More On Asian Currencies

Damn... and I thought I could get away with my flimsy comments on currencies ... along comes a regular learned reader in Hisham, an obvious economics research guy somewhere.

What's interesting was that he figured the MYR is not really tracking the yuan but rather keeping in step with the SGD - how I wish that was the case man ... maybe the relationship held true for 2-3 years ago but certainly not the past 10 or 15 years. There is no possible way we can afford to keep in step with SGD noting the huge structural differences in the industries' revenue base and margins achieved.


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hishamh to me

show details 9:29 AM (53 minutes ago)

hishamh has left a new comment on your post "Geithner Could Label China As A Currency Manipulat...":

With respect, I don't think any of the Asian currencies are really much out of line. Some experts do think the Renminbi is as much as 40% undervalued, but the range of estimates is incredibly wide - Goldman Sachs for instance thinks if anything the Renminbi is slightly overvalued. It really depends on the model used to measure misalignments.

The widest misalignments tend to come from current account based evaluations, which ignore stage of development and is also highly normative (i.e. depends on the researchers' prejudices). Econometric based models tend to show much smaller undervaluations, and a price-level based model, which accounts for the level of development of a country, shows very little undervaluation at all.

I'm wondering what the reaction will be next month as China is reportedly going to report its first monthly trade deficit in decades. BTW, factually, HKD is not on a fixed peg but a currency board, which is a very different animal (essentially Bernanke is running HK's monetary policy).

Using the IMF methodologies, SGD is undervalued, as is the MYR. But the IMF assessment IMHO has a serious flaw, because they heavily overweight the US and underweight Asia in calculating the effective exchange rate indices, which biases misalignment measures towards the USD and away from currencies of other trading partners.

In Malaysia's case, the US trade weight used is double the actual, while MY-SG trade weight is a fraction of the actual (ASEAN currencies are lumped together, and the trade weight is something like only an eighth of the real trade share). Using a more balanced weighting scheme shows that in the MYR case at least, the currency is moving within a normal trading band around its long term equilibrium value (about plus-minus 5%).

2nd BTW, the IMF's latest country report examined BNM's currency intervention statistically and didn't find any evidence of manipulation of the MYR level. My own investigation into the matter suggests that if anything, the MYR tracks the SGD, not the CNY and nowhere near the USD. Given the relative development paths of the two countries and the long standing depreciation of the MYR against SGD, it's hard to argue from the empirical evidence that BNM is surreptitiously leaning on the MYR at all.

Taken all together, I would argue that most surplus countries don't have undervalued currencies at all - it's primarily a USD problem. The 30% depreciation of the USD since 2002 is nowhere near enough, as that was started from a point where it was already highly overvalued. All this brouhaha is a way for the US to get away from having to bear the adjustment costs of reducing global imbalances. China's position is understandable and I fully support it. It's their problem, but they want us to pay for it.

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China returned to a quasi peg against the USD in 2008, meaning that, as the USD appreciated as the world suffered a liquidity crisis, so did the RMB. However, with the USD depreciating in 2009, the RMB did as well, despite the divergence in the two countries' growth outlooks. Given Chinese productivity growth, the RMB may be undervalued.

John Williamson and William Cline, Peterson Institute: Chinese productivity growth has outstripped the pace of appreciation of the RMB, meaning that the renminbi remains undervalued. According to the fundamental equilibrium exchange rate (FEER) model, the RMB remains about 20% undervalued on a trade-weighted multilateral basis, in real effective terms. A 40% appreciation against the USD is needed.

Goldman Sachs believes that the renminbi may be near fair value, based on relative prices and productivity. According to the Goldman Sachs Dynamic Equilibrium Exchange Rate model, the renminbi was no longer significantly undervalued in Q1 2010.

Helmut Reisen of the OECD assesses the renminbi's valuation based on the Balassa-Samuelson effect and finds it is only undervalued by 12%. Part of the undervaluation of China's currency is due to the fact that non-tradable goods are relatively cheap, mostly because of lower wage costs. However, there will be a convergence as China's productivity in traded goods rises. Monetary restraint and lowered corporate savings would accelerate the convergence. Despite large FX intervention by Asian central banks, most Asian currencies will continue to appreciate in 2010 due to the global carry trade (Australia, New Zealand, Indonesia, Philippines), high commodity prices (Australia, New Zealand, Indonesia, Malaysia) and strong equity inflows (Indonesia, India, South Korea, Taiwan), though smaller current account balances (India, South Korea) might limit appreciation pressures.

Appreciation of the Chinese renminbi will be delayed, or so Beijing would hope for, until export recovery is certain, therefore delaying the pace of appreciation of other Asian currencies that closely track the renminbi. Countries like India, Indonesia, Singapore and South Korea might allow currency appreciation to contain import inflation.

While capital inflows into the equity and debt markets might continue to support the MYR in 2010, movements in the currency will be determined by the central bank’s FX intervention and the current-account balance. The upward trend in the ringgit against the U.S. dollar and the revival of capital inflows into the equity market have increased central bank intervention in the FX market to support exports.

Central bank intervention in the FX market will remain dominant until exports and global commodity prices recover, and China allows the renmimbi to appreciate. Large FX reserves and external surpluses are a plus to deal with export contraction and weak capital flows. Trends in the USD and Singapore dollar will also be important determinants of the MYR's movement. In 2008, the central bank intervened in the FX market to protect the ringgit from sharp depreciation amid capital outflows.

In May 2009, the ASEAN+3 countries agreed to increase the FX reserve pool under the Chiang Mai Initiative to US$120 billion to allow members to defend their currencies. They also eased restrictions on accessing the pool.

In February 2009, to promote bilateral trade and investment, the central banks of Malaysia and China established a US$11.12 billion currency swap arrangement for three years.

p/s photos: Angelababy Yang Wing

The Nasties Of Hot Money In Asia

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