Is there "hot money" in the system? Yes, the Fed's and ECB's low interest rates policy has already started the USD carry trade a few months back, and it could add a Euro carry trade to its banner soon. So, where do you think the money is headed or has been residing? Its Asia. The easy way to see where it has been headed over the past few months is to look at Asia's strongest currency this year. At the top of the heap was the Indonesian rupiah, followed by the Korean won and then the Indian rupee. So much so that the central banks at South Korea and Indonesia have expressed strong concerns over the inflow of hot money into their system. Beware of the current gains you have been seeing in stocks, property and currency in these two countries. They could just as easily disappear overnight. It also appears that the new favoured son by these carry trades is Taiwan.
Hence, we may well appreciate the efforts of Bank Negara a bit more over the past 18 months because Zeti refused to join in the bandwagon to "allow" the ringgit to appreciate too much. Rightly or wrongly, much of the hot money bypassed Malaysia and the ringgit because the ringgit is still not "that accessible and free-floated". By maintaining a disciplined approach, Bank Negara has basically staved off any future problems that may have to do with hot money moving too fast into the system and then too fast out of the system.
Many have been wondering why the Malaysian markets did not rise by as much as their regional peers. In fact Malaysian stock market has been in the bottom quartile in performance when compared to other Asian bourses. A huge part of the answer lies in the currency issue just discussed. Safe to say that taking that point further, we may argue that much of the rise in asset prices in other Asian markets may have been mostly "inflated" by the liquidity rush.
Is the region in grave danger of a collapse when these funds exit? What would cause the funds to exit? Well, if the Fed starts to raise rates, not likely over the next 6 months at least. Well, if there is a fresh war or political instability somewhere that causes people to rush to the reserve currency, and/or a massive jump towards risk aversion. The key I guess, is to monitor the rumblings and big trades in USD and the interest rate policy discussions.
On November 10, 2009, Taiwan's Financial Supervisory Commission barred foreign investors from parking their money in time deposits after bringing funds into the country. Plus, foreign investors will not be allowed to extend the deposit maturity beyond three months. Until now, foreign investors were allowed to deposit 30% of the inflows in time deposits for three months with a possible extension for another three months. Portfolio investors can still invest 30% of the net inflows in government bonds, money market instruments, money market funds and derivatives. As of October 2009, foreign investors had parked US$15.5 billion in Taiwan dollar accounts, almost five times the level considered appropriate by the central bank. The central bank has voiced concerns that beside investing in Taiwanese stocks, foreign investors were putting money into Taiwan Dollar deposits to earn interest plus currency arbitrage given the appreciating Taiwan dollar.
The move follows large capital inflows into Taiwan's dollar accounts recently which is putting upward pressure on the Taiwan Dollar and hurting export competitiveness. The central bank has been intervening in the FX market and had recently hinted at capital controls to contain currency strength.
This need not be an explosive issue as it seems that the central bankers in the affected countries are aware of the situation. The danger is when the central bankers do not have the political will to act as they should, or they act too slow to temper the liquidity inflow. One can easily reduce the inflow with various measures, so as to minimise the ill-effects of withdrawal of these kind of hot money.
Funnily, the US Federal Reserve Bank of Philadelphia president Charles Plosser said that the capital flows into Asia are a result of a stronger recovery in the region. He added that the flows are not such that he would consider them to be threatening or inconsistent with fundamentals. OMG, the danger is when enough people in high places in Asia believe that diatribe. These are not long term FDI, its short term, its a play on currency outlook and interest rate differentials, is short term - how in the world can Plosser say its not threatening. It can move asset prices up by 30%-50% in 6 months, and we know its seriously never going to be long term, so when they exit, how can Plosser say that it won't be threatening???!!!
p/s photos: Reon Kadena
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