The Finance Secretary of the Philippines has a message for Asian policy makers tempted to follow China's lead by devaluing their currencies: Don't do it. "We must be mindful of the trade-offs involved in using the exchange rate as a trade tool to boost competitiveness," Cesar Purisima said Sunday.
Chinese exchange-rate officials probably have a thing or two to say about trade-offs. Since its surprise devaluation on Aug. 11, Beijing has been struggling to keep the yuan from outright freefall. Yesterday, Shanghai stocks tumbled a further 8.5 percent. China perfectly encapsulates Purisima's point: The short term benefits of a weaker currency pale in comparison to the costs.
If Asian policy makers are feeling any lingering doubt, here are four further reasons they should resist the urge to devalue.
Rising debt-servicing costs. A key reason that China's devaluation has been a meager 3 percent is the Kaisa factor. In April, that Shenzhen group became the first Chinese developer to default on dollar-denominated debt. Since then, very few borrowers have missed bond payments (in part because Beijing forbade it). But if the yuan suddenly plunged, President Xi Jinping's government -- and global financial markets -- wouldn't be able to control the subsequent wave of defaults.
The same goes for neighboring economies like Indonesia and Malaysia that have gorged on overseas loans in recent years. As of July, companies in those countries, together with their governments, had sold more foreign-currency debt this year than they did in all of 2014. That's becoming a clear vulnerability with the ringgit and rupiah down 18 percent and 12 percent, respectively, this year.
One-way-bet risk. Vietnam and Kazakhstan have already tried to shore up their exports by devaluing, and analysts suspect Thailand will be next. But in a weak global economy, slashing currency rates amounts to pushing on a string. Asia's two biggest economies -- China and Japan -- are sputtering to the point that their consumers will be of little help to exporters elsewhere in the region. Europe is, at best, walking in place, or at worst destined for a renewed crisis. And while the U.S. economy is stable, a mix of stagnant wages and high household debt limits its ability to help revive Asia's exporters.
The bigger risk is that lower currencies will invite investors to test how far officials will let the slide continue, as seen during the 1997 Asian financial crisis. Capital outflows would be far riskier than a few quarters of weak export growth. That's especially true for Asia's weakest countries, where currency reserves may prove inadequate to withstand speculative attacks. At the moment, Indonesia’s reserves (about $107 billion) are only enough to cover seven months of imports; Malaysia's are enough for 7.5 months.
Torpedoed confidence. Asia has come a long way over the last 18 years in terms of preventing market panic. Financial systems are stronger, governments more transparent and so-called macro-prudential limits on capital flows can shield economies from market turmoil. But Asian policy makers should also embrace the benefits of a rising currency. A strong exchange rate attracts long-term capital flows, not just hot money from investors looking to make a quick buck. It also contains inflation, reduces government debt burdens, allows companies to borrow at lower rates and encourages entire economies to move upmarket, from sweatshops to startups.
The Philippines is an unlikely case in point. For years, Purisima and central bank governor Amando Tetangco have been under pressure from exporters to devalue the peso. Instead, the government concentrated on putting its fiscal house in order, which won investment-grade ratings from credit agencies and lowered the government's borrowing costs. That freed up money to invest in infrastructure, education and poverty reduction. One big reason to be optimistic about Asia's 12th biggest economy is that Purisima is still refusing to devalue.
Less urgency for reform. For all the progress made since the 1997 Asian financial crisis, Asia has yet to abandon its addiction to exports. That's an untenable position as two big threats -- China's slowdown and the prospect of Federal Reserve rate hikes -- hit the region simultaneously for the first time in 21 years. In 1994, the Alan Greenspan Fed began doubling short-term rates over a 12-month period. That triggered hundreds of billions of dollars of bond-market losses; it also set in motion a crisis that three years later would topple the economies of Indonesia, South Korea and Thailand. That was also the year when China last devalued, which increased pressure on neighboring economies to follow suit.
Today, Washington and Beijing are positioning themselves in similarly worrisome fashion. Fed Chair Janet Yellen wants to move U.S. borrowing costs a step or two away from zero, while Xi has been devaluing the yuan as part of a desperate bid to stabilize China's listing economy and plunging stock market. The rest of Asia would be in a far better position to ride out today's storm if they'd done something in the years since the last crisis to diversify their growth engines. Instead, they opted for the sugar high of weak currencies.
Asian policy makers need to understand that currency devaluations aren't a cure-all -- and if they pursue trade-offs, as Purisima warns, there's no avoiding their downsides.
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