Capital Flight Drains Reserves as Rupee, Rupiah Fall: Currencies

Asian nations are depleting foreign reserves as they seek to bolster their currencies while investors pull billions of dollars from the region.

Of the 10 Asian central banks with the largest reserves, six have cut their holdings this year, led by a record 18 percent reduction by Indonesia, data compiled by Bloomberg show. Their reserves are rising at the slowest pace in data going back to 2000. Holdings in Asia probably contracted once price moves are taken into account, Citigroup Inc. estimates.

Asian nations are getting hit particularly hard from the rout in emerging markets, with the Bloomberg-JPMorgan Asia Dollar Index poised for the biggest annual drop since 2008. Standard & Poor’s warned last week that the flight of capital from Asia may trigger higher financing costs, especially for those nations with large deficits in their current accounts.

Countries in the region will “see a degree of reserves usage as they seek to stabilize their currencies during periods of heightened financial market volatility,” Sacha Tihanyi, a senior currency strategist at Scotiabank in Hong Kong, said by e-mail Aug. 22. “Indonesia and India are still highly likely to see further depletion in their reserves.”

Indonesia, India

Bank Indonesia reduced its foreign-exchange reserves to an almost three-year low of $92.7 billion in July, while Indian holdings fell 4 percent this year amid outflows from the region and as the two nations sold dollars to support their currencies, data compiled by Bloomberg show.

The Asian central banks with the biggest reserves increased their holdings by 2.4 percent to $6.5 trillion this year, the smallest increase since at least 2000. The People’s Bank of China, which has 31 percent of the $11.2 trillion held in global reserves, boosted its foreign-currency holdings by 5.6 percent.

The pullback threatens currencies that have received support from Asian central banks diversifying their foreign holdings beyond U.S. dollars, such as the euro, the local dollars of Canada and Australia, Swedish krona, Norwegian krone and South Korea’s won, according to ING Groep NV.

“We’re seeing to some extent the reverse of diversification, whereby Group of 10 currencies that previously benefited from central bank inflows are now, in a number of cases, seeing the opposite,” Callum Henderson, the global head of currencies research at Standard Chartered Plc in Singapore, said in an Aug. 22 interview.

Fed Concern

International investors are exiting Asian and other emerging markets on speculation that the U.S. Federal Reserve will dial back its monetary stimulus programs this year, reducing the amount of capital circulating in the global economy.

The Fed’s balance-sheet assets have grown to about $3.6 trillion, from less than $1 trillion in mid-2008 as it printed dollars to inject money into the financial system by purchasing U.S. Treasuries and mortgage bonds.

The Bloomberg-JPMorgan Asia Dollar Index, which tracks the region’s 10 most-traded currencies excluding the Japanese yen, has tumbled 3 percent this year. It touched a 14-month low of 114.11 on Aug. 22, down from as high as 119 in May.

India’s rupee fell 14 percent this year and touched a record-low 65.56 per dollar on Aug. 22, while Indonesia’s rupiah plunged 9.7 percent and reached 10,883 per dollar today, the weakest level in more than four years.

Aussie Losses

“As reserves contract and they’re selling dollars, there probably is going to be some inclination to sell currencies like Aussie as well to keep the portfolio weightings stable,” Todd Elmer, a Singapore-based strategist at Citigroup, the second-largest currency trader after Deutsche Bank AG, said in an Aug. 22 phone interview. “We’re contracting at a pace that we haven’t seen in quite some time.”

Australia’s dollar, or Aussie, is already suffering because of its domestic economy, weakening 10 percent this year according to Bloomberg Correlation-Weighted Indexes, the biggest decline among the 10 developed-market currencies tracked by the gauges. Canada’s currency slipped 1.7 percent.

Investors will continue to favor diversifying their foreign reserves into currencies other than U.S. dollars, according to Scott Mather, the head of global portfolio management at Pacific Investment Management Co. The Newport Beach, California-based firm manages the $262 billion Total Return Fund, the world’s largest bond fund.

‘Irreversible Trend’

Diversification is “probably an irreversible trend,” Mather said in an Aug. 23 phone interview. “It may slow down short-term but it’s unlikely to reverse.”

The euro grew to 23.7 percent of global central banks’ foreign holdings in the first quarter, from a low of about 17 percent in 2000, the International Monetary Fund said in June.

The Australian and Canadian dollars accounted for 1.6 percent each, according to the Washington-based fund, which identified them separately for the first time to recognize their increasing role as reserve assets. The U.S. dollar’s proportion of global reserves shrank to 62.2 percent this year from 71.5 percent in 2000, according to the IMF.

The euro has strengthened 6.5 percent, the Bloomberg indexes show. The greenback was the second-biggest gainer at 4.8 percent, followed by the krona, which advanced 4.7 percent.

A gauge of expected price swings in emerging-market currencies exceeded a global measure by the most since June 2012, according to JPMorgan volatility indexes.

Widening Spread

The spread between the two increased to as much as 1.07 percentage points last week, data compiled by Bloomberg show. The relationship was reversed as recently as earlier this month.

The “normalization” of global monetary policy may lead to “a sharp” outflow of capital from the Asia-Pacific region, triggering higher borrowing costs and exchange-rate volatility, S&P said last week in a report titled “For Asia-Pacific Sovereigns, Capital Outflows Are Likely To Be Disruptive But Not Destructive.”

“Most sovereigns are likely to see economic growth weighed down somewhat by modest-to-moderate increases in funding costs,” Kim Eng Tan, an S&P credit analyst, said in the report. “The strain is likely to be greater in economies that run sizable current-account deficits or have inflexible exchange rates.”

A total $7.6 billion flowed out of emerging-market equity exchange-traded products in the first seven months of this year, according to BlackRock Investment Institute, a unit of BlackRock Inc., the world’s largest investor.

Investment managers poured $155.6 billion into developed-market funds, with North America receiving $102.4 billion, or 65.8 percent, according to BlackRock. Japan attracted a record $28 billion, while European funds got $4.3 billion.

“The change in reserves that we’ve seen is part and parcel of the change in capital flows,” Khoon Goh, a strategist at Australia & New Zealand Banking Group Ltd. in Singapore, said in a phone interview on Aug. 22. “Asian central banks have been diversifying within the region and they have been buying into Europe as well, so all those things will see a reduction.”