Accusations against Asian policymakers of perfidious currency manipulation to help their exporters gain price advantages are commonplace, and have helped engender or justify protectionist rhetoric and reactions from governments in Europe and the US.
While Western governments have characterised foreign exchange intervention by Asian central banks as manipulation, giving their exporters an unfair advantage, Asian policy makers have responded that their actions are motivated by a reasonable attempt to contain excessive currency speculation. A surge of capital inflows, they argue, can easily segue into outflows, creating currency volatility or worse -- a replication of the collapse in asset prices suffered 12 years ago, which forced them to bow to the intrusive demands of the IMF and other international lenders.
Their fears seemed justified in the immediate aftermath of the Lehman collapse last September as overseas investors liquidated positions in their equity and bond markets to meet cash calls, closed their carry trades and rushed to conventional safe havens, such as the US dollar. The immediate effect was to cause a decline in many Asian currencies, with central banks forced to spend valuable reserves -- their accumulated war chests -- to prevent precipitous falls.
Manitaining a war chest
Subsequent pressures for currency appreciation as exports started to benefit from lower exchange rates and as regional domestic demand started to pick up, gave central banks an opportunity to recover those lost reserves, while maintaining export competitiveness.
Richard Yetsenga, managing director of Asian FX strategy at HSBC, explained: "Earlier in [2009], central banks intervened in the foreign exchange markets to resist appreciation in order to accumulate reserves. More recently, policymakers have become keen to curb excessive liquidity, either in the form of global capital inflows or a build-up of domestic liquidity. For instance, Indonesia, Brazil and Taiwan have either placed restrictions on flows from abroad, or at least considered them. Also, the authorities have limited the access to local credit China, Hong Kong, India, Korea and Singapore, in particular to curb speculative bubbles in the property markets".
So although at first, many Asian currencies depreciated against both the dollar and yen, they later strengthened against the dollar and perhaps more critically, the renminbi.
Yet, as Claudio Piron, J. P. Morgan's head of Asian currency strategy pointed out, that strengthening has been less than convincing.
"Despite the US dollar coming under renewed depreciation pressure [in November 2009], Asia FX hardly registers in terms of its currency appreciation," he said.
Piron calculated that only the Indonesian rupiah and Korean won rank among the top 10 performing emerging market currencies this year, with gains against the dollar and rankings of 18.03% (fourth) and 8.6% (seventh), respectively.
The basic charge then, is that Asian central banks are intervening to buy dollars and prevent their currencies from appreciating.
But, said Piron, "the reality is more complex". The majority of Asian currencies do not have the carry-yield appeal of their emerging-market counterparts. Secondly, though foreign investor inflows returned in the second quarter, it was only in the third quarter that the real force of foreign equity buying made its presence felt in Asia's foreign exchange markets.
Nevertheless, Piron conceded, foreign exchange reserves have risen more than $500 billion [to November] in Asia -- China alone is contributing $300 billion to that rise -- compared with $20 billion to $40 billon in other emerging countries. So intervention has been taking place, whether due to insecurities about the sustainability of nascent economic recovery or fears of speculative bubbles as equity investments from overseas have returned to record highs of more than $50 billion.
Regional cooperation
Another response to the crisis was a new impetus towards regional cooperation, with the extension of bilateral currency swap arrangements for settling trade transactions, most notably by China, which over the past year has forged half-a-dozen agreements with Hong Kong, Indonesia, Korea, Malaysia, Belarus and Argentina (and is negotiating one with Thailand).
These swaps, which have amounted to $95 billion since December 2008, allow the central banks to sell renminbi to local importers in their countries who want to buy Chinese goods. This is particularly useful for importers struggling to obtain trade finance as a result of the financial crisis.
But the swap arrangements should be seen in the context of a broader policy aim to make the renminbi more important in the global financial system, according to Ben Simpfendorfer, chief China economist at Royal Bank of Scotland. The objective also has a more practical function in reducing currency exposure and transaction costs for Chinese exporters.
The rise in the renminbi's value relative to the dollar in early 2008 was a reason why some Chinese exporters went bankrupt. The ability to settle trade in renminbi would reduce this risk in the future, argued Simpfendorfer.
