Emerging Asia: generally still intervening
Justin Lahart’s column today noted – quite correctly – that a slew of emerging Asian economies have allowed their exchange rates to appreciate against the dollar this year.
The verb “allow” is important. Their central banks previously had been intervening to defend a given exchange rate – so in effect, appreciation means that the central bank decided to stop actively holding the value of its currency down.
India is the best example. It intervened massively in February, but then scaled back its intervention and let the rupee appreciate. It is now taking heat for a “strong rupee.” And after several weeks without intervention, the RBI seems to have stepped back into the market two weeks ago (reserves went up).
Other central banks though never really stopped intervening. They just stopped defending a specific level. Asian reserve growth outside China has been quite strong this year. Malaysia is still intervening – look at its reserves (click on the chart option if you follow the link). Bank Negara Malaysia’s non-reserve foreign currency assets also seem to rising – if anyone knows what is going there, do tell!
Korea has – over the past few years – allowed the won to appreciate significantly. But it has gotten worried that a "strong won" risks becoming a "too-strong won." It seems to be intervening in the markets again. The May increase in Korea’s reserves is higher than can be explained by the interest income on Korea’s $250b.
Thailand let the baht appreciate in 2006. And then it got scared by the baht’s strength and imposed capital controls. That hurt the baht for a while, but only for a while. The central bank has been intervening again this year.
Look at the following chart. One legacy of Thailand’s crisis is that it reports both its actual foreign exchange reserves and the forward position of the central bank. I have summed up Thailand's cash reserves and its forward purchases (you can debate whether this is the right measure, or whether the forward position should be marked to market, but that is another issue). Thailand’s near bankruptcy in 1997 (the first year in the chart) shows up clearly, as does the ongoing increase its reserves now.
The basic dynamics of Asian reserve accumulation outside of China – at least in those countries with reasonable interest rates, as the low-rate, carry-trade funding currencies are a case apart – has been pretty clear. At various points in time, most Asian currencies have come under pressure to appreciate. The central bank usually initially resists the pressure. But sterilization is expensive (local interest rates are often higher than US rates), and eventually, the central bank gives in a bit, and lets the currency appreciate.
But then the currency rises a bit too much against the RMB, the country’s exporters get scared, they start to pressure the government, and sooner or later the central bank ends up intervening again.
That is one reason why China’s exchange rate policy isn’t just a matter of concern to the US and China. Many emerging countries are willing to let their currencies appreciate against the dollar. But they would rather not see their currencies appreciate against the RMB.
One of the strongest conclusions that emerged from the Peterson institute/ Bruegel/ KIIEP conference is that there is a huge difference for most countries between appreciating against the dollar together with other regional currencies and appreciating against the dollar when other regional currencies don’t move. European countries trade extensively among themselves. So long as all European currencies appreciate together against the dollar, a big move in the dollar v Europe need not imply a big change in the overall real exchange rates of most European countries. The same is true of Asia.
That is why I would suggest renaming Lahart’s column – how China can help the rest of Asia ease their grip …
There is another issue – one that I discussed at a recent hearing of the US-China Economic and Security Review Commission. China’s new state foreign exchange investment company supposedly wants to join Chinese firms and invest in emerging Asian equities. Such investment, though, implies additional capital inflows into these economies, and generally speaking, they all now receive larger inflows than they really want.
If say China wanted to invest in Thailand and the Thai central bank didn’t intervene, the baht would likely appreciate against the dollar, and against the RMB. If the Thais decided that they didn’t want the baht to appreciate, the Thai central bank would effectively end up buying the dollars China no longer wants.
I suspect that the Thai central bank would rather that the state foreign exchange investment company invest directly in the US!
If both China’s investment fund and the Gulf investment funds invest more in emerging Asia and if emerging Asian economies allow their currencies to appreciate and effectively use these inflows to finance a current account deficit not just more reserve growth, China would effectively start acting a bit like Japan acted in the early 1990s.
Back then Japan ran a current account surplus (saved more than it invested) and a large share of that surplus was invested – actually lent by Japanese banks – in emerging Asia. In the mid-90s, Japan’s surplus financed deficits elsewhere in Asia, not a deficit in the US.
China’s surplus now is so big though that there is no reason why it couldn’t finance large deficits elsewhere in Asia and help finance the United States large deficit at the same time. But it isn’t totally clear that the rest of Asia is any more comfortable with deficits financed by China’s state investment company – along with the Gulf investment funds — than it is with deficits financed by private financiers.
