Currency Imbalance: Redux

At the current juncture most of the SE Asian, East Asian and Latin American (Brazil primarily) are facing an acute problem of balancing inflation and currency appreciation effects on their economies. This problem is being further aggravated by the reluctance of China in appreciating its Yuan. Most of the countries in these regions were primarily exporters to the US or China (commodities) in the pre crisis era taking into advantage the lopsided currency imbalances during that period. Economies of these countries are well on the path to recovery on the back of economic stimulus packages implemented by the respective governments. South Korea had the fastest quarter on quarter growth in the 3rd quarter 2009 (due to strong domestic growth), Australia had a exports growth in the third quarter 2009 on the back of rising exports of raw materials, Singapore has also shown a pick up in GDP growth after contracting in the first half of 2009.

With the pickup in economic activity, most of the countries are now looking forward to tackling the twin issues of inflation and currency appreciation. With most of the growth seen due to the domestic growth which was facilitated due to the stimulus packages. As the economic activity rises, the increasing liquidity in these economies will lead to strong inflationary pressures. The governments may look at tackling these pressures by slowly removing the stimulus packages or raising interest rates. Few of the countries have already started increasing interest rates or are having more hawkish stance with regard to interest rates. Australia has increased the interest rates twice in last two months.

Increasing interest rates brings another major issue in front of the countries. The carry trade that is being seen currently. With the US forecasting a low interest rate regime for a long time period, most of the countries which are contemplating a rate increase have to contend with foreign money flows. Most of these countries are increasingly undertaking market operations to ensure that the currency appreciation relative to their competing export countries is not very high. Leading to a situation of accumulation of currency reserves. Appreciation of currencies in these economies is very important to reverse the trade imbalances seen in the 2003-08 period. But with the fear that increased currency appreciation, would only reduce their export competitiveness vis-a-vis other exporting countries thus limiting export growth, is leading to many countries artificially keeping their currencies low. The situation is being aggravated with the dollar peg of China, the biggest of the lot. Lack of interest from China on the appreciation of the Yuan will only precipitate the matter further.

This issue is one which can derail the little economic growth that is being seen. If the countries do not raise interest rates in the fear of increased inflows, then they might face a situation of asset bubbles returning back and causing more pain going forward on there bursting. In case they allow currency to appreciate, then the economic recovery might be short lived as their main engine of growth (exports) may not recover and domestic consumption may be able to sustain itself.Many countries have started thinking of using different means by which they are able to contain the inflow of money into their economy. Brazil has started a sort of Tobin tax on the inflows. Other countries may raise barriers to investment. Limiting the investment flow is an option which many end being counterproductive. It is pertinent to remember that the impact of the currency appreciation has not been felt as strongly by the commodity exporting countries on their exports yet.