The surging US dollar has sparked much concern over where Asian currencies are headed. The devastation caused by the Asian currency crisis of 1997 remains fresh in many minds. So does the “taper tantrum” of 2013 when the Indonesian rupiah, the Indian rupee and the Philippines peso all swooned because the US Federal Reserve was thinking of tightening its monetary policy,
Although many years have passed since those troubling events, the recent depreciation of exchange rates in Asia has led to unsettling speculation of a worsening situation, such as a possible devaluation of the Chinese yuan.
In the near term, this nervousness may cause more turbulence in the currency markets here. But, beyond that, our sense is that the worst will soon be over. A primary reason is that we do not see the current strength of the US dollar being sustained once financial markets start examining the US dollar’s fundamentals more critically. Moreover, China will not pro-actively devalue the yuan, given its policymakers’ concern with maintaining stability.
Finally, Asian economies have strengthened their resilience in the past decade: their currencies are underpinned by generally robust external balances, credible management of exchange rates and fiscal policy and stronger foreign exchange reserves. They should be further supported by rising global demand as the electronics cycle turns up and tourism continues to recover.
US dollar likely to peak
The main reason why Asian currencies have weakened is the strength of the US dollar. But, several factors that have propelled the dollar’s surge are not likely to last.
Take its out-performance against other major economies in terms of economic growth. There is building evidence that US economic growth will be slowing in the second half of this year, as the impact of higher interest rates takes a toll and some of the supports that the economy enjoyed become weaker. Consumer spending, for instance, could weaken. The April payrolls report showed slower job creation while other data showed the ratio of job vacancies to unemployed individuals declining: that means income growth could ease. Moreover, the large buffer of savings that consumers built during the pandemic will have largely been spent by the second half of the year.
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Another risk is the lagged impact of the brutal monetary tightening of the past two years. A risk to consumer spending comes from signs of credit stress emerging in the US economy, particularly among lower-income borrowers struggling to meet their loan obligations. As consumer delinquency rates rise, there are also more reports of individuals suffering a depletion of savings amid rising prices and persistently high interest rates. The commercial real estate sector continues to show signs of stress as well.
The US dollar has also been bolstered by the proliferation of geopolitical risks, which have boosted safe-haven flows into the American currency. At first glance, with the situation in Ukraine and the Middle East continuing to simmer, investors are unlikely to expect a safer world for now, so the US dollar should continue to enjoy inflows. But, as the American presidential election campaign heats up, markets may also focus more on the implications of former president Trump returning to office. His agenda of extremely aggressive trade restrictions, heavy-handed containment measures against China and a less amenable attitude towards longstanding allies will worry investors worldwide. The campaign is also likely to be heated and nasty, further affecting markets’ perceptions of risk in the US vis-à-vis the rest of the world.
Beyond these immediate issues, there is a more fundamental question about the US dollar, and that relates to the fiscal position in the US. The International Monetary Fund (IMF), among other agencies, has issued warnings about the large US fiscal deficit which is projected to reach 7.1% of GDP in 2025. That figure is more than three times the 2% average for other advanced economies and unprecedented for the US in times of peace and continued economic growth. The American political elite is divided and prefers to avoid discussing a solution to the fiscal challenge. It would not surprise us if the US fiscal position and its huge public debt levels come into greater focus in financial markets as the year progresses.
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A Chinese devaluation is unlikely
Some respected economists argue that China will have little choice but to allow its yuan to depreciate because its faltering economy requires easier monetary policy to stimulate domestic demand.
However, lower interest rates and more yuan liquidity will probably result in capital outflows and a weaker yuan. Supporters of this viewpoint to how the economy is struggling to stay afloat amid weak domestic demand and a sluggish property sector. Recent data show the economy is steadying a little, but the headwinds remain strong.
Nevertheless, the concerns of Chinese policymakers with maintaining stability mean that they are wary about relinquishing control over the exchange rate. If they had not devalued the yuan during the dire moments of the Asian Financial Crisis in 1997, why would they do so now, when the challenge is so much less? The Chinese authorities know that the downsides of a yuan devaluation would almost certainly outweigh any benefits. Devaluing the yuan will be guaranteed to trigger sharp depreciations in competitor currencies and create turmoil in financial markets generally.
With President Xi Jinping now touring Europe and trying to forestall protectionist measures against Chinese exports, the last thing the Chinese decision-makers want is to encourage even more complaints against China over currency manipulation and so on. Sentiments in Europe and large emerging economies such as Brazil, Mexico and India have turned against China amid allegations that China’s recent export success is due to unfair practices and industrial overcapacity.
