SINGAPORE: Regional currencies have been under pressure of late, weakening to multiyear lows against the US dollar and following emerging-market currencies such as the Brazilian real and Turkish lira, which have fallen sharply. Notably, the Malaysian ringgit and the Indonesian rupiah have been breaching multi-year lows in recent days. A confluence of factors appears to be at work — investors pricing in a US Federal Reserve rate lift-off in September, sharp falls in commodity prices, and growing political and economic risks in many emerging economies. The question is whether the falls in these currencies will continue and what the consequences might be.
Some currencies are greatly undervalued, others clearly overvalued
Asian currencies will not be immune to global forces that will tend to depress emerging-market currencies over the coming months.
Given this global context, there are two further drivers of currency movements. One is the underlying value of the currency, that is, whether a currency has become so undervalued that it is difficult to see it depreciate further. The second is whether the political prospects and economic fundamentals such as commodity prices could drive even a weak currency much further down.
A useful measure of whether a currency is grossly undervalued is to look at the real effective exchange rate, which measures the total effect of all currency changes and relative cost shifts on a currency’s competitiveness. Studying the changes in REER allows us to better determine which currencies have fallen too far, that is, unjustified by economic fundamentals and that might snap back if conditions improve. Combining this with other important drivers of likely currency changes produces the following conclusions:
• How much renminbi strength is tolerable? The Chinese renminbi’s REER has appreciated 55% since it was de-pegged from the US dollar in July 2005, substantial by any measure and enough to potentially risk export growth over time — particularly as it continues to hold its value against a rampant US dollar. Many argue that China’s leaders will allow no renminbi depreciation because they are keen to demonstrate the renminbi’s strength and stability to ensure that it is incorporated into the International Monetary Fund’s Special Drawing Rights (SDR) basket. That decision is likely to be made within the next few months. Once that is done, there could well come a time when policymakers decide that the threat of further appreciation to export growth outweighs the political need for the currency to remain stable. The authorities are already planning to widen the band of fluctuation for the renminbi. Should China’s current economic lassitude worsen, the renminbi could well come under more pressure;
What impact will weaker currencies have?
Weaker currencies should boost exports and, so, be positive for economic growth. However, currency depreciation can also raise inflation rates. Moreover, where countries have borrowed heavily in foreign currencies such as the US dollar, financial stresses could rise. Putting all these factors together, a pattern of winners and losers emerges:
The bottom line: Currencies to remain under pressure, risks persist
Overall, it looks like most Asian currencies remain at risk of continued depreciation as the US embarks on monetary normalisation. As a result, countries with high foreign debt could see some degree of stress.
Manu Bhaskaran is a partner and head of econo mic research at Centennial Group Inc, an economics consultancy.
This article appeared in the Corporate of Issue 689 (Aug 10) of The Edge Singapore.