161004 fx watch a more resilient asian fx

FX Watch

Group Economics Macro & Financial Markets Research

04 October 2016

A more resilient Asian FX Roy Teo Senior FX Strategist Tel: +65 6597 8616 roy.teo@sg.abnamro.com

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Slow Fed rate hike path and …

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… a stabilisation of the Chinese yuan have supported Asian FX…

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… as well as improved export and inflation dynamics

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Inflows from Indonesia’s tax amnesty program supporting the IDR

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We have become less bearish on Korean won, Taiwan dollar, Indonesian rupiah and Indian rupee …,

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… but maintain our forecasts for the Chinese yuan, Thai baht and Singapore dollar

 Asian currencies have recovered, as exports and inflation dynamics improved Asian currencies have recovered against the US dollar in recent weeks, as both external and domestic factors have improved. The Fed has scaled down its rate hike projections in 2016 (from two hikes to one) and 2017 (from four hikes to two). In addition, economic data in China have shown some encouraging signs of recovery, while the stabilisation of the Chinese yuan has also supported Asian currencies. Export growth in bellwether economies such as Taiwan have also improved in recent months. In addition, real interest rates in South Korea, Taiwan, Indonesia and India have become more attractive, as inflation has declined at a faster pace than benchmark policy rates. As a result, the South Korean won (KRW), Taiwan dollar (TWD), Indonesian rupiah (IDR) and Indian rupee (INR) have benefited from carry trades. The Indian economy is expected to expand at a faster pace in the third quarter, after a slower pace of growth (around 7% yoy) in the second quarter. Market concerns that the Reserve Bank of India’s monetary stance will change materially under the leadership of new governor Patel have also receded.

Inflows from Indonesia’s tax amnesty program supporting the IDR A more favourable inflation outlook and a narrower current account deficit have supported sentiment in the IDR. Bank Indonesia has cut monetary policy rates, next to changing its monetary policy framework, and is expected to do more to stimulate the economy.

However, the strength in the IDR has exceeded our expectations. The tax amnesty program has reaped USD 271bn (as of 30 September) in previously unreported assets or nearly 90% of the government target, expanding the tax base for future reforms. In addition, more than USD 10bn of assets have been repatriated, about 25% of Bank Indonesia’s forecast of USD 42.5bn under the tax amnesty program which commenced in July and is due to end 31 March 2017. Penalties paid under the tax amnesty have also reached 97 trillion IDR, almost 60% of the government’s target for the program.

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FX Watch - A more resilient Asian FX - 04 October 2016

Less bearish on KRW, TWD, IDR and INR As a result of the factors mentioned above, we have revised our forecasts for a number of Asian currencies, even though an expected Fed rate hike in December 2016 may lead to some weakness ahead. Compared to our current forecasts, we have become less bearish on the KRW, TWD, IDR and INR. Our new 2016 year end forecasts are: USD/TWD (lowered from 32.80 to 31.80); USD/KRW (lowered from 1,165 to 1,120); USD/IDR (lowered from 13,400 to 13,100) and USD/INR (lowered from 69 to 67).

We maintain our forecasts for the CNY, THB, and SGD We maintain our bearish view on the Singapore dollar (SGD), as financial markets have not priced in that the MAS is likely to ease monetary policy in October. For more details, please refer to our FX Watch – Will the MAS ease policy in October? The Thai baht (THB) is still likely to weaken moderately later this year. Economic growth is projected to slow in the coming months, as softer earnings from the manufacturing sector and fragile private confidence weigh on private consumption. Last but not least, our view that the Chinese yuan (CNY) will depreciate gradually has not changed, as outward direct investments increase at a faster pace than foreign direct investments. Sentiment in the yuan is likely to remain soft, given lingering concerns on the deleveraging and restructuring progress, despite recent signs of an improving macroeconomic momentum. However, we still do not expect China policy makers to tolerate a sharp deterioration of the CNY versus the USD, as that would turn out to be counterproductive as it might trigger a surge in capital outflows.

