Currency wars and rate hikes: another year in emerging FX

CHEAP money and attractive returns have seen investors plough their money into emerging market currencies. Yet hot money inflows have forced currency appreciation despite authorities’ best efforts at capital controls and other methods of weakening their exchange rates.

Thanks to highly accommodative monetary policy in the West and efforts to remain competitive among the emerging markets, currency wars have been, and will remain, on the agenda.

China’s attitude to yuan revaluation and internationalisation will be central to how emerging market currencies move next year. Many countries are feeling the pressure to keep their currency cheap in order that their exports remain competitive relative to China.

Given that emerging markets are struggling with inflationary pressures and appreciating currencies, it will be difficult for authorities to bring both under control. After all, the standard response to higher inflation is to hike rates, but this will only serve to encourage hot money inflows, especially in a strong growth environment.

This week, we take a look at the Bric currencies as well the South Korean won, which has been in the news as a result of geopolitical pressures.



David Hauner, emerging Europe strategist at Bank of America-Merrill Lynch, makes the Russian rouble one of his strongest conviction calls for 2011, provided that oil prices remain well supported. “The rouble has lagged commodities and equities since September due to large redemption flows and confusion about the CBR [Russian central bank] intervention policy. We expect the rouble to catch up materially when the redemptions are out of the way.”

He also points out that the rouble has held up well throughout the Eurozone sovereign debt crisis, thanks to the country’s balance sheet strength.

Higher oil prices and the likelihood that monetary policy will soon be tightened will support the value of the rouble.



Heated exchanges and escalating tensions were not able to prevent the South Korean won from making gains against the US dollar in 2010. Over the past six months, the won also delivered the best performance among Asia’s 10 most-traded currencies excluding the yen. But the won has weakened slightly in the last month, perhaps partly in response to increased geopolitical risk on the Korean peninsula. Traders see this only as a short-term risk, with RBC Capital Markets’ analysts continuing “to see significant downside to dollar-won when tension with the north has eased”.

A bank levy on banks’ non-deposit FX debt, announced on Sunday, is expected to weigh on the won against the dollar in early 2011, says Standard Chartered. But it sees scope for a rally later in the year.



The Chinese authorities will approach FX policy in 2011 in the same way they have always done: slowly, steadily and with a strong dislike of external interference.

It was a momentous step in June when China announced that it would start to let the yuan revalue and six months on, the dollar-yuan is trading at 6.67 yuan, a rise of 2.47 per cent since depegging.

Yet a government think-tank urged China to widen the yuan's trading band against a basket of currencies in 2011.

With concerns over asset bubbles forming, Beijing has already hiked borrowing rates and reserve rate requirements. Standard Chartered economist Jin Yang says: “We think that the yuan will appreciate by as much as 6 percent next year – so faster than this year.”



The Indian rupee has strengthened some 2.3 per cent against the US dollar over the course of 2010. The expectation among analysts is for the rupee to remain within a trading band, never falling below 47.20 to the greenback and never strengthening beyond 43 rupees – a level predicted for March 2011.

But although the expectation is for a stronger rupee, India’s lower exposure to the global economy and relatively weak public finances suggest it may underperform other
regional currencies, says Nick Chamie at RBC Capital Markets.

With the governor of the Reserve Bank of India Duvvuri Subbarao stating that inflation is still above his tolerance level, analysts predict that benchmark rates will rise to 7 per cent by end-2011. This should encourage flows into the rupee.



The real is still described by Goldman Sachs as the most overvalued currency in the world, in spite of capital controls imposed earlier this year.

Overseas investors have flooded into Brazilian equities and debt, driving up the real by 36 per cent against the dollar since the start of 2009. Rates of 10.75 per cent and strong growth prospects have made Brazilian assets very attractive.

Many economists see the central bank hiking rates – the consensus predicts rates to rise to 12.25 per cent by the end of 2011. In the near-term, the real is not in favour – Brazilian finance minister Guido Mantega has stated that the government is “ready to take new steps” to contain real gain and that the currency war will continue due to the European debt crisis. BNP Paribas’ end-2011 forecast is 1.63 real to the dollar.