Have been on the ground in Europe and Asia last couple of months and I must say things look some what more interesting than in the States. Couple of points:
1. I don’t expect the Yuan to appreciate strongly second half of this year. With the stock market drop, the PBoC will now focus on real estate bubble instead. Housing prices are rising sharply again very quickly, so sterilization has its effects but expect tight lending policies to allow Yuan on a continued slow crawl.
2. I see lots of Chinese activities in Europe. The new investment company may say it’s interested in emerging Asia, but most of the money is going to Europe. Germany, France and regions of central and eastern Europe are all flooded with Chinese businessmen and money. It looks like China will finance a larger European deficit as well as the US deficit.
Brad,
What is the rationale behind the appreciation of the rupee? India runs a deficit and still has high domestic inflation. Having the domestic consumption funded by inflow of foreign capital (esp. portfolio investment) seems dangerous for a country like India — another 98 crisis in the making?
It just seems that opening the control of the capital account without a true open border to labor and goods is a very dangerous thing. If I were China or some other EM I’d rather live with some inefficiency than with systemic risk. At least during the catch up phase (the developing part) there are plenty of other inefficiencies to be wrung out the real economy.
HZ, in a word- inflation. Maintaining an artificially weak exchange rate and incurring sterilization costs in the context of rising inflation just became unpalatable, so the RBI changed policy and decided to let the currency bear some of the brunt of tightening monetary conditions. It’s probably THE classic example in recent history of how inflation is nthe greatest threat to pegged/BWII type exchange rate systems
How much, and in what ways might new products and markets, such as the DGCX Indian Rupee contract and new commodity futures contracts exacerbate, offset or create opportunities (for what/whom) to profit from BWII’s weaknesses.
“The Singapore Exchange on Wednesday launched trading for crude palm oil futures to compete against Bursa Malaysia… as palm oil prices surged to a record high… US dollar futures are seen as less expensive to hedge than ringgit ones…” http://www.ft.com/cms/s/4e14114e-1456-11dc-88cb-000b5df10621.html
“JPMorgan… plans to increase its commodity-trading staff worldwide by more than a third in the next 12 months to help clients protect against swings in energy and metal prices…. is looking to expand its agriculture-trading desk…” http://www.bloomberg.com/apps/news?pid=20601087&sid=aGhuvWvuO1UA&refer=home
India’s Service Providers Need to Sell Products
http://www.bloomberg.com/apps/news?pid=20601039&sid=aigaEYxE913A
Beating back the margin pressures from a rising currency requires a significant jump in revenue productivity per worker without an attendant increase in costs. It’s possible to do this by moving away from merely selling time to creating products.
Tata Consultancy has made a good start. Last week, it announced the formation of TCS Financial Solutions, a product unit focused on banking and capital markets. “The idea is to grow our revenue disproportionate to the headcount,” says Krishnan Ramanujam, the Sydney-based chief operating officer of the new division.
Tata Consultancy has, largely through acquisitions in Australia and Switzerland, come to own proprietary financial products that span everything from core banking to securities lending. Half of all banking transactions in South Korea and 45 percent in Taiwan are now processed using Tata’s products.
With 2,500 employees, the unit had $170 million in sales in the financial year 2007. Its per-employee revenue of $68,000 is two-fifths higher than for Tata Consultancy as a whole.
This is the way forward for Indian software companies. They must utilize their robust cash flows to acquire products. Or else, they will remain efficiently run commodity producers.
It’s bizarre that just when old industrial companies in India are scouring the world for leveraged-buyout targets, some of the new-age software-services companies are paying out more money as dividends than they are setting aside for investments. Are they running out of ideas? Do they want to get acquired?
It’s widely believed that the global market for outsourcing will continue to grow, and a lot of the new business will come to India simply because of demographics: No other country between now and 2025 will add 273 million people to the workforce.
But the stock market has already rewarded homegrown Indian software companies handsomely for their ability to execute outsourcing projects with efficiency. Now investors would like to see a blueprint for withstanding currency risk.
The rupee is at present trading at about 40.5 to the dollar. According to the University of Pennsylvania’s Penn World Table, 8 rupees have the same purchasing power in India as $1 has in the U.S.
