Most Asian currencies would continue to weaken in the days ahead in the face of the looming reduction of the U.S. Federal Reserve’s quantitative easing, the feared U.S. military strike against Syria, and the declining foreign exchange reserves in some Asian emerging economies, according to market analysts.
In fact, Indonesia’s central bank raised its main interest rates on Thursday, the latest country forced to defend its currency that has steadily dropped against major currencies in recent weeks. The Indian rupee also continued to plunge to a record low earlier this week as policymakers scrambled for solutions.
With Asian currencies remaining under constant pressure, market watchers are anxious to know if there is a turning point in sight.
HSBC Global Research believed there may be differentiation among movement of Asian currencies, but collectively Asian currencies are”not out of the woods.” It said that while the size of the foreign exchange reserves is much larger in Asian economies now than a decade ago with some countries recording all- time highs, this buffer has not increased as fast as the liabilities in some emerging economies such as India, Indonesia, Malaysia and Thailand. Indeed, external liabilities have multiplied so fast in these four countries. The preferred methods that HSBC had used to evaluate the potential vulnerability of a currency is to look at the foreign exchange cover ratio–the ratio of foreign exchange reserves plus the current account balance relative to the total size of short term external liabilities.
This ratio went quite a long way towards explaining the divergent paths among Asian currencies. Based on this ratio, HSBC remained cautious in evaluating most currencies of Asian emerging economies. Indian’s rupee and Indonesia’s rupiah will continue to underperform, followed by the Malaysia’s ringitt, Thai baht and to some extent Philippine peso although in the case of the latter, the slide would be in a smaller degree.
In contrast, the Chinese yuan, China’s Taiwan dollar and South Korea’s won will be more supported by their current account surpluses and comfortable foreign exchange reserves. The Singapore dollar’s strong external position should largely offset rising domestic bank leverage allowing the currency to do better than others in the region.
Bank of America-Merrill Lynch Research used historical intervention capability to forecast the outlook of Asian currencies. This capability is assessed by looking at the percentage drop in foreign exchange reserves from its peak, with time horizon of the third quantitative easing period (September 2012 to July 2013) for analysis. The initial assessment by the American research agency is that the less recent the peak, the more vulnerable the currency.
From the standpoint of historical intervention capability, foreign exchange reserves peaks of most Asian countries have occurred during or after April 2013. Bank of America-Merrill Lynch said this bode well since it implied that countries have started intervening only very recently. Indonesia and Thailand are the worse off on this criterion. Their foreign exchange reserves peaked in December 2012 and September 2012, respectively.
In fact, they are also the countries to have the highest deterioration in their foreign exchange reserves compared with peaks — 18 percent for Indonesia and 5.3 percent in Thailand in nominal terms.
On the other hand, South Korea and China’s Taiwan appear to be best positioned from intervention capability standpoint, as their foreign exchange reserves peaked only in July 2013. This made them become the least vulnerable currencies in the region ahead of the tapering of the U.S. monetary stimulus.