However, he pointed out, these swaps should not be mistaken for full renminbi convertibility: the renminbi can't be sold for other currencies, in particular, the dollar, and nor can it be used by the other countries as part of their reserves to defend their own currencies -- unlike swap agreements several countries signed with the US Federal Reserve.
Perhaps more notably, the Chiang Mai Initiative (CMI) for multilateral foreign exchange regional support, first set in motion in 2000, was reignited and for a while at least, taken seriously once more.
The CMI was set up in 2000 by the central banks of 10 members of the Association of Southeast Asian Nations (Brunei, Cambodia, Laos, Indonesia, Malaysia, Myanmar, the Philippines, Singapore, Thailand and Vietnam) plus China, Japan and South Korea, with the purpose of weaving a web of bilateral currency swaps to stave off any future run on their currencies.
The shock of the current global financial crisis impelled the CMI towards more ambitious objectives, including "multilateralising" the existing bilateral currency agreements, and creating a common fund of $120 billion, with Japan and China providing the main contributions, from which the crisis-stricken countries can draw to battle speculative attacks.
"The Chiang Mai Initiative and bilateral currency swap arrangements set up at the beginning of the year, sent the important message that Asian countries would exercise regional self-help rather than turn to international organisations such as the IMF to deal with any financial crisis," said Olivier Desbarres, Asia FX strategist at Credit Suisse.
But, arguably this is too little. That $120 billion is small change compared with the more than $4 trillion of reserves held by China, Japan and other countries in the region, such as India, South Korea and Singapore.
Speaking at an East Asia summit in Thailand between the 10-member Association of South East Asian Nations and China, Japan, South Korea, India, Australia and New Zealand, he said currency movements threatened the growth of trade between Asian countries, which might mean less reliance on exports to the US and Europe.
Kuroda said East Asian countries had made progress on regional financial stability through the Chiang Mai Initiative, intended to combat short-term liquidity problems, but that there had been no discussion about a coordinated approach to currency movements.
The momentum for greater cooperation seems to have subsided along with the threat to Asian currencies, asset prices and the affordability of foreign debt repayments. Especially vulnerable countries such as Korea and Singapore had sufficient foreign exchange reserves to counter the damage of capital flight, weaker currencies made their exports more competitive, and stimulus packages throughout the region -- and especially in China -- gave a boost to regional domestic demand.
By the second half of last year, foreign exchange rates were appreciating against a sliding dollar -- even on a trade-weighted basis. Central banks acted to curb that strength and, in doing so, were rapidly replenishing reserves depleted earlier in the year.
No sudden shifts
For the time-being, regional central banks are keen to continue building up foreign exchange reserves to insure against any sudden reversal of equity inflows. Equally, said J.P. Morgan's Piron, "this hedging approach can be used when Asian currencies are depreciating and Asian central banks intervene to slow risks of disruptive and violent capital outflows as well as risks of adding to rising import inflation".
So it's likely, said Johanna Chua, head of emerging market economics for Asia at Citi, that the key theme for the region [in 2010] will be how it manages liquidity, capital flows and asset prices. Strong growth and fundamentals, rising interest rate differentials and cheap dollar funding costs will likely fuel more inflows into the Asia region".
But, much depends on whether the Chinese authorities will let the renminbi appreciate. The consensus among Asian-based economists is that it will. Chua believes that the People's Bank of China will allow the renminbi to appreciate by 3% [this] year, and that revaluation should start from the first quarter. If anything, her forecast is at the low end, with others such as Desbarres predicting a 5% to 6% appreciation against the US dollar.
But, warned Chua, "if there is no appreciation, then this will complicate the outlook for FX in the region with central banks intervening more, especially the more export driven ones like Taiwan and Korea, and we can see higher risk of more serious restrictions on capital flows.
Moreover, there would be a heightened risk of trade protectionism, especially from the US and Europe".
The primary objective for regional central banks will be to provide an environment for economic recovery and high employment levels. So, they are unlikely to act aggressively when that recovery, especially in a global context, remains precarious. Furthermore, as Desbarres reiterated, "regional central banks will be reluctant to allow their currencies to appreciate forcefully on a trade-weighted basis, if the Peoples Bank of China doesn't adjust its FX policy to a gradual appreciation against the dollar".
In that environment, accusations of currency manipulation would certainly shrill even louder.
This article first appeared in the "FX Report 2009" which was published together with the December/January issue of FinanceAsia magazine.
