In a dollar winter, the real chill could be from China for currencies
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It all started in August 2015 when the People’s Bank of China decided to devalue the yuan, triggering a rollercoaster ride for other emerging market currencies. Depending on how deeply their economies were entrenched into trade with Asia’s largest economy, the impact on their currencies has ranged from mild to merciless.
In 2016, the South Korea won fell 1.7%, the Malaysian ringgit tumbled 3.1% and the Vietnamese dong dropped 1.16%. These are the countries whose exports to China account for more than 10% of their gross domestic product.
In the meantime, the US Federal Reserve’s resolve to raise rates strengthened, the elections there threw up an unexpected President-elect in Donald Trump, the drooping commodity cycle turned and the dollar established its might. All these shocks aside, the hangover of China’s changing economic milieu and exchange rate policy continue to keep emerging market currencies ailing. Nearly half of the 24 emerging market exchange rates tracked by Bloomberg have depreciated more than 2% so far in 2016 and the yuan itself dropped steadily to its weakest since 2008.
Analysts are forecasting another difficult year for emerging market exchange rates and it is not only because of the dollar’s rise. It is also because of China’s inability to put its house in order as corporate defaults are on the rise, the credit cycle is near its end and much of the economic growth is fed by either credit or fiscal spending. Japanese brokerage Nomura Securities notes, “Potential triggers for a major economic setback include accelerated capital flight, snowballing corporate defaults, rising inflation or a large external shock perhaps emanating from President-elect Trump’s America first policies.”
The chances of the Chinese government going for serious reforms instead of pumping in more money to ensure growth are minimal. Therefore, faced with sagging exports, a flight of capital and a shrinking working population, China is most likely to continue with monetary and fiscal stimulus. The risk to the rest of Asia is whether these stimuli will prop up growth in the absence of serious supply-side reforms. Analysts are already sounding sceptical over China’s ability to arrest the slowdown and Nomura expects the growth rate to slow to 6.5% in 2017.
What could make things even more difficult for currencies is the tussle between the two behemoths—China and the US. Trump’s threat to name China as a currency manipulator could be a precursor to a clash via trade channels. As such, Asian economies are already off to a weak start and will be the biggest losers in Trump’s inward-looking trade policies.
For currencies outside of Asia, Trump is a major disturbing factor although local political events are likely to create more trouble for them.
Where does India stand in all this? Not entirely tall but the Indian rupee is not expected to be worse than what it was last year. The median of the forecasts for the rupee on Bloomberg predicts a 3% drop by end of 2017 and that is marginally more than the 2.6% it lost in 2016. As investors begin to get more bang for the buck and China wobbles, emerging market currencies are sure to catch a chill. In the rupee’s case, it might just be a minor cold.