Asian central banks deploy FX reserves to prop up currencies

Analysts remain confident in Asia’s financial stability, but recession risks are building

Global finance

The foreign reserves of many major Asian economies have been shrinking over the past few months, as central banks tap into their coffers to back their weakening home currencies against the rising US dollar.

Frederic Neumann, co-head of Asian economic research at HSBC, says declines in foreign reserves in central banks in Asia suggest a number of them have intervened in the foreign exchange markets in the past few months.

“It’s natural for central banks to do so when there are big foreign exchange moves,” he notes. “FX intervention is designed to cushion adjustments.”

Neumann says Asian economies such as India, Indonesia and the Philippines injected vast amounts of liquidity into the financial markets during the Covid pandemic and, by selling their foreign currency reserves and snapping up their local currencies, central banks are effectively withdrawing liquidity from the financial markets and cooling the economy down.

Thailand’s foreign reserves have seen a 10% drop this year, from $246 billion by December 2021 to $221.7 billion on June 24. Indonesia’s foreign reserves have fallen by 6.5% so far, from $144.9 billion in December 2021 to $135.6 billion in May. During the same period, the Philippines’ foreign reserves fell 4.8%, from $108.8 to $103.6 billion.

Foreign reserves at India’s central bank stood at $593.3 billion as of June 24, down 6.4% from $633.6 billion by the end of 2021. Korea’s foreign reserves totalled $438.3 billion by the end of June – shrinking for four straight months – down 5.4% from $463.1 billion by the end of last year.

Many central banks do not disclose details about their FX interventions. However, Peter Chen, head of official institutions coverage for Asia-Pacific at BNP Paribas, says it would not be “untrue” to say that some in Asia have intervened in the FX markets. He adds they have not been in a “panicked state of intervention”.

The Bank of Korea is among a few central banks in Asia that regularly reports its interventions. The latest data shows that the BoK sold $8.31 billion in the first quarter this year. This was the biggest selling of US dollars by the central bank since its quarterly release began in the third quarter of 2019. It follows a selling of $6.89 billion in the last quarter of 2021 and $7.14 billion in the quarter before.

The Hong Kong Monetary Authority, the city’s de facto central bank, intervened at least 14 times in the FX markets this year to defend the Hong Kong-US dollar peg, buying more than HK$100 billion ($12.7 billion). Hong Kong’s foreign reserves have declined by 6.4% from US $496.8 billion by the end of last year to $465 billion by the end of May.

Weakening Asian currencies

The South Korean won fell to a 13-year low against the US dollar on July 5, while the Philippine peso was at its lowest since 2005 the same day. The Thai baht has lost around 8% of its value against the US dollar this year, the Indian rupee around 6%, and the Indonesian rupiah around 5%.

The yen is down about 15% against the US dollar this year, as the Bank of Japan pledged to maintain an ultra-loose monetary policy. The Chinese yuan has also depreciated by about 5% against the dollar over the past half year.

Max Horgan, head of Asia-Pacific FX sales at State Street Global Markets, says large capital outflows from emerging markets in Asia due to rising US interest rates have been a key driver of weakening Asian EM currencies.

“This has been more apparent in the commodity importers of course, but also significant across the board,” he said.

Neumann says FX interventions are not “terribly effective” in reversing declining trends of local currencies, given there are bigger macroeconomic forces at play – such as balance of payments movements against local currencies and a strengthening US dollar. But they can slow down the depreciation of local currencies, or “smoothen their adjustments”, he said.

Some analysts predict that most Asian currencies will weaken further in the near term, as central banks in Asia have yet to catch up with the US Federal Reserve in raising interest rates. In a move to tackle surging inflation, the Fed on June 15 raised the federal funds rate by 75bp to a range of 1.5–1.75%, the most aggressive hike since 1994.

“The most worrisome case is the Indonesian rupiah since Bank Indonesia has not yet lifted rates and is clearly falling behind the curve,” says Alicia Garcia-Herrero, chief economist for Asia-Pacific at Natixis. BI kept its key interest rate unchanged at 3.5% in its last policy meeting in June.

“The Thai baht may also suffer further since the Bank of Thailand is also falling behind the curve,” the expert adds, noting that the BoT had kept interest rates at a record low of 0.5% in its June meeting.

Neumann says he believes most Asian currencies will come under pressure for the rest of the year with the US dollar remaining strong, “except maybe the RMB”. He predicts that the US dollar will weaken when China’s economy “gains more traction”.

But he says further interest rate hikes by Asian central banks would create “stabilising effects” on their currencies, thereby easing the need for them to intervene in the FX markets between the third and the fourth quarter.

Another Asian financial crisis?

Some analysts have warned that the broad weakening of Asian currencies could precipitate a financial crisis in the region, similar to the Asian financial crisis 25 years ago.

Veteran economist Jim O’Neill told Bloomberg that further depreciation of the yen to 150 per dollar may prompt China to devalue the yuan in order to protect its own economy, leading to financial turmoil.

“If the yen keeps weakening, China will see this as unfair competitive advantage so the parallels to the Asian financial crisis are perfectly obvious,” O’Neill was quoted as saying.

The Asian financial crisis began in Thailand in July 1997, when Bangkok was forced to float the baht after failing to defend its peg with the US dollar from massive speculative attacks.

The crisis quickly spread to other countries in Asia, including Malaysia, the Philippines, Indonesia and South Korea, leading to a series of currency devaluations. The events brought some countries in the region into deep recession and had wide economic repercussions on countries like Russia and Brazil.

“I think drawing parallels between the Asian financial crisis [and the current weakening of Asian currencies would be misleading,” says Neumann. “I don’t think there is a big risk.”

He says unlike the past, most Asian economies now have little hard currency debt, adding that their current account positions are “not unsustainable”. He said many Asian central banks have also built a large amount of foreign reserves to prepare for FX interventions since the Asian financial crisis.

Chen from BNP Paribas agrees: “The Asian financial crisis was a very different animal.” However, it is still too early to say whether the weakening of Asian currencies could snowball into something more serious, he adds. He believes many economies are heading towards recession as central banks around the world tighten monetary policy to fight inflation.

“When US interests rates reach 3.5%, a lot of countries will come under recessionary pressure,” he says.

Horgan, meanwhile, highlights recession risks for Korea. “Korean inflation in June rose 6% from a year before, which came in higher than even the forecast, and a 50bp rate hike seems likely at the next scheduled meeting on July 13, further increasing recessionary risks.”

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