Surging APAC forex reserves may portend currency frictions: Fitch Ratings

November 04, 2020: A rise in foreign-exchange reserves across Fitch-rated sovereigns in the Asia Pacific (APAC) over the last two quarters has bolstered external buffers and should support ratings. However, the trend also reveals a tendency among some national authorities to resist currency appreciation, and could revive international frictions over currency valuations, especially in economies that run persistent current-account surpluses, says Fitch Ratings.

Many investment-grade emerging markets (EMs) in APAC saw significant increases in foreign-exchange reserves over 2Q20-3Q20. In value terms, the largest was in China (A+/Stable), where they rose by USD100.9 billion (or 3.2%). However, a proportionally stronger growth of 10.9%, or USD24.6 billion, was recorded in Thailand (BBB+/Stable) which, like China, runs a current-account surplus.

Indonesia (BBB/Stable), the Philippines (BBB/Stable), and India (BBB-/Negative) also saw sizeable increases. In each of these markets, reserves rose by 12%-13% over the period, bolstering external buffers. The increase in Indonesia more than offset reserve losses associated with large capital outflows at the onset of the coronavirus pandemic shock in March.

According to the report by Fitch Ratings, the increase in foreign-exchange reserves, which was also evident in all East Asian developed markets, partly reflects intervention by the authorities to smooth currency volatility and build external buffers. However, it may also reflect efforts to prevent currency appreciation and preserve export competitiveness in economies such as China, Taiwan (AA-/Stable) and Vietnam (BB/Stable), where exports are playing an important role in supporting recoveries after the pandemic shock.

Determining what constitutes excessive levels of exchange-rate intervention is complex and forms part of the IMF’s regular assessments of exchange-rate valuation. The US Treasury also uses a set of criteria in its reports on foreign-exchange policies of major trading partners – consisting of indicators on current accounts, bilateral trade balances and foreign exchange intervention.

In its last report, issued in January 2020, Vietnam was on a monitoring list of potential “currency manipulators”. The report also noted that Taiwan and Thailand were close to triggering key thresholds. In addition, US policymakers have frequently raised concerns about China’s exchange rate policies, most recently designating it as a “currency manipulator” in August 2019.

Tensions over exchange-rate policies could escalate in 2021 if portfolio inflows into trade-surplus EMs were to accelerate as the coronavirus subsides and global market risk aversion declines. This could contribute to an even faster build-up of reserves if governments seek to offset the resulting upward pressure on local currencies. So far figures from the Institute of International Finance show that net capital inflows over 2020 as a whole have been negative for all major APAC EMs except for China and Korea - although inflows have recovered after sharp outflows in almost all markets over 1Q20.

In general, external finances, as per the report, remain a rating strength for many APAC sovereigns. However, external positions vary and some are in a weaker position relative to their rating peers. For example, Fitch’s liquidity ratio, which expresses the level of a country’s liquid external assets as a percentage of its liquid external liabilities, shows Indonesia, Mongolia (B/Stable), Sri Lanka (B-/Negative), Pakistan (B-/Stable) and Laos (CCC) all have ratios below the median for their rating categories. External liquidity factors remain an important consideration in Fitch rating assessments for markets like these.

The report highlighted that reserves in some of the lower-income emerging and frontier markets were reinforced over 2Q20-3Q20 by IMF assistance through its rapid financing or credit facilities to support efforts to counter the effects of the coronavirus pandemic. These included disbursements of USD732 million to Bangladesh (BB-/Stable), USD28.9 million to the Maldives (B/Negative), USD1.4 billion to Pakistan and USD99 million to Mongolia. Nonetheless, the Maldives, Mongolia and Sri Lanka reported declines in their foreign-exchange reserves over the period.

Fitch Ratings