ODI has exceeded FDI by USD 44bn from Jan to Aug USDbn

12 8 4 0 -4 -8 -12 -16 -20 -24 Jan-11

Pace of depreciation in CNY TWI has slowed Index level

107 105 103 101 99 97

95 Jan-12

Jan-13

Jan-14

Jan-15

Jan-16

93 Dec-14

Jun-15

Net FDI - ODI USDbn Source: NBS China

Dec-15

Jun-16

CNY Index Source: CFETS, ABN AMRO

Can Asian currencies build on their recent strength? Headwinds remain…

We have previously communicated that Asian currencies face headwinds from a weaker Chinese yuan, a slower Chinese economy and tighter monetary policies in the US. These risks remain. We also expect central banks in Asia to lean against further strength in their domestic currencies. While the export outlook seems to have improved in Taiwan, the strength in the KRW and TWD (both are at the strongest level against currencies of main trading partners in the past year) is complicating the central banks’ aim to inflate the economy and could hurt exporters’ earnings. Corporate restructuring and the recent enforcement of the anti-corruption law in South Korea could also dampen economic activity, as consumer and business spending decline in the coming months. On the other

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FX Watch - A more resilient Asian FX - 04 October 2016

hand, we expect central banks in India and Indonesia to keep their currencies relatively stable as exports remain fragile, while a sharp depreciation in the currency could push up tradable inflation. In India, the redemption of USD 27bn of foreign currency non-resident deposits between September and December 2016 and concerns on bad loans in the banking sector are also likely to limit upside in the INR. Last but not least, Bank Indonesia is unlikely to tolerate strong gains in the IDR which may reverse the improvement in the current account balance. Growing levels of bad debt is also likely to impede bank loan growth in Indonesia.

Strong KRW weighing on inflationary pressures %

RBI is unlikely to tolerate a strong INR

Reverse scale %

6

-40

5

-30

USDm

Index level

15000

115

10000

110

5000

105

0

100

-20

4

-10

3

0

2

10

1

20

0 Jan-08

30

Jan-10

Jan-12

Core CPI YoY % (lhs)

Jan-14

Jan-16

KRW NEER YoY% (rhs)

Source: Korea National Statistical Office, BIS

-5000 -10000 Jan-10 Jul-11 Jan-13 Jul-14 RBI net purchase of USD USDm (lhs)

95 90

Jan-16 INR REER (rhs)

Source: RBI, BIS

... but there are also some bright spots Nevertheless there are some bright spots. Since the Fed tapering tantrum in 2013, the US dollar has outperformed Asian currencies. However, Asian currencies have been resilient this year, as it has become clear that the Fed will continue to hike rates at a gradual pace this year and next year. Monetary policy easing measures from the European Central Bank and the Bank of Japan have had less impact on the euro and yen. This has contributed to the positive sentiment towards Asian currencies, especially the KRW and TWD given that exporters from these countries are competitors. Investors have also shifted their focus to domestic data (which have improved), as the Chinese yuan remained stable in recent months. Hence, an improvement in the domestic growth and inflation outlook should support sentiment towards Asian currencies, notwithstanding a gradual depreciation in the yuan and a structural gradual slowdown of the Chinese economy. Indeed, our correlation analysis shows that the direction in the KRW and TWD can deviate from the CNY when the volatility in the CNY is low or declining.

There are also some encouraging signs that volatility in the CNY is declining due to better policy communication from China policy makers and investors coming to terms that economic growth will slow gradually over time. Finally, an improvement in commodity prices is likely to support sentiment towards Asian currencies. In short, yes there are some encouraging signs. We expect a recovery in Asian currencies (with the exception of the Chinese yuan) in the second half of 2017 as economic growth in several Asian economies gathers momentum and inflation dynamics improve.

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FX Watch - A more resilient Asian FX - 04 October 2016

Correlation between KRW and CNY; realized volatility Correlation

1 week USD/CNY realized volatility

1.0 0.5

Volatility in USD/CNY has declined 1 week USD/CNY realized volatility

10

10

8

8

6

6

4

4

0.0

-0.5

2

-1.0 Jan-15

0

Jul-15

Jan-16

Correlation KRW vs CNY (lhs)

Jul-16

2

0 Jan-15

Jul-15 Jan-16 1wk USD/CNY realized vol

CNY 1wk vol (rhs)

Source: Bloomberg

Jul-16

Source: Bloomberg

ABN AMRO Asian currency forecasts

USD/CNY (onshore) USD/CNH (offshore) USD/INR USD/KRW USD/SGD USD/THB USD/TWD USD/IDR

03-Oct 6.67 6.68 66.6 1,101 1.37 34.63 31.34 12,985

Q4 2016 6.80 6.83 67.0 1,120 1.40 35.00 31.80 13,100

Q1 2017 6.85 6.88 67.5 1,130 1.42 35.50 32.00 13,100

Q2 2017 6.90 6.93 68.0 1,150 1.42 35.50 32.50 13,300

Q3 2017 6.95 6.95 67.5 1,140 1.40 35.00 32.00 13,200

Q4 2017 7.00 7.00 67.0 1,120 1.38 34.50 31.80 13,000

Source: ABN AMRO Group Economics

Find out more about Group Economics at: https://insights.abnamro.nl/en/

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