As the currencies of the Philippines, Indonesia and India come under “excessive” pressure amid full-blown crises in Turkey and Argentina, now is the time for Asia’s policy-makers to consider a collective and coordinated policy response against an unwarranted currency freefall, Japanese investment house Nomura said.
These countries could be reaching the point “where the extent of net capital outflows has gone beyond what is justified by economic fundamentals,” Nomura said, noting that the Philippine peso, Indonesian rupiah and Indian rupee were now all “undervalued.”
“Twenty years ago, Asia experienced a devastating financial crisis, and an important policy lesson learnt was to be prepared and build strong regional defenses instead of being at the mercy of stringent IMF (International Monetary Fund) programs,” Nomura said in a research note dated Sept. 14.
Since the Asian currency crisis of 1997, Nomura noted that Asia’s total foreign exchange reserves had been built up to over $6.5 trillion from under $1 trillion in 1996 while a web of intra-Asia central bank foreign exchange swap lines have been established, including with Asia’s two largest forex reserve holders, China and Japan. In 2010, the Association of Southeast Asian Nations plus China, Japan and Korea launched the Chiang Mai Initiative, a multilateral currency-swap arrangement to pool some of their forex reserves which now provide a $240-billion buffer.
The crises in Turkey and Argentina have sent ripples to the Philippines, Indonesia and India due to their current account deficits, even if these deficits were relatively small, the research said.
Based on Nomura’s newly-launched “Damocles,” an early warning indicator of exchange rate crises, there’s the lowest possible risk score zero for Indonesia and the Philippines, and 25 for India—all safely below the danger threshold of 100.
Similarly, Nomura’s exchange rate valuation models as of Sept. 12 found that the Indonesian rupiah, Indian rupee and Philippine peso were now all “undervalued” by 7.7 percent, 4.2 percent and 6.6 percent, respectively.
As of Friday, the peso closed at 53.97 against the US dollar. The local currency is now trading at 13-year lows against the greenback.
Despite having been established several years ago, the financing arrangements in the region have not yet been activated when external shocks occurred, such as the 2013 taper tantrum, possibly due to the stigma on those seeking external help.
However, Nomura believes the current emerging market turmoil is the kind of external shock involving financial contagion for which access to these regional financing arrangements would make sense.
First, Nomura noted that the sharp depreciation of the rupiah, rupee and peso was “starting to look excessive.”
“Second, collective regional action can be a more powerful tool than individual policy responses. Moreover, if these currencies continue to depreciate, the economic cost and side effects from individual country policy responses can become overwhelming,” Nomura said.
While currency depreciation can boost export competitiveness in the longer run—but less so if several competitor currencies are depreciating at the same time—it could stoke imported inflation and raise the cost of servicing foreign debt in the near term, Nomura said.
Responding to currency depreciation by raising interest rates will only hurt economic growth, while administrative measures and capital controls can heighten business uncertainty and crimp investment, Nomura said. —DORIS DUMLAO-ABADILLA