The rise of the dollar has made it likely that Asian currencies will have their worst quarter since 1997. This has put central bankers in a tough spot.
Policymakers are already dealing with the fastest inflation in decades, and now they have to decide between three hard options: they can forcefully raise borrowing costs to protect currencies, which could hurt growth, they can use reserves that took years to build up to intervene in foreign exchange markets, or they can just stay out of the way and let the market run its course.
“Central banks are thrust into a difficult position to tighten, even as the recovery from the pandemic is not yet complete and with the spectre of a US recession ahead”
“Complicating the picture is the strong greenback, which adds to the pressure to tighten as weak currencies exacerbate imported inflation.”
Eugenia Victorino, head of Asia strategy at Skandinaviska Enskilda Banken AB in Singapore
Most emerging Asian currencies fell on Wednesday, led by the South Korean won, as investors worried about a US recession flocked to the dollar for safety. The Indian rupee, the Thai baht, and the Philippine peso all went down as well.
This quarter, the Bloomberg JPMorgan Asia Dollar Index is likely to fall by 4.4%. This would be the biggest drop since 1997 when the Asian financial crisis hit currencies hard. As a way to speed up the recovery from the pandemic, Asian central banks have been slower to raise interest rates than their peers in other emerging markets. The yen has lost 11% of its value against the dollar since the end of March, but for different reasons. This is because the Federal Reserve is raising interest rates while the Bank of Japan keeps its ultra-easy monetary policy.
But Asia’s central banks might have to change course because consumer prices are going up steadily and weaker currencies are making worries about imported inflation worse. After two quarter-point moves, Bangko Sentral ng Pilipinas has said that there will be at least one more rate increase in August. Meanwhile, the Bank of Korea has left the door open for a bigger-than-usual rate increase in July.
Inflation is proving to be persistent and central banks may have to move ahead of schedule and be even more aggressive than expected
Growth is still holding up for the time being and that gives them leeway to focus on fighting inflation.
Eddie Cheung, senior emerging-markets strategist at Credit Agricole CIB in Hong Kong
The South Korean won and the Philippine peso have both lost more than 5% of their value against the dollar this quarter because of the Fed’s aggressive rate hikes. Faster and more aggressive rate hikes could help these currencies.
Currency depreciation could cause regional central banks to tighten “if it adds to import-led inflation on top of the already seen supply-side inflation,” Morgan Stanley economists led by Deyi Tan wrote in a report released Sunday. Analysts think that interest rates will keep going up because inflation expectations are going up.
Central banks have already taken billions of dollars out of their foreign-exchange reserves to stop their currencies from falling. Stockpiles in Thailand and Indonesia are at their lowest level since 2020. This is because their governments have promised to make their currencies less volatile, but they haven’t raised rates yet.
But the worst may be yet to come for Asian currencies, as the Fed has hinted at another big increase in July and traders are pricing in a 75 basis-point increase. Goldman Sachs Group Inc. has warned that high-yielding currencies like the Indian rupee and Indonesian rupiah could fall if the Indian government’s finances get worse and the Fed raises rates, which makes people less willing to take risks.
Even though currencies are falling, “central banks across the region are unlikely to come close to matching the Fed’s rate hikes like for like,” Miguel Chanco, chief emerging Asia economist at Pantheon Macroeconomics Ltd., wrote in a report on Monday. “There are still a lot of reserves, and they are likely to keep being used to protect against too much currency volatility.”
According to my analysis, the Fed’s policy tightening causes waves of volatility in the Asian currency market. The majority of Asian economies are hesitant to raise their interest rates because they are still recuperating from the pandemic. But imported inflation and currency depreciation place policymakers in a difficult position.
To revitalize their economy, interest rates must remain low for a length of time, but the Fed’s interest rate hike has made imports more expensive. The majority of Asian economies are employing their foreign exchange reserves to prevent the increase, but the question remains. How long can these economies continue until the interest rates rise?