SINGAPORE, Aug. 25 (UPI) -- The performance of Asian stock markets over the last couple of months says it all: funds are again piling into the region. But while Asian central banks can expect to see their foreign exchange reserves swell further, economists warned appreciation pressures on Asian currencies is also to be expected, even if they are fought all the way by the central banks.
With the majority of Asian economies similarly geared towards exports for growth, changes in exchange rate policy remain a potent tool in macro-management, argues Mike Moran, economist at Standard Chartered Bank.
With so many economies in the region still very dependant on export growth to pull their GDP upwards, many central banks have been trying very hard to keep their currencies from appreciating in order to keep the local economies competitive. That is why Asian currencies have strengthened only marginally against the dollar this year, whilst the dollar has fallen much more sharply against the European majors.
"External competitiveness remains a key policy priority given its integral influence on growth. Given this, central banks will continue to resist pressures to allow their currencies to appreciate significantly, at least until inflation becomes an issue," says Moran.
But they're facing an upward battle, economists warn.
"The flow of funds back into Asia is just at its start," points Eddie Wong, Chief Asian Strategist at ABN-AMRO.
"Currently, Asian central banks are trying to stabilize their currencies or prevent them from appreciating too fast. But I believe there will be less pressure on them to do so next year, once exports growth starts to pick up more strongly (with the economic recovery in the U.S), and so there will be a sharper appreciation of Asian currencies early next year," adds Michael Spencer, Head of Asian Research at Deutsche Bank.
Asian equities have performed strongly in the last two months, fueled by optimism that the regional economies are now on a recovery road after the disastrous impact of the SARS outbreak on second quarter data. The MSCI index ex-Japan, a broad measure of regional stock performance, has risen 17.3 percent since the beginning of June, and most stock markets index are now at levels not seen for 13 months.
The rise in those stock markets has been mainly driven by foreign investors in search of better return given the low environment for interest rates in the United States and Europe.
As a result appreciation pressure for Asian currencies has been intensifying and central banks are once again busy bees.
"These influxes of funds are certainly complicating life for central bank. They are threatening to create incredible excess liquidity when there is already quite a lot in excess," Spencer says.
Each central bank in the region has been reacting differently to the sharp capital inflows.
"Korea, Thailand and Taiwan are facing the biggest inflows right now and central banks are intervening one way of the others to keep their currency stable and sterilize flows," Spencer notes.
In South Korea, the won has hit a 13-month high and the finance ministry plans to auction off one trillion won ($850.7 million) worth of bonds Tuesday in an effort to sterilize this excess liquidity.
Meanwhile, the Taiwan dollar is near an 11-month high and the central bank has been repeatedly intervening in the market to cap gains. As a result, the country's foreign reserves have jumped $20.6 billion during the first seven months of this year and the central bank has had to issue massive amounts of paper to mob up the resulting rise in surplus liquidity.
In Thailand, the baht has also reached a 13-month high and the central bank has taken several steps to liberalize capital outflows, while keeping interest rates at record lows. It started last month to relax foreign exchange controls to encourage capital outflows, but announced further relaxation of regulations last week aimed at promoting Thai residents' investment abroad. The Bank of Thailand now permits $2.45 billion of investments by local financial institutions in overseas securities sold by resident and non-resident issuers, above the earlier limit of $500 million.
"While we do not expect an immediate large outflow of capital towards these overseas investments, we continue to expect these measures to offset the existing appreciation pressure on the baht and to ease the need for central bank's activism (intervention) in the market," says Jimmy Koh, head of Treasury research at UOB.
But the hottest money inflow has been into China, with an estimated $25-30 billion flowing in the first half of this year alone, prompting the central bank to intervene almost on a daily basis.
Economists point that in the last two weeks the central bank has been issuing large amount of paper to mob up liquidity. It has also been liberalizing restrictions to allow more companies to invest overseas and to hold foreign exchange to reduce appreciation pressure on the yuan.
In its latest move, it has allowed local companies involved in international project contracting and labor services to keep all foreign exchange earnings, instead of 20 percent earlier.
But Wong points that as companies are not eager to keep foreign currencies in the expectation of an eventual appreciation in the yuan, this measure may not be very effective in reducing the pressure on the currency.
Economists believe Asian currencies and the need to allow them to strengthen will be at the forefront of talks between U.S. Treasury Secretary, John Snow and countries in the region when he comes here early September to Japan, China and attends the Asia Pacific Economic Cooperation forum in Thailand.
That said, most economists expect China to only pay lip services to calls for a more flexible yuan.
