“There is no smoke without fire” is often a good rule of thumb, but there is a strong case for arguing that contagion fears, as they apply to Asia, have been grossly exaggerated. If so, Asian currencies appear oversold.

Fig 11. Spreading Emerging Market contagion fears drag Asian currencies down


The dynamics behind recent currency movements are revealing.

Turkey’s large current account deficit and the level of the external debt (particularly in US dollars), for example, have both been frequently cited as reasons for the Lira’s collapse. But if these were the only two reasons, that currency would have/should have fallen several years ago.

Clearly other factors are in play; one critical factor is confidence.

Once confidence in Turkey was shaken by rising tensions with the US, there was little fundamental support for the currency. The failure of the Central Bank to act in an orthodox manner exacerbated the fall.

Similar fundamental challenges exist for Argentina (where the trigger for the currency’s fall apparently was the need to seek IMF aid) and South Africa (the dual triggers apparently being rising consequences of the government’s land reforms and a slide into recession).

All three instances, arguably, were falls looking for a trigger.

But does this same logic stack up for Asia’s currencies?

The External Balance Argument

The external trade and services balances provide major long-term support for any currency. On this basis, both Turkey and Argentina do extremely poorly as illustrated in Figure 2 below.

Fig 22. Large external deficits undermine some Emerging Markets’ currencies


But, it is clear a large external deficit, alone, is insufficient to entirely explain the falls. If it were so, the US dollar should have sold off by now given the widening US deficit.

South Africa, India, Indonesia and the Philippines, for example, have approximately similar sized deficits (with that for the Philippines forecast to deteriorate into 2019). Yet their currencies have fallen at dissimilar rates; South Africa’s Rand has fallen around 18% since the start of the Lira’s collapse in September 2017, India’s Rupee and Indonesia’s Rupiah have fallen 12% and 13% respectively while the Philippines’ Peso has fallen only 5%.

Given the deficits are all a relatively similar size, one would have expected any falls to be also similar if external deficits were the only player.

This is where a country’s external debt comes into focus.

The Foreign Debt Argument

The Emerging Markets, so the prevailing argument goes, have gorged themselves with ever-increasing levels of US dollar debt in recent years thanks to low US interest rates, courtesy of the US Federal Reserve’s quantitative easing program.

The flip side to this argument is, of course, that once the Fed reverses policy, which it has done, rising US interest rates will become an ever-increasing burden for the US debt holder.

A “double whammy” can arise. If the debt holder’s local currency falls against the US dollar, the pain of servicing US dollar debt intensifies as both US rates and the cost of buying US dollars, rise.

The above situation has undoubtedly occurred, in some instances. But, as with the external deficit argument, a part-picture is being presented as the whole. Figure 3 illustrates the point.

Fig 33. Asia’s corporate debt is mostly funded in local currencies


Only 34% of Turkey’s total debt is funded in local currency. US dollar debt accounts for 48% of total debt. Having one of the world’s largest external deficits, from where was Turkey to find the foreign exchange to service its foreign debt – apart from borrowing even more? A currency collapse waiting for a trigger? No surprise there!

But there is more to the story.

Within Asia, US dollar debt exposures are the highest for Indonesia at 35%, followed by Philippines, Malaysia and India at 19%, 18% and 15% respectively. This is where the powerful impact of an external surplus becomes apparent.

Malaysia is the only one to be recording an external surplus (Figure 2), and this surplus has been reflected in the Ringgit’s stronger performance. Since the Lira started its collapse, the Ringgit has risen some 3% (although it too, is not immune from the contagion web falling most of this year).

Of the remaining three, Indonesia’s dollar debt stands out. Still, it would be unfair to bracket Indonesia with Turkey and Argentina. The latter two have much more serious vulnerabilities; having to battle double digit inflation rates, high current account deficits and service large amounts of US dollar debt.

The concern is on Indonesia’s short term external debt (USD 57bn) which at 16% of the total external debt is not low. But the good thing is that the rollover risk is low. Excluding government, bank and foreign affiliated non-bank corporate debt, the short-term debt is about USD 16bn, of which 11bn is trade credit. All of which seems to be manageable.

This is where, we argue, the ability to service one’s debt comes into play.

The Debt Servicing Ability Argument

It is much easier to live with debt if one has the reserves to service it. Our spotlight is focused on this in Figure 4.

Fig 44. Foreign Reserves and the Ability to Service Debt


The big take-away from Figure 4, is the inability of both Turkey and Argentina to service their external debts from their foreign currency reserves. Seen in this light, it becomes clear that their currencies would have come under pressure at some point.

But this picture does not apply to Asia generally. Malaysia is on the borderline, but is, as already highlighted, “protected” by its current account surplus.

It also becomes apparent why the Philippine Peso has performed relatively better despite the current account deficit and external debt; it has the foreign reserves to service its foreign debt.

The extent of the fall in India’s Rupee is called into question. The Indian Rupee has sold off by more than the Indonesian Rupiah year-to-date. Most macro specialists would agree that India has good macro fundamentals and ample reserves to service its debt.

Which leaves Indonesia. As mentioned earlier, Indonesia is much better positioned, which is not reflected in this year’s Rupiah performance.

Indonesia has been hiking to stave off currency depreciation, not to tame inflation as is the case for both Turkey and Argentina.

The difference between Indonesia and Turkey and Argentina is that, since the taper tantrum, the government has embarked on much needed structural reforms. Inflation is much lower than it has been in the past.

In contrast, Turkey and Argentina are being penalised for not doing the right thing.

Overall, it is difficult to shake the feeling that Indonesia’s “sin” is its current account deficit; that, apparently, is why it is being punished in Asia.

Where to Now

The US dollar’s strength should pass, if forecasts for the US “Twin Deficits” are any guide (Figure 5).

Fig 55. The deteriorating US “Twin Deficits” suggest US dollar strength is temporary


In the current environment, with both trade war and higher oil price fears circulating, the uncertainties are unlikely to abate soon. Contagion fears will likely circulate for some time yet, particularly as investors await the outcome of the US November elections and scrutinize the data for signs of the impact of the Fed’s quantitative tightening swinging fully into action.

Asian currencies will unlikely distance themselves from these fears.

But equally, it seems that Asian currencies have more than adequately discounted these fears.

One will need to be positioned for the bounce-back when it arrives.

  • ASIA