Can ASEAN Currencies Hold Up as the Fed Raises Rates?

When the US Federal Reserve raises its benchmark interest rate, especially when it does so aggressively and when further increases are expected as is currently the case, the dollar gains value against world currencies. And countries with current account deficits or large debt loads will generally see their currencies fall faster.

Emerging market currencies often bear the brunt in this situation, as investors move out of riskier assets into things like US bonds to capture rising returns. But in this round of Fed tightening, something interesting is happening. Many currencies in Southeast Asia hold up quite well; they are depreciating, but not at such a panic-inducing pace as to trigger massive capital flight or cause a balance of payments crisis.

Interest rates in ASEAN countries have been rising in response to a strengthening dollar, but many central banks are moving in a measured manner and are not under the same intense pressure to defend their currencies as, say, the Bank. of England or the Bank of Japan. How can we make sense of this?

On the one hand, some currency depreciation, especially in emerging markets, is not all bad. A weak baht will help Thailand do more of what it really wants to do right now, which is export goods and services. As the baht weakens and the dollar strengthens, more people may decide that now is a good time to take a Phuket holiday. More people will buy products made in Thailand. That is what the politicians want.

The key, as in all things, is balance. Emerging market central banks do not necessarily want to stop their currencies from depreciating, but rather prevent them from weakening too much too quickly. That can cause panic and damage credibility, leading to bigger problems. Depreciation needs to be managed, and this is achieved primarily through interventions in capital markets and through the central bank’s policy rate.

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Emerging markets have plenty of hard-earned experience with capital flight, currency volatility and the capricious whims of global investors. They usually accumulate large foreign exchange reserves precisely to be able to support the currency in times of volatility like this. The central bank can also raise or lower interest rates. A higher rate will help boost the currency by attracting more capital inflows or reducing outflows. But raising rates can also dampen economic growth and increase borrowing costs.

Therefore, policymakers are presented with a difficult choice. If they do nothing and leave rates intact, their currencies will continue to lose value against the dollar and they will have to burn reserves to stabilize it. The lack of political credibility here can also accelerate capital outflows and debase the currency, which is bad.

On the other hand, raising rates can squeeze the economy and growth forecasts for 2023 for most of Southeast Asia have been quite good. You don’t want to hit the brakes unless you have to. Also, if you’re a heavily indebted government, business, or consumer, rising interest rates won’t be a welcome sight. Central banks in the region will need to carefully weigh these risks and try to balance them.

Malaysia and Indonesia have raised their rates by 75 basis points each. As of May, Malaysia policy rate it increased three times from 1.75 percent to 2.5 percent, while Bank Indonesia waited until August before raising the rate from 3.5 percent to 3.75 percent. In the past week moved to 4.25 percent. These are fairly modest gains given what the Fed is doing, and are anchored in strong current account positions thanks to booming commodity exports. However, as global demand for palm oil and coal cools, Malaysian and Indonesian central bankers may face tougher policy decisions next year if capital markets remain volatile.

Interest rate hikes are not the only tool at play here. Central banks will also tap into their foreign exchange reserves to curb the rate of depreciation. In Thailand, foreign exchange reserves it stood at $225 billion in December 2021. By August 2022, they had fallen to $195 billion, likely due to interventions in capital markets to prop up the baht. Meanwhile, the benchmark interest rate increased by a very modest 25 basis points, from 0.5 percent to 0.75 percent. The baht is down around 20 percent against the dollar from its 2021 highs. All of this is quite manageable.

Of the major emerging market economies in the region, the Philippines has had to be the most aggressive, increasing Reference rate from a low of 2 percent in May to 4.25 percent in September. This reflects the country’s comparatively weaker position, with less foreign exchange reserves than Thailand, rising public debt due to the pandemic, and a sizeable current account deficit. The peso has moved around 20 percent lower against the dollar since 2021, and this is likely to present an ongoing challenge for President Ferdinand Marcos Jr. in his first year in office.

All ASEAN currencies are feeling the pressure of a rising dollar. Not surprising, and we should expect continued volatility as well as more rate hikes in the coming months. However, most currencies have held up fairly well, as central bankers raise interest rates and tap into foreign reserves to check depreciation, hopefully without putting too much pressure on economic growth or driving borrowers into debt. insolvency. Crucially, they have so far maintained the overall credibility of the policy, which is key. Just take a look at England to look what’s up when a central bank or a government begins to lose credibility on this issue.

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