Robust fundamentals back Asian currencies
It is fair to say that Asian policymakers have reasonably managed the current turbulence in currency markets. Central banks have quickly shown investors that they will do what is necessary to protect their currencies, which is why recent policy decisions have leaned toward hawkishness.
For example, Taiwan’s central bank hiked rates recently, while Bank Indonesia surprised markets with a rate hike that was explicitly tied to its determination to defend the rupiah. The Bank of Thailand has gently rebuffed government pressures to cut interest rates, communicating its reasons for doing so. Other central banks have signalled to investors not to expect premature rate cuts. This adherence to rigorous monetary policy signalled Asian policymakers’ commitment to maintaining price stability and controlling inflation, enhancing investor confidence in the region’s economic fundamentals.
It also helps that the various metrics of external resilience remain strong — a huge difference from 1997 and 2013. Foreign exchange reserves have been improving in most economies. The reserves-to-debt ratio remains broadly stable across the region’s main economies, providing a cushion against external vulnerabilities. This reassures investors about the economy’s stability and resilience.
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Finally, the most important measure of external strength — a country’s current account balance — has also been improving for most economies. Investors will have more reason to expect strong external positions as the recovery in trade proceeds and as tourism receipts increase:
More evidence of a strong recovery in the global electronics cycle will boost Asia’s exports. Rising consumer sentiment bolstered tech purchases, driving an industry recovery that began earlier this year. Evidence for this recovery is visible in bellwether technology power-houses such as South Korea and Taiwan. Recent export data reveals a 165% surge in Taiwan’s information, communication, and audio-video product sales. This growth, bolstered by robust demand for AI-related applications, has propelled export orders to US$133.32 billion ($180.82 billion) in the first quarter, marking a mere 2.1% contraction annually, the slowest in five quarters. Similarly, South Korea’s exports have enjoyed robust growth, primarily driven by a surge in semiconductor-related product demand. This signals a sustained recovery in the global electronics cycle, emphasising South Korea’s pivotal role in driving economic growth and stability in the region.
Adding to this improvement is the recovery in tourism. According to the International Air Transport Association, travel demand in the region rebounded significantly in December 2023, reaching nearly 83% of pre-pandemic levels, compared to just 57% in January of the same year. The rise in tourism is expected to continue as countries across the region implement measures to attract tourists.
For example, South Korea has introduced visa-free travel initiatives, following in the footsteps of nations like Singapore and China, which have agreed to a 30-day mutual visa-free entry for their citizens since Feb 9. Similarly, Thailand has waived visa requirements for citizens of China and India to stimulate tourism, with plans underway to extend visa-free travel privileges to citizens of additional countries. All these are poised to attract more tourists in 2024 and support growth and demand for a country’s goods and services.
Overall, the Asian region’s economic performance will likely satisfy financial markets. Apart from exports and tourism, the region is also poised to enjoy renewed infrastructure spending by governments and foreign investment. Although there remain questions over China’s economy, the most likely outcome is one where the Chinese economy recovers modest momentum. It is also clear that policymakers in China are stepping up measures to ensure that this year’s ambitious 5% growth target is met.
Indeed, the latest set of Purchasing Manager Index (PMI) surveys showed that things are beginning to pick up from the trade-induced slowdown of 2023. Several international institutions, most recently the IMF, have affirmed the view that Asian economies are poised for improved growth in 2024 on the back of supportive forces in domestic and external consumption and increased capital spending.
India and Southeast Asia do not get enough credit for the hugely improved economic resilience they have achieved in recent years, which will help support their currencies. In a world filled with many risks, this is important — there are bound to be shocks from time to time for any economy connected to the world economy.
The key issue is whether an economy can absorb those potential shocks and bounce back. The region’s marked improvement in resilience is clear in how it has faced a range of shocks, such as the sharpest monetary tightening in decades, a series of geopolitical shocks, growing trade protectionism and a Chinese slowdown.
One of the most important sources of resilience for these economies and their currencies is the improved credibility of policymaking. Compared to a decade ago, financial markets are more comfortable with how the region’s central banks conduct monetary policy and how they have maintained independence even under political pressure. Finance ministers have also determined to keep fiscal deficits under control, even at the cost of a slower economy.
The bottom line is that the US dollar may rise further in the coming weeks and put more pressure on Asian currencies. But beyond that near-term risk, there are good grounds for confidence in an eventual rebound in Asia.
Manu Bhaskaran is CEO of Centennial Asia Advisors
