske notes in terms of likely outcomes for currencies in the region it is necessary to split them up according to their national policies, as there are de facto dollar pegs in place in Hong Kong, China and Malaysia, but South Korea and the Philippines have more freely floating currencies. This is significant as the outlook is for a weaker US dollar going forward, meaning currencies that are more freely floating should perform better.
The other factor to take into consideration is the current account balance of each nation, as the bank suggests those countries with current account surpluses such as Singapore, Malaysia and Taiwan should benefit, as while the US is likely to move into a lower growth phase the size of the slowdown should not be significant.
In contrast, nations such as the Philippines, South Korea, Thailand and India no longer run current account surpluses, with India now having a large deficit. This is due in part to the impact of higher oil prices and with Danske Bank expecting the oil price to stay strong, there is a likely negative impact accompanying these deficits.
Looking forward, the bank still expects Asian currencies generally to rally, as it notes economic theory suggests countries enjoying large productivity gains in the tradeable sector should see their currencies appreciate. ANZ offers an example where the opposite is the case though, this being Vietnam.
The bank notes the Vietnamese government has in place a policy of gradual exchange rate depreciation as it targets strong economic growth, the theory being the depreciation will enhance the country’s trade competitiveness and attract additional direct foreign investment.
But the bank points out the downside of the policy is it lifts the domestic inflation rate, with the potential in place to lift it enough there is actually a negative impact on export competitiveness. Despite this, it expects the government to continue to gradually depreciate the currency over the course of the year. Needless to say, Vietnam doesn’t make the list of countries where Danske Bank sees the potential for the currency to strengthen.
Instead, this list is dominated by those countries where the currency is allowed to move more freely, or is pegged to basket of currencies rather than to the US dollar. With this in mind, its favourites for outperformance include the currencies of Malaysia, Singapore and Taiwan. The Chinese Yuan is also on the list of likely winners, its unique circumstances enough to offset the fact it is a currency tied to the US dollar. On the other hand, likely losers include the currencies of Indonesia, Thailand and the Philippines.
