China will wait until the June/July period, before loosening the dollar peg in our view, pending greater clarity on the strength of the overall economic recovery. Additionally, when the CNY does strengthen, the move is likely to be gradual in manner, rather than a massive appreciation.  We expect a gain of less than 5 percent from the current level of 6.83 per US dollar (USD).

Nevertheless, we expect Asian currencies to rise irrespective of any renminbi hike against the USD, although a higher currency move by China would make the rest of Asia more tolerant of currency appreciation.  This is particularly so given rising intra-regional trade between China and the rest of Asia.  Therefore, regional GDP growth is likely to perform strongly, even if there are continued hiccups in the 2010 global economic recovery.

This means that Asian interest rates will continue to move higher, ahead of the US and the eurozone.  Although interest rates have moved up in places like India and Malaysia, equity valuations, although demanding (e.g. Indonesian market 2010 market PE of 17.2x) appear to have upsides in the light of continued short-term capital flows.  

In this note, we look at what the market consensus are telling us in terms of which Asian currencies would benefit most leading up to the loosening of the renminbi’s dollar peg (see table for details).  

Based on Bloomberg’s consensus, the forecast for the Korean won (KRW) is an appreciation of 5.3 percent to 1,050 from the current level of 1,108.  This is clearly the biggest beneficiary in the region amid the de-pegging of the renminbi to the USD, helped by strong trade ties with China.  In this light, in second place is the Taiwan dollar (TWD) which is expected to strengthen from 31.4 now to 30.5 by year-end, or up 2.7 percent from current levels, according to consensus forecast.  

In third and fourth spot respectively are the Singapore dollar (SGD) and Indian rupee (INR).  On the later, the Indian authorities are more tolerant of currency appreciation on the back of high productivity growth and inflation concerns; hence, the monetary policy tightening that is currently taking place with the central bank having increased interest rates twice already this year.  

Now onto the rupiah (IDR), it is interesting to note that in spite all of the foreign funds flow into the market via both stock and bond markets, the currency has not managed to break the 9,000 psychological barrier.  Perhaps this is because the rupiah is not closely correlated to the renminbi historically.  

Additionally, Bank Indonesia (BI) has expressed concerns that asset bubbles are developing, although this statement was later retracted.  However, in light of this issue, it is also possible that BI could intervene in the market in order to prevent the IDR from over strengthening.  In the past, the government has stated that if the IDR were to appreciate below the Rp 9,000 level that Indonesian exporters could suffer.  Moreover, the government is currently planning an average currency assumption of Rp 9,300/USD in the revised 2010 state budget (RAPBN-P).

Furthermore, Bloomberg consensus points to a 2010-end exchange rate to only Rp 8,950/USD, translating to minimal gains from current levels.  

However, note that the IDR has strengthened 5% since the beginning of the year, the second best performing currency behind the Malaysian ringgit, which is closely correlated to the renminbi.

There are three downside risks which could result in Asian currencies ending the year weaker than consensus forecasts in our view:  

1.  Central banks in the region could over tighten, causing lower than expected GDP growth rates.  Or at the other end of the spectrum, tightening may not be sufficiently aggressive to prevent overheating and asset bubbles from forming.

2.  Continued strong regional inflows could prompt the adoption of some forms of capital control.

3.  We cannot completely rule out the possibility that China could retain its US dollar peg throughout this year and into 2011.  In this event, other Asian currencies could still appreciate in the short-term, but trade frictions with the US are likely to escalate ahead of the end-2010 US elections.  This coupled with a possible Fed rate hike in 4Q10 on inflationary pressure could mean all Asian currencies, including the Indonesian rupiah, could weaken later in the year.

Source: Bloomber, Bahana

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