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

On Bank Negara, PPP & The Ringgit

hishamh said...

A couple of problems here. Purchasing Power Parity (PPP) is no more than an academic curiosity these days, for the simple reason that it doesn't remotely describe currency movements even between advanced economies, much less for emerging markets. So there is no firm foundation for using it as a basis for evaluating currency misalignments.

It therefore follows that analysing currency policy based on PPP values is also a red herring.

In fact, based on current theories, it's possible to argue that the causality runs the other way from your analysis - an export-oriented strategy results in low relative incomes and a depressed exchange rate, rather than a weak currency being used to support export competitiveness. Which means that the MYR exchange rate is in fact market-determined, and there is no deliberate central bank policy to weaken the currency.

3:14 PM

hisham,

You make a few good points... herein lies the 64,000 dollar question... is Bank Negara deliberately suppressing the ringgit?

Considering that the ringgit is tightly controlled, and is not totally freely exchangeable overseas, BN exerts a lot of control over the ringgit. What I mean is that no hedge fund or trade would seriously dare to bet against BN's persuasions, they would rather bet alongside with BN's persuasions. When the currency is "limited" in its free trade and its circulation, that is tantamount to controlling the currency - not that that is a bad thing. For a small open economy like ours, we cannot seriously have a totally free floating currency, how do you think our exporters and services sector going to adjust if in January the ringgit is 3.6 to the USD and in May its 4.1 but by October its 3.1.

I am more concerned in the usage of the ringgit to shape the industries we have over the longer term. Yes, short term, fighting inflation is priority number one followed by maintaining a sustainable economy. But just look at where the ringgit has been over the past 20 years. I remember it was 2.7. What that tells me is that we are deliberately attracting FDI via such a mechanism.

The ringgit should be managed, but manged to appreciate so that we can flush out those industries that should not be here. We need to move up the value curve. Ifwe have an internal target of 3.2 average for 2010, 3.0 average by 2011 and 2.8 average by 2012, believe you me, we will see some industries being taken out naturally or indrectly. The kind of FDI we attract will be different for sure. We have the resources, don't short change ourselves, don't keep adding low cost foreign workers, it makes the substantial bottom rung of the industries stay manual and low value add.Yes, its easier said than done as industries will be displaced, jobs will be lost... in other words this is exactly the structural unemployment that we need to go through. Its tough, business wise and politically, but being in positions of leadership, we must make tough decisions or else we will lock ourselves into the same sandstorm. It is very sad to see the same sunset industries still operating in Malaysia 5 or 10 years from now.

... Oh, you want to do large scale manual soldering... go to Malaysia, there got plenty of cheap labour... Even if we keep bringing these labour intensive FDI, the best jobs that Malaysians can hope for is factory manager of a labour intensive factory looking after foreign workers. Get the ringgit to where our resources should be, and not cater and pander to the lowest common denominator.


p/s photo: Miwa Cocoa

Outlook For Ringgit For The Rest Of 2009

• Malaysia Ringgit (MYR) has appreciated 6% after hitting a low in early March taking the ytd losses to 1% as of May-end 2009
• March 3, 2009: MYR fell to the lowest level (3.725-3.735/USD) in 3 years due to weakening exports and foreign investment
• February 2009: To promote bilateral trade and investment for economic development, Malaysia's central bank and Chinese central bank established RMB40billion currency swap arrangement for 3 years
  
  Risks for ringgit in 2009:
• External balances: electronic and commodity exports are contracting at a sharp pace and the trend is likely to continue through 2010 with a sluggish recovery in 2010. Presently greater contraction in imports relative to exports is sustaining the trade and current account surpluses and forex reserves
• Easing capital flows: keeping interest rate on hold in April and May 2009 has helped reverse some of the past capital outflows. Rising bond issues at higher yields and sharia bond issues are a plus. But ratings downgrade due to increasing fiscal deficit can weigh on debt inflows. Impact on lower corporate earnings ad revival of risk aversion can weigh on stock market. A recession in 2009 and rising bond issues in U.S. (safer-haven) can be a negative. FDI is expected to fall over 50% y/y in 2009 due to decline in export manufacturing related capex
  
• Central Bank policy: In 2008, central bank was intervening in the FX market selling USD reserves to contain currency depreciation but in 2009 the central bank has been defending the exchange rate to support exports especially as reserves have also been declining. foreign exchange reserve stood at US$88bn as on 15 May, 2009 which is sufficient to finance 8.3 months and 3.8 times the short-term debt. Large forex reserves and external surpluses are a plus to deal with export contraction and any revival of capital outflows. Trend in USD and SGD will also be improtant determinants of movement in ringgit
  
• Since the central bank decided to keep key rate at 2%, USD/MYR is expected to be higher by the end of Q2 2009. But USD/MYR will be lower in H2 2009 as the economic situation is improving. But further stabilization in domestic and global economy is still necessary to guide USD/MYR around 3.45 by the end of 2009
• MYR continues to track the SGD and is expected to weaken against USD in mid-2009 due to anticipated resurgence in USD strength
  
• Declining forex reserves and depreciating SGD would put further pressure on ringgit
  
• Confidence of ringgit would be dampened due to increasing deficit on overall balance of payments, declining exports, outflow foreign capital, and expectation of further rate cut by central bank
• In 2009, ringgit would be weak against USD as the process of de-leveraging by international investors will continue to boost demand for USD
  

p/s photos: Hanako Takigawa