The greenback remains the reserve currency of choice with many countries despite the lingering woes of the American economy.
OF late, global economic prospects have turned murkier, prompting investors to rush back to the safe-haven currency of the US dollar (USD).
And the growing scepticism over the economic prospects of several major and regional countries in the near term (arising from their recent, decidedly disappointing macro releases) will likely help the greenback reclaim its long-held status of a darling currency in the foreseeable future.
In fact, the USD’s position as a global reserve currency has risen in prominence, comprising 62% of global reserve currencies despite America’s economic woes.
Economic growth has, indeed, moderated in several Asian countries. In India, for instance, Gross Domestic Product (GDP) grew at a much slower pace of 5.3 % in the first quarter of 2012, down from its usual 7% to 8% clip. It was India’s slowest economic expansion since 2004.
Similarly, Singapore, which holds the distinction of having one of the strongest economic growth rates in Southeast Asia, is feeling the pinch of shrinking global trade, with the country’s growth plummeting to barely 1.6% on a year-on-year basis in the first three months of 2012. Thailand’s economy almost screeched to a halt with a 0.3% expansion following supply-chain disruptions due to the massive flooding in the fourth quarter of 2011.
Even the seemingly indomitable China, whose economy normally cruises along easily at rates of around 9%, is feeling the heat after growth skidded to 8.1% in the first quarter of 2012.
In the advanced countries, news from the crisis-hit euro region are also less-than-inspiring, although the latest measures put forward to deal with the problem have somewhat lifted the sentiment of the financial markets at the end of June.
Despite this positive development in Europe, the greenback’s strength has not waned. Jitters among international investors over the wobbly state of the global economy induce them to continue betting on further upsides to the USD.
As a consequence, some Asian currencies have come under pressure, depreciating against the greenback for the most part of 2012.
For instance, the Indian rupee has plunged to a historical low of R57.3 against the USD in June 2012. Although much of the decline was mainly attributed to India’s twin deficits (ie, deficits in the current account of the balance of payments, and the government’s budget), the plunging rupee has nonetheless fuelled imported inflation, which presented the central bank with a veritable conundrum of having to switch to a more accommodative monetary stance to support growth in spite of inflationary pressures. This dilemma, naturally, weighs on the rupee’s already-diminished strength.
In Indonesia, the rupiah’s depreciation has been the direct consequence of Europe’s economic malaise, which is affecting the former’s external trade and investment. Although the economy has primarily been supported by strong domestic demand, recent reactions by Bank Indonesia to trim the policy rate from its cyclical high of 6.75% indicates policymakers’ anxiety about the prospects of the economy in an era where uncertainty reigns supreme.
In addition, the easing of the central bank’s monetary stance in the first half of 2012 has dented confidence in the rupiah this year.
As for the ringgit, its weakness against the greenback is also attributed to the expected moderation in economic growth, which, according to some observers, will then open the doors for more monetary accommodation in the near future.
Going forward, there are, indeed, reasons to think that Asian currencies will continue to remain weaker than their levels in 2011. The reasons are obvious: economic and financial conditions in Europe, although having improved somewhat following the greater flexibility recently accorded to troubled banks in Spain, will remain unstable.
They will thus impart continued volatility in the financial markets as investors indulge in a guessing game over the fate of the banking institutions as well as the overall macro developments of several countries within the region.
Economic fundamentals have also not improved tremendously. Spain, for instance, is still grappling with high unemployment following the bursting of the property bubble. Youth unemployment was reported to have surged to a whopping 52%. Similarly, in Italy, the budget deficit widened to 8% of GDP in the first quarter of 2012, while its debt-servicing cost jumped by a hefty 16% year-on-year following the spike in yields on Italian sovereign debt.
This will naturally mean persistently elevated risk aversion which, in turn, would support the greenback against other major currencies, including those of Asia.
Secondly, weaker growth prospects of regional economies will also not bode well for Asian currencies, going forward. Speculation over further interest-rate cuts by central banks after China, India, Australia and Vietnam slashed their policy rates means Asian currencies will likely depreciate further against the greenback.
Even in a country like Malaysia, the policy rate may not budge in view of the decent economic performance in the first quarter of 2012. Thus, expectations of a policy-rate hike by some quarters during the earlier part of the year will not likely materialise. Again, this connotes a limited upside for the ringgit against the greenback in the near term.
Thirdly, the challenges besetting some Asian policymakers in delicately manoeuvring their economies amidst slowing growth and rising consumer prices will also detract from regional currencies’ attractiveness. In India, for instance, stubbornly high inflation of nearly 8% (as measured by the wholesale price index) means the delicate balancing act between bolstering growth and containing inflation will become an even more complex task.
Singapore is finding itself in a rather similar predicament, with its inflation rate climbing to 5% in May 2012 – way above its 50-year average of around 2.8% – causing a serious policy dilemma as this is happening at a time when the country’s economic growth has tumbled to merely 1.6% on a year-on-year basis.
Higher risk aversion, which is currently reflected in the weak performance of regional equity markets, may intensify the downward pressure in the near term. Although news on European Union officials’ decision in the final week of June to directly lend to troubled banks jolted the markets temporarily, the rebound may not sustain unless more positive news emerge in the region.
For the Malaysian equity market, rising equity risk premiums continue to signal limited upside potential of the FBM KLCI. This will, once again, be one of several factors in inducing capital outflows and clamping down further on the ringgit’s performance.
The deluge of capital that inundated some Asian countries since the recovery from the Great Recession in 2009 has also become a very real concern. In Indonesia and Malaysia, for instance, the proportion of foreign holdings of government bonds has surged to historical highs. Foreign holdings of Malaysian Government Securities (MGS) have reached 38.5% of total outstanding MGS in April of 2012, raising fears that a quick exit by foreign investors may hurt financial-market sentiment and dent the value of the ringgit.
So, in the overall scheme of things, with the seemingly intensifying global uncertainty stemming primarily from the economic turmoil in Europe, the USD will likely remain international investors’ favourite currency.
At the same time, anaemic global trade will dampen Asia’s export-dependent economies, effectively constraining the upsides of their currencies against the greenback in the near term.
*The writer is chief economist for Malaysian Rating Corporation Bhd (MARC)
By Nor Zahidi Alias*
16 July 2012