Dejavu 1993, Capital Inflow, Asian Currencies Uptrend

It looks increasingly likely that we have seen the start of an inflow of capital into Asia. The weakening USD will help prop up US shares, but may see more international investors migrating excess funds into Asia to obtain a better return over the next 6 months. This looked much like the 1993 bull run in Asia. No, before you get ahead of my views, this is not going to be the repeat of the extended 1993-1996 bull run. The last 2 months have seen what we shall refer to as the US$ carry trade - borrowing in USD to invest elsewhere in anticipation of a weaker USD down the road. This is a replication of the yen carry trade which fueled much of the liquidity sloshing around all markets in 2007.

An example is the recent upgrade by Macquarie on Malaysian markets, mainly in anticipation of a higher ringgit value over the next 24 months. They forecast the RM/US$ will hit 3.20 (+6%) by end 2010 and 3.00 (+14%) by end 2011. Gawd, I hope they are right as I can travel overseas with a fatter wallet then. In fact Macquarie said that currencies usually overshoot, so we could easily hit 20%. The two key cross-rates to watch are RM/US$ and RM/Rmb:
- Immediate 10% upside suggested by RM/Rmb cross-rate: Macquarie believe over the next two quarters, the ringgit will appreciate to its previous fixed level against the Rmb.
- Additional 5–10% upside suggested by RM/US$ cross-rate by end 2010: They expect the renminbi and Asian currencies to resume its upward appreciation against the US$ in late 2010.

Taking this tack, importers will gain the most, eg Astro and auto companies, who import from Europe and the US. Thats the view of Macquarie, my view is that auto, auto parts and protected industries should be largely ignored over the next few years. Exporters such as plantations would suffer from an effective price cut. Companies with a high proportion of offshore earnings such as Parkson (> 90% of EBITDA), MISC (> 90%), YTL Power (75%), and KNM (60%) would have lower translated earnings.

Back to the foreign capital inflow - YTD net foreign portfolio investment in equities as of November 4, 2009: Best-performers: South Korea: US$21.18 billion, India: US$14.21 billion, Taiwan: 10.87 billion; Others: Thailand: US$1.51 billion, Indonesia: US$0.77 billion, the Philippines: US$0.40 billion, Pakistan: US$0.19 billion, Vietnam: US$0.01 billion, Japan: -US$17.12 billion. Can't seem to get the Malaysian figure but it should be negative judging from the previous posting on net foreign investors holdings of Malaysian stocks. All major Asian currencies are an appreciation path thanks to improving export performance and liquidity condition. Unlike 1997-98 crisis, Asia has enough reserves to defend its currencies and dollar liquidity has improved considerably when compared to Fall 2008, although it remains tight in some countries.

Notable economist Joseph Stiglitz said, "The inflows of easy money" is posing a risk of asset bubble in Asia as "such funds are usually not long-term investments and won't be a foundation for robust growth for Asia." Yes, we are seeing these short term funds finding Asia as a nice playground, but unlike the 93-96 rally, these funds will not be here very long, so we need to watch the US$ carry trade when they start unwinding in a big way. Presently, the outlook for most Asian currencies are still good for the next 6 months, and as Macquarie pointed out, the ringgit is a great selling point, so we are "safe" for the time being.


p/s photo: Han Ga In

Outlook For Asian Currencies For Rest Of 2009

Why is it important to look at currency outlook? If you are investing in stocks or bonds in an emerging country, the outlook for the local currency is very critical. The outlook will sway foreign and institutional investors one way or the other in global capital flows. You will only invest aggressively in things that will go up - currency bullishness becomes a major factor in calculating the absolute returns for foreign and institutional investors. there is not much point if a local stock market returns 12% in a year if the local currency whacks 8% off their net returns. Yes, you can do hedging blah, blah... but the crux is still good confluence of positives when making an asset allocation decision. You do not want to have so many "conflicting variables" in your asset allocation model. Good currency outlook = good equity outlook.

