Asian economies are seeing large fund inflows as global economic recovery continues, while major central banks are not withdrawing liquidity in a big way just yet.
This is perhaps the sweet-spot for Asian currencies: funds are being put to work in risky assets and Asian currencies at the expense of currencies which pay lower interest rates. This seems likely to persist for the near one- to three-month horizon.
But Asian central banks’ mercantilist tendencies will remain a hindrance for larger currency appreciation. Beyond this period and for the rest of the year, the threat of inflation and how central banks handle such a threat, even as the sustainability of the global recovery remains questionable, could be the major factor in picking currency outperformers in Asia this year.
In the shorter of the two time-horizons, we think that currencies such as the Indian rupee, the Indonesian rupiah, Philippines peso and Malaysian ringgit are likely to outperform currencies that have held up well through most of the crisis, such as the Singapore dollar.
The currencies of countries with more interventionist central banks such as Taiwan are also likely to underperform. For this time-frame, our top picks are the rupee, the won and the rupiah.
We also expect the renminbi to be allowed to resume appreciation from the middle of the year, ending 2010 some 5% stronger at Rmb6.50/US$1. This could lead to pressure for the US dollar to gravitate lower against regional currencies.
For the second half of the year, we think the key to relative currency performances would be determined by the pace of global recovery and how Asian central banks handle the likely rise in inflationary pressure.
In our base case assumption of higher but manageable inflation, we maintain that the diminishing incentives to intervene in the foreign exchange market in the face of rising imported inflation and its low dependence on exports for growth would still make the Indian rupee a good currency to hold.
India needs a stronger currency to curb food and imported inflation. This is less so should inflation spike uncontrollably, which is not our base-case assumption.
Some inflation could also be supportive for the Korean won. The Bank of Korea is arguably the most credible targeter of inflation in the region. It is likely to react aggressively to any threat of inflation with rate hikes and allow currency appreciation.