Mirza Baig, head of FX research, Asia
Calling it a war is perhaps overkill, although it is true that authorities in emerging markets are facing tremendous challenges in dealing with large and potentially disruptive capital inflows.
Inflows into emerging market debt and equity funds have surged this year, thanks to a more favorable outlook for these economies, and the expectation of near-zero interest rates in G5 countries. This is driving up the value of emerging market currencies in an uneven manner, and also creating risks of asset price bubbles in a few places.
Consequently central banks have stepped up intervention to slow the rise in their currencies. A few, such as Brazil, have imposed taxes on debt-creating inflows. We think the threat of similar sort of capital controls, or ‘Tobin taxes’, in some Asian economies should be taken seriously, though we think authorities would make such measures their last rather than their first resort.
The initial focus, we think, will continue to be on strengthening compliance with existing regulations, tightening macro-prudential safeguards and tactical use of FX intervention and moral suasion.
The upcoming G20 summit and International Monetary Fund (IMF) meetings should be very interesting. We hold out little hope for a globally coordinated agreement on currency market intervention. However FX markets will be watching closely to see if the developing countries are willing to join hands and form a common front against being forced to allow revaluation of their currencies.
Callum Henderson, global head of FX research
Ahead of the IMF’s annual meetings, which start October 8, the decline in the value of the US dollar (USD) continues to gather pace and is becoming increasingly broad-based. The Japanese yen (+11.21%), Thai baht (+11.19%), and Malaysian ringgit (+10.74%) have been among the strongest performers against the US dollar this year. Accelerating US dollar weakness and the attempt of emerging markets to limit the impact of massive fund inflows has sparked talk of a possible currency war. In the Financial Times, IMF Managing Director Strauss-Kahn highlighted the risk using currencies as a “policy weapon”, warning that such behaviour could pose a “serious risk to the global recovery”.
G4 central banks have provided excess liquidity to boost economic prospects, which continue to be weighed down by balance-sheet de-leveraging. This has meant local-currency weakness and massive fund outflows, particularly in the US. Weaker currencies have boosted exports, offsetting the hit to domestic demand. However, not everyone can have a weak currency or try to export their way out of trouble.
The US wants stronger Asia ex-Japan currencies as does Europe, while Asia wants ‘currency stability, or limits on the strength of regional currencies versus both the US dollar and euro. There appears to be little prospect of a major currency agreement; the question is whether such an agreement is desirable. Looking back at historical precedent, the Plaza Accord of 1985 ended up helping sow the seeds of major-country discord, leading to the financial crash of 1987 and the bursting of the Japanese bubble in 1990.
Asia will do all it can to avoid a repeat of this. Nevertheless, there is a need for the US dollar to weaken against regional currencies, not least to boost Asian domestic demand. But gradualism is key. Asia cannot manage the shift from externally-led to domestically-led growth overnight, nor should it. Nevertheless the domestic sector should play a bigger part in overall regional growth in Asia, the most important being that Asia cannot rely on the west to support its external sector in the way it used to do. From a trading perspective, this means that the US dollar should continue to drop—a number of USD-AXJ exchange rates remain well above 2007/2008 lows let alone 1997 lows—albeit gradually, allowing exporters to adjust.
Nizam Idris, emerging markets strategist
The Bank of Japan’s move last week to shave its benchmark interest rate from 0.1% to between 0% and 0.1% is not likely to have a material impact on the cost of funds for consumers and investors in Japan. What the decision and the accompanying plans to infuse further liquidity into the domestic banking system would really do is to potentially debase the yen, in the hope that the weaker yen could help reflate the economy through exports. In effect the central bank is targeting a weaker currency to help exports and to instigate inflation to reinvigorate the domestic economy.
Such considerations have also been toyed with by many other major central banks in recent weeks. As the stimuli from the traditional Keynesian fiscal boosts fade, global central banks are again looking at ways to reignite economic recovery via creative monetary policies. With interest rates at historical lows, weakening the currency through pumping more domestic currency liquidity seems the next logical move.
A currency war – where central banks attempt to outdo each other in forcing currency weakness to help reflate their own economy – would have its implications on Asia and indeed the world’s economy. For one, with so many countries now focusing on currency policies, implicitly trying to export their way out of the economic malaise, the whole idea of encouraging global consumption to emerge from the global crisis is at risk. Energy spent on currency wars would take the policymakers’ focus away from working on other more direct measures to boost domestic demand.
A battle over exchange rates is much like a trade war, except that it may not have such a devastating impact on global trade as the latter. A trade war driven by widespread import tariffs could force trade activities to a halt, dealing Asian exporting economies a potentially fatal blow. A currency war on the other hand could have the net effect of large of amount of liquidity being pumped into the global financial system leading to more fund inflows into Asian and other emerging markets for yields.
This in turn may lead to capital controls as emerging economies try to prevent liquidity-driven currency and asset price appreciations. The net effect of a currency war is elevated global policy risks, which is clearly to no one’s benefit and adds to the already complicated business of engineering a recovery from the two-year-old global credit crisis.