It’s natural for developing-country currencies to remain undervalued relative to purchasing-power parity for a long time, though there usually is a process of convergence.
If the appreciation in the rupee turns out to be even half as rapid as it was in Japan, the exchange rate might climb to 30 rupees to the dollar in three years.
The assumption that the Indian central bank won’t allow the rupee to rise so quickly is no excuse for complacency. It shouldn’t stop Indian software companies from starting their search for productivity gains. Otherwise, the poor corporate treasurer will be forced to become a gambler. And that, if the experience of Japan is anything to go by, won’t be a good thing.
Capital Perspectives By Ramin Toloui, June 2007
When Capital Flows Uphill: Emerging Markets as Creditors
http://www.pimco.com/LeftNav/Global+Markets/Capital+Perspectives/2007/Capital+Perspectives-+June+2007.htm
“The recent rise of emerging markets as massive creditors to industrialized countries is historically unprecedented.”
links, short excepts and a comment explaining why the material is germane to the discussion, not open-ended “is this potentially relevant” and a post style comments please.
There is a lot in toloui’s piece which is germane for example, and the Mukherjee piece is obviously relevant to post of the Xr appreciation v. reserves trade off, but rather than simply pasting it in, spell out what you think it adds. thanks. brad.
i thought they were pretty self-explanatory
1) emerging markets can’t/shouldn’t rely on reserve accumulation/depreciated currencies to boost export-led development policy and 2) a lot of “emerging markets” really aren’t so much anymore…
cheers!
re: open-ended “is this potentially relevant”…
why not, if the post is short, as there seem to be a great many significant, or potentially significant developments that are not (yet) incorporated in conventional thinking.
…and a post style comments??
agree with ‘:P’ - that if a parsed comment adds a referenced perspective, provokes a bit of creative thinking, or says it all with a link to a broader explanation for those who need or want it, why add more blather to the post
not trying to argue - just trying to understand
i didn’t see any connection between Jp morgan beefing up commodity trading (especially agricultural trading) and a post about asian economies reserve growth/ sterilization costs. I didn’t see the need to post the full muhkerjee comment/ and rather than rather than asking whether the ability to trade rupee in dubai creates opportunities to bet on BW2 (of course it does to the extent the indian rupee is proxy for the rest of asia, but that is debatable), make an argument about its relevance, lay out your thoughts (briefly)/ argument about its relevance (in light of what was discussed in the post).
I find links without context break up the flow of conversation, and i find have a similar view of long blocks of text. I don’t mind if the conversation develops in new ways, but the conversation needs to build.
I found the toloui link germane and on topic.
the comment followed the previous post which mentioned inflation, and assuming that high commodity prices contribute to inflation, food being a concern, if/how these contracts contribute to or reduce that.
“whether the ability to trade rupee in dubai creates opportunities to bet on BW2 (of course it does to the extent the indian rupee is proxy for the rest of asia, but that is debatable)” - yes…
The post refers to Asian economies reserve growth/ sterilization costs. An excellent point made is “that there is a huge difference for most countries between appreciating against the dollar together with other regional currencies and appreciating against the dollar when other regional currencies don’t move.”
These developments are ver5y complex and difficult to manage in real time. As some have proposed, an alternative to address excess dollar liquidity worldwide, could be to transform the IMF into a Central Bank of Central Banks so that the Special Drawing Right (SDR) is strengthened to become the main International Reserve Asset. In this framework, regional appreciation of currencies against de USA could be better managed and coordinated. The G8 countries, plus China, India, Brazil and the net Oil Exporters could discuss this highly sensitive issue.
JSP — interesting point. at the council on foreign relations a few weeks ago, former treasury secretary summers was asked a similar question, and he argued that the sdr was a solution to “too little int. liquidity” and right now the problem is rather the opposite … i would note that if a country wanted to hold a basket of reserve assets that mimicked the Sdr ($, euros, pounds, yen) they could do that outside the imf.
that said, the reduced cost of move jointly is prima facia an argument for more not less coordination, especially among the obvious regions of the world (east asia, gulf). but so far, agreement on regionally coordinated appreciations has been hard to come by …
…unless a crisis forces an agreement, which is generally the way it goes.
Macro Man,
Agree it is inflation driven. But for a country like India is it really sustainable to drive down inflation through short term capital inflows — i.e. trade deficit financed through short term borrowing or portfolio investment? Sentiment could turn on a dime.