Asian central banks’ resolution to defend the value of their currencies so far this year may be weakening after dipping heavily into their reserves, according to leading foreign exchange experts.
“We believe we are approaching the point where some Asia central banks allow for greater FX flexibility,” said Craig Chan, Asia FX strategist at Nomura. “While central banks have leaned heavily against depreciation by drawing down their FX reserves, this strategy has limits.”
Nomura expects Asian central banks to allow for more currency depreciation from now on, even if this means higher imported inflation and more rate hikes than would otherwise be the case.
Several Asian jurisdictions, most notably Japan and India, have dipped deep into their foreign exchange reserves in order to defend their currencies. Japan’s reserves fell by a record $54bn during September, according to the Ministry of Finance, led by a ¥2.84tr ($20bn) yen-buying and dollar-selling intervention by the government on September 22.
India’s foreign exchange reserves are down almost $100bn this year following market interventions by the Reserve Bank of India, led by Shaktikanta Das, in defence of the rupee.
FED TIGHTENING
Asian currencies have declined against the US dollar all year, but not much against one another. This reflects the fact that the Federal Reserve has led on tightening, with knock-on effects on others. “They can’t just follow the Fed blindly,” said Taimur Baig, chief economist at DBS. “They all lag the Fed, which means against the US dollar, they’ve all weakened.”
That, in turn, creates inflation pressure in those markets, particularly if they have high commodity import bills, since commodities are priced in dollars.
Baig said both Japan and India might now be tolerant of a weakening currency: India is an exporter whose hand ought to be strengthened by a lower valuation of the rupee, while a weak yen creates a tailwind for Japanese tourism and helps with the country’s competitive edge against China.
Baig said central banks’ main objection was over “the pace with which the currency was depreciating. They will be nervous if there are sudden movements, and some degree of intervention could be warranted to allay market concerns.”
Neither Japan nor India need worry about running out of reserves: India still has over $500bn of reserves, and Japan’s record outflow left it with $1.24tr at the end of September.
But in smaller Asian markets, a shortage of reserves is very much in prospect, chiefly in India’s neighbours, Sri Lanka and Pakistan.