Corporate Finance : Foreign Exchange
High Oil Prices Tar Asian Currencies


The rising price of oil sent ripples through Asian currency markets in late summer, as Indonesia’s rupiah found itself at the epicenter of a tempest of speculation against the currencies of regional oil importers. Indonesia, Asia’s only member of the Organization of Petroleum Exporting Countries, has been a net importer of oil for the past 18 months.

The rupiah fell from about 9,000 to the dollar early this year to 11,900 on August 30, when the currency fell 8.7% from the previous day’s close in near-panic selling, before the Indonesian central bank tightened monetary policy and raised bank reserve requirements by four percentage points to defend the currency.

The central bank, which had been intervening directly in the currency market for months, spending billions of dollars of reserves in a failed effort to prop up the rupiah, raised its overnight funding rate by 125 basis points, to 10%. Meanwhile, the Indonesian government plans to cut its subsidy on fuel prices to relieve some pressure on the budget deficit.

“Most of Indonesia’s problems are home-grown, and we do not expect its woes to spread to the rest of the region,” says Anne Mills, director of currency research at Brown Brothers Harriman in New York. “But some of the problem—mostly the price of oil—is a negative for other Asian currencies, though to a much lesser degree,” she says.

Countries such as Indonesia, the Philippines and Thailand, which all have been experiencing strong economic growth this year, are suddenly seeing their trade surpluses shrink as a result of rising oil prices. “For now at least, the bloom is clearly off the regional rose,” Mills says.

Analysts say the Indonesian central bank was partly to blame for the attack on the rupiah, by falling behind the curve and allowing real, inflation-adjusted interest rates to fall to zero. Indonesia will need to continue implementing aggressive monetary policies to maintain market stability, they say.

 

“If the Indonesian government truly wants to defend its currency, it will announce changes to the tax code to simplify it and to cut taxes across the board,” says Dennis Gartman, editor and publisher of the Gartman Letter, a Suffolk, Virginia-based advisory service. If it is serious, the government will announce invitations for foreign oil companies to aggressively search in Indonesia for new oil supplies, he says. It will free the price of crude products and will adopt on balance free-market policies that the market can believe in, Gartman says. “Until then, raising rates will be a stop-gap measure,” he adds.

Japan, which imports all of its oil, is on a long-term trend toward a less-regulated economy, with lower taxes and lower government spending, says Jeffrey Young, head of currency research at Citigroup in New York.

“The dollar is in a long-term downtrend, and the yen will get stronger,” Young says. “Japanese domestic demand is fairly deeply rooted,” he notes. “The Bank of Japan’s monetary policy will become less anti-deflationary, but it will remain more accommodative than expected.”

 

 

Japan’s central bank prematurely raised interest rates in 1992 and again in 1994 and wants to be sure that the recovery has taken hold before it raises rates, Young says. Asian currencies in general will tend to rise against the dollar following the revaluation of the Chinese yuan, but only gradually, according to Young. Countries in the region will adopt a “you first” attitude on allowing their currencies to appreciate, he says, because these countries are worried about losing their competitiveness.

The rate increase by Indonesia may well be signaling that the US federal funds rate has reached a level high enough that it will progressively drain liquidity from emerging markets, according to analysts at HSBC.

Mexico, a major oil exporter, will feel the effects of higher energy prices on inflation, says Clyde Wardle, chief currency strategist for emerging markets at HSBC in New York. “Even though Mexico is a net oil exporter, domestic energy costs are still subject to global prices of electricity and natural gas,” he says.

 

 

The Mexican peso has been relatively strong this year, thanks to strong portfolio inflows, overseas remittances from Mexican workers in the US and higher domestic interest rates, Wardle says.

The Mexican central bank will need to be cautious in cutting rates, having fought hard to achieve credibility, according to Wardle. The peso could come under modest downward pressure for the rest of this year, as Mexican interest rates come down, portfolio investors take profits, and growth in the US economy moderates, he says.

Perhaps the most important factor for Mexico’s competitiveness in the long run will be structural reform, particularly of the labor market, Wardle says.

Meanwhile, Mexico’s private pension funds have made minimal use of their newly awarded opportunity to diversify their holdings out of the country, Wardle says. These funds are now allowed to place up to 20% of their assets overseas and up to 30% in foreign currencies, but most have done neither, he says. They likely will move about 5% of their assets, and possibly more, into foreign markets as Mexican interest rates come down, he says.

 

Currency Forecasts

 

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Gordon Platt

 

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