Did Asian currencies perform more strongly than believed in 2022?
Conventional wisdom suggests that Asian currencies endured a difficult 2022, but that is not the whole story. There were significant differences between the region’s markets.
Currency performance in 2022 was dominated by US Federal Reserve (Fed) interest-rate tightening. This initially led to US dollar strength, followed by a weakening of the greenback in the latter stages of the year – as expectations about the pace of future interest rate increases eased, investors assumed a potentially lower peak would be needed to counteract inflation1. During 2022, Asian currency movements were less driven by market-specific factors and more by how the US dollar was performing, but despite this, there was still some variation between economies.
How Did Different Currencies Perform?
Despite the gloomy sentiment about currency weakness, performance was surprisingly resilient. In some cases – for instance, the Singapore dollar – it was even positive2.
Interestingly, despite a resurgent US dollar, the Chinese renminbi was only slightly weaker3. China used its reserves to maintain the value of its currency to prevent any dislocation – its size and economic power mean it could successfully manage this feat. For smaller markets, like Taiwan or Korea, this was not possible.
Asian central banks generally reacted to Fed tightening by increasing interest rates. They also used their reserves to smooth currency depreciation and avoid the more destructive and volatile movements that occur when foreign investors panic and rapidly withdraw their capital – a process known as capital flight.
The Japanese yen declined considerably in 20224. This was chiefly because the Bank of Japan opted not to raise interest rates to match the Fed. Instead, it persisted with a program of low long-term interest rates and continued with quantitative easing. At the end of the year, this position changed, with long-term interest rates allowed to move slightly higher.
Why Were Asian Currencies More Robust Than in the Past?
Several factors could, in part or combination, explain the relatively robust performance of Asian currencies. The region’s markets had largely moved away from fixed currency pegs to floating exchange rates – although the floating element is managed, to some degree, by central banks. This makes currencies less susceptible to speculators attempting to ‘break’ a currency peg. In 1997 currency pegs attracted speculative market participants who stood to make large profits if the links were broken. A case in point was Thailand’s currency peg to the US dollar that ruptured in July 1997, leading the Thai baht to devalue by 60% in the following four months5. Experiences like this have made Asian central bankers cautious and reluctant to permit destructive currency devaluations.
Foreign reserves and debt coverage ratios were also higher than in previous economic cycles. This offered more ammunition and a degree of protection for central banks as they attempted to manage orderly currency devaluations. Certain economies, like Indonesia, also benefited from exporting considerable amounts of higher-priced raw materials, such as coal, which provided valuable foreign income and reduced downward pressure on its currency, the rupiah.
Rises in the price of basic foodstuffs are often socially problematic, but central banks stood firm, raised local interest rates, and managed to avoid currency collapses. This principled behaviour is a sign of growing economic maturity, and that valuable lessons have been learned from past crises.
The Appeal of Local-Currency Bonds
US-dollar-denominated bonds are often more popular than local-currency issues because international investors believe they are removing local-currency risk. However, some local bonds may pose less risk because the issuing companies generate much of their income in their home currency. This means cash flows and interest payments are less likely to suffer a mismatch. Historically a mismatch between income and debt currencies has caused companies to struggle to avoid default6. The relative attractiveness of issuing bonds in local currency saw bond issuance in Asia rise strongly in the second half of 20227.
What is the Outlook for 2023?
While the actions of the Fed will continue to drive short-term market sentiment, the outlook for Asian fixed income looks more promising as we move into the second half of 2023. For instance, declining energy and food prices may reduce inflationary pressures, which will help curb further interest-rate rises. Most Asian markets are net energy importers, so price increases lead directly to cost-push inflation. Increasing interest rates does little to counteract this other than bolstering currency values.
Any decrease, or less of an increase, in interest rates would support economic growth as funding costs are reduced, boosting profits and encouraging investment. Likewise, if China navigates the removal of COVID restrictions with minimal financial and human costs, economic growth should pick up quite strongly with flow-on benefits for the wider region. 2022 has demonstrated that the risks historically associated with Asian currencies may no longer be as high as in previous economic cycles.
Inflation data will drive the actions of central banks. If there are signs that interest-rate hikes will ease, then the US dollar may continue to weaken, boosting Asian currency values. Investing in Asian fixed income provides access to the potential upside created by the continuing economic development and maturity of Asian economies.