The race to lower interest rates and possibly weaken currencies to boost growth and exports raises the risk of currency wars. Also known as competitive devaluation, currency wars disrupt the orderly functioning of the foreign exchange market, giving rise to unpredictable movements.
Greater currency volatility increases hedging costs for exporters and importers, and obstruct the flow of trade, currently on a downtrend. Growth, and thus demand for goods and services, will be affected; prices fall as supply exceeds demand, impacting businesses and wages.
A deflationary spiral occurs as consumers defer spending which results in even less demand. Actions to ease the cost of borrowing and pump more money into the system tend to lower the value of currencies.
“But waging a currency war comes at a big cost, ’’ said Socio Economic Research Center executive director Lee Heng Guie.
Competitive devaluation occurs when one country matches the fall in the currency of another, with a similar move down.The problem is rate cuts may not be effective, as some advanced countries already have very low rates or consumers and businesses, especially those laden with debt, fail to be lured by cheap money.
Increasingly, the focus of rate cuts could be on reducing the value of currencies that will make exports more attractive and imports expensive, and in the process, prop up prices of domestically produced goods, according to AmBank Group chief economist Anthony Dass.
There are limits to any attempts at competitive devaluation. With yuan weakness at above 7.0 to the dollar, and the macro picture in China continuing to deteriorate, there are expectations for further weakening although not in a disruptive manner.
“It’s a natural thing for a currency to weaken in the face of weaker exports. The International Monetary Fund says the yuan is fairly valued; it is the dollar that is overvalued, ’’ said Inter-Pacific Securities head of research Pong Teng Siew.
Possible scenarios for the yuan, said AmBank Research, include a 10% depreciation to offset the impact of a 10% US tariff on the remaining US$300bil of Chinese imports (this has just been raised to 15%); range bound movement that may see it hit a low of 7.10 to the dollar, and a trade deal that will see it appreciate gradually to around 6.99 to the dollar.In allowing the yuan to weaken, China faces the risks of capital flight and high external borrowing; according to Bank of International Settlement, China’s international borrowings had hit US$22.5 trillion at end 2018.
China is now more dependent on foreign capital; its current account surplus has “disappeared” while net foreign direct investment inflows have “zerorised” due to earlier domestic outflows via tourism, direct investment abroad and overseas mergers and acquisitions. Besides the rise of China’s weights in global equity and bond indices, the yuan’s inclusion into the International Monetary Fund’s special drawing rights currencies has prompted central banks to hold yuan and yuan-denominated assets in their external reserves.
“China has to make its currency more stable if it wants the yuan to be more prominent in global reserves, trade and finance, ’’ said Maybank Investment Bank group chief economist Suhaimi Ilias. The higher yielding dollar, despite complaints of its strength, is expected to stay positive as liquidity tightens following the rebuilding of the general cash account (GCA) of the US Treasury.
With the suspension of the US debt ceiling until July 2021, that allows the US to borrow to pay its bills, the US Treasury will borrow US$280bil to US$350bil for the rest of 2019, to rebuild the GCA to normal levels.
This action that removes liquidity from the banking system, will lead to a strong dollar
Any attempt to weaken the dollar also risks a response from China to prevent the appreciation of the yuan.
History shows that forex market intervention to weaken the dollar had required co-ordination among economies, as in the case of the Plaza Accord which allowed the dollar to weaken, and the yen to strengthen.We don’t see the US and China co-operating in this way, said Suhaimi.
Businesses gird themselves to mitigate currency volatility.
“War creates uncertainty, ’’ said Top Glove Corp Bhd executive chairman Tan Sri Lim Wee Chai. Top Glove will focus on internal factors which are within its control by levelling up its quality, efficiency, innovation and automation.
“The only certainty is uncertainty, ’’ said Muhibbah Engineering Co Ltd group chief financial officer Shirleen Lee.
Using a natural hedge helps, for example, to reduce the currency risk of repatriating sales revenue from a particular country, if expenses are also incurred in the same currency.
Increasing uncertainty only makes their jobs even harder.
Columnist Yap Leng Kuen sees companies intensely monitoring currency fluctuations.