ECONOMETER

Asian currencies appear to have lost some of their upward momentum over recent days.  Although the outlook remains positive further out, they are likely to struggle to make further gains over coming weeks.  One the one hand strong inflows into Asian equity markets have given support to currencies but on the other hand, data releases reveal only a gradual economic recovery is taking place, with continued pressure on the trade front as seen in the weakness in recent export data in the region.  Even China has been cautious about the prospects of recovery in the country.   

Almost all currencies in Asia have recouped their losses against the US dollar so far this year, with the Indonesian rupiah the star performer, having strengthened by over 11% since the start of the year.  More recently the Indian rupee has taken up the mantle of best performer, strengthening sharply following the positive outcome of recent elections.  The rupee has strengthened by around 3.5% since the beginning of the year and its appreciation has accelerated post elections.   

Much of the gain in the rupee can be attributable to the $4.4 billion of inflows into local equity markets over the last few months, a far superior performance to last year when India registered persistent outflows. Notably in this respect, the Philippines peso is set to struggle as foreign flows into local equities lag far behind other countries in the region.  Inflows into Phililipines stocks have been just $226 million year-to-date as fiscal concerns weigh on foreign investor sentiment.   

South Korea has been the clear winner in terms of equity capital inflows in 2009, with over $6 billion of foreign money entering into the Korean stock market.  Elsewhere, Taiwan has benefited from the prospects of growing investment flows from China and in turn equity market inflows have risen to around $4.3 billion supported by news such as the recent report  that Taiwan will allow mainland Chinese investors to invest in 100 industries.  Equity inflows into these currencies are far stronger than over the same period in 2008, highlighting the massive shift in sentiment towards Asia and emerging markets in general.

Unsurprisingly stock markets in Asia have been highly correlated with regional currencies over recent months, with almost all currencies in Asia registering a strong directional relationship with their respective equity markets.  Recent strong gains in equities have boosted currencies but this relationship reveals the vulnerability of currencies in the region to any set back in equities, which I believe could come from a reassessment of the market’s bullish expectations for Asian recovery.  

Central banks in the region have been acting to prevent a further rapid strengthening in Asian currencies by intervening in FX markets but a turn in equity markets and/or risk appetite could do the job for them and result in a quick shift in sentiment away from regional currencies. The Indonesian rupiah remains one to watch in terms of further upside potential, supported by the Asian Development Bank’s $1bn loan to Indonesia.   The outlook for the Indian rupee also looks favourable as post election euphoria continues.  Nonetheless, the gains in these and other Asian currencies have been significant and rapid and I believe there is scope for a pull back or at least consolidation in the weeks ahead.