Exchange currency booths in Hong Kong. The recent dollar depreciation is a welcome reprieve for emerging economies. Photo:Sam Tsang
Opinion
Sasidaran Gopalan and Ramkishen S. Rajan
Sasidaran Gopalan and Ramkishen S. Rajan
Covid-19 shows up Asia’s vulnerability to a strong dollar in a crisis
Beyond concerns about sharp exchange-rate gyrations, there is growing recognition that the shock-absorbing powers of exchange rates are highly limited when the dollar is the invoicing currency
Following the Bretton Woods agreement, maintaining a stable and competitive exchange rate has been one of the cornerstones of Asian industrialisation strategies, at least until the Asian financial crisis of 1997-98. To what extent have Asian exchange-rate regimes evolved over the past two decades?
The latest available International Monetary Fund report on exchange-rate arrangements reveals that many smaller economies in the region continue to have either fixed (Hong Kong) or heavily managed (Singapore) exchange-rate regimes. At the other end, larger Asian economies such as Japan and South Korea have relatively more flexible regimes, while India has swiftly moved in this direction since 2016 when it officially adopted an inflation-targeting regime.
China has, for a long time, walked an unconventional path. Despite having a large domestic economy, China relied on a heavily managed exchange-rate regime for decades, given its dependence on the external sector for growth. While this has led to periodic accusations in the United States of currency manipulation, China has been transitioning to a more flexible market-determined exchange-rate regime, driven largely by its efforts towards rebalancing its economy and developing its financial markets.
Some emerging markets in Asean such as Malaysia and Vietnam have chosen to manage in the middle, giving up some monetary policy autonomy and exchange-rate fixity while managing capital flows to deal with volatility.
Others such as Indonesia, the Philippines and Thailand, which have also managed in the middle, appear recently to have favoured a move towards greater exchange-rate flexibility while strengthening the use of interest rates to target inflation.
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Thailand’s dark economic outlook a painful side effect of coronavirus success story
Thailand’s dark economic outlook a painful side effect of coronavirus success story
While many mid-sized and larger economies in the region have officially moved towards a floating exchange rate, in reality, even those that have adopted an inflation-targeting framework have continued to use foreign exchange intervention to manage excessive exchange-rate volatility.
The spread of Covid-19 has again brought to the forefront the vulnerability of emerging markets to sudden halts in capital flows and sharp exchange-rate fluctuations.
Beyond concerns about sharp exchange-rate gyrations, there is also growing recognition that the insulating powers of exchange rates as shock absorbers are highly limited, especially in countries where the US dollar plays a dominant role as the invoicing currency for trade.
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What is the Hong Kong Dollar Peg?
What is the Hong Kong Dollar Peg?
For the 10 members of the Association of Southeast Asian Nations plus China, Japan and South Korea, together known as “Asean plus three”, nearly 80 per cent of their exports were invoiced in dollars on average over the past two decades. Recent IMF work has shown that this dollar dominance in trade invoicing effectively weakens the ability of countries to benefit from currency depreciations to recover economically in the short term, limiting the cushioning role of exchange rates to deal with external shocks.
Also, more firms rely substantially on dollar funding via the banking system and the bond market. Dollar-denominated non-financial corporate debt in the Asean-plus-three region, which has more than doubled since the global financial crisis from less than US$90 billion in 2007 to over US$210 billion last year, has also emerged as a key source of vulnerability for the region.
Agustín Carstens and Hyun Song Shin, of the Bank for International Settlements, have cautioned about the existence of “original sin redux”. They argue that the risk of currency mismatches may have shifted to the lenders’ balance sheets as their assets are in foreign currency while their liabilities are in their own currency, with any weakening of emerging market currencies leading to a deterioration of creditors’ balance sheets.
Overall, this combination of the dominance of US dollar as the invoicing and funding currency in the region severely aggravates the negative impact of falling exchange rates on many emerging Asian economies, a problem that has surfaced again with the Covid-19 pandemic. While the recent dollar depreciation is a welcome reprieve for emerging economies, currency markets could turn sharply at any time and prove to be highly disruptive.
Some economies such as Singapore and South Korea have been able to access temporary bilateral swap lines with the US Federal Reserve, but many countries in the region remain excluded and thus continue to be highly susceptible to global dollar shortages.
China and Japan have been pursuing bilateral swaps to reduce the US dollar’s structural dominance while also promoting financial stability by acting as liquidity backstops. These are useful but highly limited steps to reduce the region’s vulnerability to shocks from the US dollar market.
Sasidaran Gopalan is a senior research fellow at the Nanyang Business School, Nanyang Technological University. Ramkishen S. Rajan is Yong Pung How Professor at the Lee Kuan Yew School of Public Policy, National University of Singapore. The views expressed here are personal