• YTD Currency performance as of May 4, 2009: Worst-performers-> Singapore (-2.63%), India (-2.47%), Vietnam (-1.69%), Pakistan (-1.69%), Malaysia (-1.67%), Thailand (-1.29%), Philippines (-1.18%), Taiwan (-0.81%), South Korea (-0.02%), HK (-0.01%) Best-performers-> China (+0.05%), Indonesia (+7.86%)
• In the beginning of 2009, heightened global risk aversion and investor redemption from EMs had led capital outflows from Asia and hence currency depreciation. Since March, however, all major Asian currencies are on an appreciation path with the exception of Vietnam. During March 6- May 4 period, South Korean Won gained from -18.6% ytd to -0.02% ytd and Indonesian Rupiah gained from -5.9% ytd to 7.86% ytd, whereas Vietnamese Dong have lost its value from 0.1% ytd to -1.69% ytd
  
  Causes
• Equity fund inflows: diminishing risk aversion among global investors have led continuous FII inflows to Asian equity markets with ytd net flows to a positive $1.6bn in mid-April 2009 and 4-week average as strong as those experienced in 2006 and 2007 (Citi). Attractive valuations, relatively sound economic fundamentals and aggressive fiscal and monetary stimulus policies have supported the current rally in equity markets
• Easing external balances: Asian exports will continue to contract through most of 2009 due to sharp contraction in global demand, however the extent of export drop has been easing since Feb/Mar 2009. Imports contracting greater than exports in some countries is containing risks to the trade deficit
• Improving liquidity condition: Although it remains tight in some countries, dollar liquidity has improved considerably when compared to Fall 2008. Countries needing dollar liquidity have adequate access to bilateral and Chiangmai currency swap agreements as well as aid from bilateral sources, multilateral agencies and international groups to avoid IMF assistance
  
  Outlook
• Risks: in spite of recent currency appreciation path, Asian currencies still face some downward pressures due to easing capital flows. Slowing GDP growth and bleak earnings outlook may drive out FII inflows. Furthermore, FDI has already started to contract due to cutbacks in capex, debt inflows are under pressures because of declining interest rate differentials with the U.S. and external bank borrowings is also waning amid global credit crunch; this may lead to capital outflows and currency depreciation. Countries with stronger FDI prospects and/or stronger fiscal and currency account positions are less vulnerable to currency depreciation than their regional peers
• Central Banks: Increasing number of central banks might favor undervalued currencies to support exports and growth (especially as interest rate cuts are approaching low levels in many countries with the risk of deflation which have been ineffective to stimulate lending and the size of fiscal stimulus is constrained by fiscal deficit). In the face of growing deflationary pressures, currency depreciation might also help to contain deflationary risks by raising import inflation
• DBS: Asian currencies have been appreciating on the back of rising equities on improving prospects for economic recovery. Most bullish currencies, Chinese Yuan and Hong Kong Dollar, are those where their spot rates have broken below their 100-, 200- and 400-day moving averages. The next most bullish currencies are the Asian NIE currencies (Taiwan Dollar, South Korean Won and Singapore Dollar) by virtue of their high dependence on the external sector for growth. In Southeast Asia, the Malaysian Ringgit and Indonesian Rupiah clearly outperformed the Thai Baht. The Philippine Peso, and to a lesser extent the Indian Rupee, do not appear to be as enthusiastic in embracing appreciation from recovering stocks
• Asian Development Bank: Although most Asian currencies are expected to recover somewhat over the course of the year, further depreciation is possible in the near term amid continued deleveraging and as weaker exports reduce dollar earnings in the region
• Nomura: Asia has the highest average fundamental undervaluation based on Flow Equilibrium Exchange Rate (FEER) and Stock Equilibrium Exchange Rate (SEER) of the emerging regions, and this will provide a strong support for Asia FX appreciation when capital flows stabilize
• Citi: Near-term outlook more mixed as appreciation trend moved faster than expected, and vulnerable to relapse of risk aversion, but longer-term appreciation view maintained
• Citi: Currency depreciation is expected as Swine Flu outbreaks would have greater proportional impact on non-tradable/services than they would on tradable sectors; one should therefore expect the relative price of non-tradables to fall vis-a-vis tradables, which would imply the real depreciation of one's exchange rate. This should be particularly for small open economies where this relative sectoral shift has a more notable impact
• Scotia: While the Chinese authorities profess confidence in the economic outlook, they will be willing to countenance only a marginal appreciation of the renminbi vis-a-vis the U.S. dollar in 2009. Despite the rally in the local equity securities market, the appreciation trend in India will not persist with the export outlook relatively bleak and political uncertainties unlikely to be resolved by the election. The Korean Won has been a major beneficiary of the diminished risk aversion among global investors in spite of the persistent weakness in the domestic economy, whereas Thailand's political uncertainties may tend to discourage investment inflows and encourage capital flight although current account surplus provides some support
• Standard Chartered: Given the fundamentals are solid and growth prospects are bright, KRW, PHP, INR, IDR to lead the rally in AXJ currencies in H2 2009 just as they led the AXJ currency correction in 2008. Small, open economy currencies such as SGD, MYR, TWD,THB, VND will weaken on slowing growth, capital outflows, global recession

p/s photo: Deborah Priya Henry