We have become more bearish on several Asian currencies, as domestic growth and exports have disappointed. Against this background central banks in South Korea, Taiwan, Indonesia and Singapore are expected to be more tolerant of a weaker currency. FX intervention to weaken currencies is also a policy option. We expect the central banks of China and Taiwan to cut the policy rate later this year to stimulate the economy. The Monetary Authority of Singapore is also likely to shift the current modest appreciation of S$NEER to neutral in the next monetary policy decision in October. On the other hand, we expect the Bank of Thailand to slow the pace of depreciation in the baht given concerns related to the pace of the recent fall. We have left our moderately bearish forecasts for the Indian rupee and Chinese yuan unchanged.
BoK more tolerant towards weak KRW
The South Korean won (KRW) has declined faster than expected and has now fallen below our year-end target. We expect further KRW weakness going forward. This was triggered by several developments. The Middle Eastern Respiratory Syndrome (MERS) outbreak since May has dampened domestic consumption significantly. As a result the Bank of Korea (BoK) last month lowered this year’s economic growth forecast from 3.1% to 2.8%. The Finance Ministry has also announced some measures to recycle some of the country’s current account surplus. Given the uneven global recovery and strong KRW, exports have contracted yoy since the beginning of this year. Though the KRW real effective exchange rate (REER) has eased in recent months, it is still 2% stronger than at the end of last year. Hence, we judge that the central bank will be more tolerant of a weaker exchange rate, which will fuel speculators to use the KRW as a funding currency. However we do not expect the BoK to loosen monetary policy further as core inflation has remained steady in recent months. In addition there are encouraging signs of a recovery in consumer confidence and businesses’ optimism as the government has declared a de facto end to the outbreak of the MERS and announced a fiscal stimulus package last month (also see our South Korea Watch, Growth subMERSion, published in July).
More bearish on the TWD – rate cut not priced in
We have downgraded our Taiwan dollar (TWD) forecasts. A rate cut has become more likely later this year, which is hardly priced in by financial markets. Domestic growth in Taiwan has disappointed. Economic growth in the second quarter expanded 0.64% yoy, the slowest pace since Q2-2012. This was due to weak exports and tepid domestic demand. The outlook remains challenging as consumer confidence remains weak and export orders continue to contract. In addition, headline inflation has remained in negative territory for six months and core inflation is edging further away from the central bank’s 2% target. In addition, the TWD real effective exchange rate in June strengthened to the highest level since July 2008. As a result, we expect the central bank to be more tolerant of a weaker exchange to stimulate exports and inflate the economy. A combination of a policy rate cut and intervention to weaken the currency are likely policy tools. Indeed the central bank’s FX reserves in June have risen to the highest level since November 2014, implying that the central bank has been intervening in the currency market to weaken the TWD.
BoT to slow pace of THB depreciation
We are also more bearish on the Thai baht (THB) as the recent drought is likely to reduce economic growth by as much as 0.5pp, according to the central bank’s estimate. The 50bp rate cut earlier this year has also failed to stem the decline in consumer confidence, which is at the lowest level since May last year. In addition, exports have underperformed the government’s target and inflationary pressures remain muted. Hence a weaker exchange rate is necessary. Looking ahead, as inflation has remained below the central bank’s target of 1-4% for seven consecutive months, there is a case for a looser monetary policy. However given the Bank of Thailand’s concerns on the pace of depreciation in the Thai baht (THB), a rate cut is likely only if the outlook for economic growth and inflation does not improve in the coming months.
Weaker IDR- slow GDP and decline in FX reserves
The Indonesian rupiah (IDR) has reached our Q3 target of 13500 against the US dollar. We see further weakness in the IDR as domestic growth has continued to disappoint and the terms of trade have deteriorated. The government also now expects the budget deficit to widen to 2.2% of GDP, compared to an initial forecast of 1.9%. In addition, the current account deficit is also expected to widen in the second quarter. Furthermore, we judge that the central bank’s capacity to defend weakness in the IDR is less given that FX reserves have declined by 7% since February this year. Current FX reserves are at the lowest level since June of last year and cover about eight months of imports. Last but not least, foreign ownership of local government bonds has increased by more than 1pp to almost 40% in June. Hence the IDR is vulnerable to reversal of capital flows when monetary policy in the US tightens later this year.
MAS to shift S$NEER policy to neutral in October
We expect the Monetary Authority of Singapore (MAS) to shift its policy for a current modest appreciation of S$NEER to a neutral policy at its next meeting in October. This is because economic growth in the first half of this year has averaged 2.25% yoy, the slowest pace since 2009. In addition, core inflation has been lower than the MAS forecast of 0.5-1.5% for three consecutive months from April to June, while headline inflation has been negative for eight consecutive months now. In addition the impact of expected higher food price inflation could be offset by the recent decline in oil prices. Furthermore, wage inflation could rise more slowly as the resident unemployment rate rose by 0.3pp to 2.8% in the second quarter of this year. The strong exchange rate is also weighing on core inflation. Indeed, we expect the MAS to lower the upper bound of its economic growth and inflation forecast in October. We also do not rule out that the MAS may widen the width of the policy band if volatility in currency markets increases when the Fed tightens monetary policy later in September, which is not fully priced in by financial markets. However a shift of the level of policy band lower is not likely as a recession or deflation is not envisaged.
Indian rupee and Chinese yuan forecasts unchanged
We keep our moderately bearish forecasts for the Indian rupee (INR) and Chinese yuan (CNH) in place. The INR is expected to decline further as short term real yields have become less attractive as inflation remains sticky. The strong INR remains a headwind for exports, which have contracted for seven consecutive months. The Reserve Bank of India is also expected to lean against gains in the INR. We also expect the yuan to decline as the currency is expected to trade at the weaker end of the trading band when the latter is widened from +/-2% to +/-3% later this year. The strong currency has pressured corporate profits and export growth, while reducing inflationary pressures.