Currency Flows Reverse

As trade slows, developing nations move to weaken their exchange rates and revive exports.

Just three months after the biggest developing economies sold dollars to support their currencies, policy makers from Colombia to China are moving to weaken exchange rates and revive exports as the International Monetary Fund forecasts the slowest trade growth in three years.

Colombian Finance Minister Juan Carlos Echeverry urged the central bank on Aug. 3 to boost minimum dollar purchases from $20 million a day, saying the country needs “more ammunition” to drive down the peso in the global “currency war.” The Philippines banned foreign funds from deposit accounts and unexpectedly cut interest rates in July as the peso hit a four- year high. In China, authorities lowered the yuan reference rate to the weakest since November, which according to Citigroup Inc. will create “headwinds” for other Asian currencies.

After spending more than $59 billion in foreign reserves in May and June to stem currency depreciation, developing nations are reversing policies as the European debt crisis outweighs the risk of faster inflation. South Korea and Chile may weaken exchange rates to make their exports cheaper, according to UBS AG. The IMF estimates global trade will expand at the slowest pace since 2009.

“Policy makers will become more aggressive,” said Bhanu Baweja, a London-based strategist at UBS. “The currency strengthening is in contrast with the state of the economy. That argues for much weaker foreign-exchange rates.”

Options traders are bracing for wider currency swings in some emerging markets in coming months. The gap between implied volatility on one-year and three-month options for the South Korean won widened to a 10-year high of 2.85 percentage points on July 12, from 1.96 percentage points two months earlier, according to data compiled by Bloomberg.

Bank of America Corp. lowered its end-September forecast for the yuan on July 25 to 6.45 per dollar from 6.30, saying “downside growth and disinflationary risks” may prompt China to let its currency depreciate. The new forecast represents a 1.4 percent decline from yesterday’s close.

“People aren’t expecting currency appreciation from emerging Asia anymore,” said Albert Ma, a Taipei-based bond fund manager at PineBridge Investments LLC, which oversees $67 billion of assets globally. “These countries are mainly export- oriented. They’d want their currencies to be weak when the global economy is going this bad.”

Just three months ago, policy makers were taking steps to prop up exchange rates when emerging-market currencies, as measured by JPMorgan Chase & Co.’s ELMI+ Index, lost 5.9 percent in May, the most since September.

 

Debt Crisis

As the deepening European debt crisis led investors to retreat from developing nations, central banks drew on foreign- exchange reserves to limit declines, causing a combined $19.7 billion drop that month in Brazil, Russia and India, official data show. China’s holdings, the world’s largest at $3.24 trillion, fell $65 billion in the second quarter.

Since May, the ELMI+ index has climbed 4.4 percent as European policy makers pledged to tackle the crisis and record- low yields on U.S. Treasuries and German bunds spurred demand for riskier assets. Emerging-market bond funds have taken in more than $46 billion this year, surpassing the $43 billion of inflows in the whole of 2011, according to JPMorgan.

Chile’s peso advanced to the strongest level since September on Aug. 9, approaching levels that prompted the central bank to buy dollars in 2008 and 2011. The peso declined for a second day yesterday, falling 0.6 percent.

The won, which reached a four-month high on Aug. 9, strengthened 0.1 percent today. Malaysia’s ringgit gained 0.2 percent after touching its strongest level since May on Aug. 7.

The currencies are rebounding as slowing exports drag down economic growth in developing countries. The global trade expansion will ease to 3.8 percent this year, from 5.9 percent in 2011 and 12.8 percent in 2010, according to the IMF. China’s export growth collapsed to 1 percent in July from an average 18 percent over the past seven years as demand from Europe, the country’s largest trading partner, declined.

“We have a growth problem in the global economy,” Michael Ganske, the head of emerging-market research at Commerzbank AG in London, said in a phone interview. “Emerging-market central banks can’t let their currencies appreciate on the back of portfolio flows to the point it kills exports.”

 

‘More Diverged’

With Asian and Latin American currencies down about 9 percent since their peak in July 2011, policy makers aren’t worried about their nations’ losing competitiveness, said Kieran Curtis, who helps oversee $4 billion in emerging-market debt at Aviva Investors Ltd. in London.

“We haven’t seen particularly broadly based intervention,” Curtis said. “I don’t think they are all seriously concerned about the currency strength. It’s more diverged.”

All except four of 25 emerging-market currencies tracked by Bloomberg have weakened over the past 12 months. Brazil’s real lost 20 percent against the dollar in that period as the Hungarian forint fell 15 percent.

In Colombia, it’s a different story. The 26 percent gain in the peso since 2008 threatens to undermine local industry and farmers. Flower growers cut 30,000 jobs in the past seven years because of the peso’s rally, according to the Association of Colombian Flower Exporters. Echeverry said Aug. 8 that he has asked the central bank to double its daily dollar purchases to $40 million.

“We are in a currency war, and those who don’t fight lose,” he said in an interview in Bogota on Aug. 3.

In the Philippines, the central bank tightened rules on capital inflows last month by prohibiting foreigners from parking funds in so-called special deposit accounts. Policy makers also cut the benchmark interest rate by a quarter- percentage point on July 26 to a record 3.75 percent, a move that Deputy Governor Diwa Guinigundo said will help “temper” peso gains. The currency’s 4.6 percent advance versus the dollar this year is the best performance in Asia. The peso fell 0.1 percent today.

South Korea, which sent a combined 44 percent of its overseas shipments to China, the U.S. and the European Union last year, will step up monitoring foreign purchases of won- denominated debt, Shin Hyung Chul, director general of the treasury bureau at the Ministry of Strategy and Finance, said in an Aug. 8 interview in Seoul.

 

Overseas Holdings

Overseas investors boosted bond holdings by 1.4 trillion won ($1.2 billion) to a record 89.7 trillion won in July, or 17 percent of the total outstanding, government figures show.

After keeping its currency little changed during the 2008-2009 financial crisis, China has allowed the yuan to depreciate this year. The central bank set a reference rate of 6.3456 on Aug. 13, the weakest level since November. The daily fixing, around which the currency is allowed to fluctuate by as much as 1 percent, was reduced 0.7 percent in the past three months, the most since a peg ended in 2005.

The Czech Republic’s central bank may weaken the koruna by about 10 percent against its trading partners to help the export-led economy recover from recession, according to Bank of America. A 10 percent depreciation will lead to as much as a 5- percentage-point increase in exports, Mai Doan, a London-based economist, wrote in a report to clients on Aug. 6.

Pressure for emerging-market currencies to appreciate may persist as central banks in developed nations boost monetary stimulus to revive growth, according to Frances Cheung, a strategist at Credit Agricole CIB in Hong Kong.

The Federal Reserve said Aug. 1 it will pump fresh funds into the economy if necessary to bolster growth. European Central Bank President Mario Draghi said the following day that policy makers will buy shorter-maturity government securities to help quell turmoil in the region’s debt markets.

The U.S. central bank bought $2.3 trillion of mortgage and Treasury debt from December 2008 to June 2011 in two rounds of so-called quantitative easing, sending the dollar to record lows against its trading partners. In response, countries from Brazil to China bought dollars to curb their currency rallies, boosting foreign reserves in the eight largest developing economies 46 percent in the three years through 2011, according to data compiled by Bloomberg.

Developing countries “don’t want a strong currency, losing export momentum and losing domestic momentum,” said Phillip Blackwood, who oversees $2.9 billion in emerging-market debt as a managing partner at EM Quest Capital LLP in London. “They want to boost GDP as much as possible. A weaker currency is another measure they can use.”

 

 


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