World Bank, IMF at odds over hot money flows

Tensions over foreign exchange rates rising ahead of G7, IMF meetings; Japan PM warns against excessive yen moves

Tokyo/Washington: Emerging economies should consider steps to contain fund flows that could cause currency rallies and asset bubbles, the World Bank chief was quoted as saying, but the International Monetary Fund (IMF) called such actions “undesirable.”


The contrasting views over capital controls come amid rising tension between emerging and developed economies over exchange rates, which is expected to be a hot topic at Group of Seven (G-7) and IMF meeting starting on Friday.

Western leaders are worried efforts by emerging economies to weaken their currencies could derail the fragile economic recovery. Officials from developing markets say ultra-low interest rates in rich countries are fuelling massive fund flows into their markets, pushing up their currencies and inflating prices of stocks, property and other assets.

World Bank President Robert Zoellick said emerging nations should consider various measures to control short-term capital flows, according to the Nikkei newspaper.

But IMF deputy managing director, Naoyuki Shinohara, said it was natural and welcome for money to shift into economies with strong growth and policymakers should not try to curb such flows or use intervention to defend specific currency targets.

“When there are occasionally volatile moves in the market, intervention cannot be ruled out,” he told Reuters in an interview in Washington on Wednesday.


“But it’s totally undesirable for a country to intervene consistently to keep currencies at a certain level.”

SLAP ON THE WRIST

Shinohara, who was Japan’s currency tsar before assuming the IMF post, warned Tokyo faced a losing battle trying to go against the tide and weaken the yen as monetary conditions in the United States and Europe are expected to remain easy.

“This is not something that Japan can control. If Japan tries to adjust this, it will distort markets,” Shinohara said, adding that Tokyo should instead focus on structural reforms and monetary easing to beat deflation.
Zoellick, however, was careful not to judge Japan and other nations which have stepped into markets to weaken their currencies.

Japan sold the yen in the currency market for the first time in six years last month, The currency drifted back up, hitting a 15-year high against the dollar on Wednesday.

Prime Minister Naoto Kan reiterated that sharp currency moves cannot be ignored and the government would act decisively as needed.

Signs of a “currency war” are growing as major industrial nations want to keep their exchange rates weak to help their struggling exporters while emerging economies such as Brazil and South Korea are taking or planning steps to curb capital inflows.

Using exchange rates as a policy weapon to undercut other economies and boost a country’s own exporters “would represent a very serious risk to the global recovery,” IMF managing director Dominique Strauss-Kahn was quoted as saying in Wednesday’s edition of the Financial Times.

Instead, nations with large trade surpluses should let their currencies rise to prevent a devastating round of competitive devaluation, US Treasury Secretary Timothy Geithner said on Wednesday.

China, accused by the West of keeping its yuan artificially weak to support its exports juggernaut and the prime target of such advice, has repeatedly rebuffed such calls. On Wednesday, Premier Wen Jiabao told the European Union to stop piling pressure on Beijing to revalue the yuan, saying a rapid exchange rate shift could unleash social turmoil in China that would prove disastrous for the world economy.

 

IMF warns against currency war, dollar heads lower

Using foreign exchange as policy weapon could wreck recovery, says IMF chief; G-7 to discuss currencies,experts see little sign of accord

London: The head of the IMF warned that a growing drive by nations to cap the strength of their currencies risked derailing economic recovery while the dollar dropped further on Wednesday.

Concerns that the US Federal Reserve is about to embark on another round of policy easing that could weaken the dollar, tallied with China’s polite refusal to let its yuan rise fast, has pushed currencies to the top of the agenda at Friday’s meeting of finance chiefs from the Group of Seven nations.

Few hold out much hope of any meaningful agreement at the G7 or the International Monetary Fund (IMF) meeting that follows.

“It’s doing nothing for the American economy, but it’s causing chaos over the rest of the world. It’s a very strange policy that they are pursuing,” Nobel economics laureate Joseph Stiglitz said of US policy.

The dollar extended its losses on Wednesday, falling to an 8-1/2 month low against a basket of currencies and edging towards a 15-year trough versus the yen.

That trend prompted Japan to intervene to weaken the yen last month and some emerging economies have followed suit or are threatening to.

“There is clearly the idea beginning to circulate that currencies can be used as a policy weapon,” IMF Managing Director Dominique Strauss-Kahn was quoted as saying in Wednesday’s edition of the Financial Times.

“Translated into action, such an idea would represent a very serious risk to the global recovery ... Any such approach would have a negative and very damaging longer-run impact,” he said.

The IMF, which holds its twice-yearly meeting in Washington this weekend, is also expected to discuss foreign exchange moves as part of its mission to get countries working for balanced global growth.

Brendan Brown, economist at Mitsubishi UFJ Securities International in London, said the Fund, which has the United States as its biggest stakeholder, would not try to prevent further US monetary easing or a resulting slide of the dollar.

“That Washington institution has failed in its central mission to prevent currency war,” he wrote in a report.

CHINA UNMOVED

Euro zone policymakers urged Chinese premier Wen Jiabao on Tuesday to allow the yuan to rise more rapidly, but he politely rebuffed them, repeating Beijing’s standard line on seeking currency stability.

Wen was due to hold a joint news conference with EU leaders in Brussels at 11.15 am

Policymakers have highlighted the issue of global imbalances for years, with fundamental problems seen as the dollar’s global dominance, China’s overvalued yuan and Germany’s lack of domestic consumption.

Emerging nations say the cash flows seen this year have damaged their exports due to the determination of major economies to restrain their own currencies’ levels.

But entrenched positions make it unlikely that officials sitting down to IMF and G7 meetings this weekend, and G20 meetings later in the year, will resolve their differences.

Brazil fired the latest shot in what it has dubbed an “international currency war”, doubling on Monday a tax on foreign investors buying local bonds to 4 % to curb a strong real.

Policymakers from emerging Asian economies have voiced growing concerns about the risk of a flood of hot money inflows. South Korea warned investors it might impose further limits on forward trading and India and Thailand said they were looking at steps to control speculative surges.

MORE FED EASING?

Adding to speculation that the Federal Reserve will soon extend asset purchases to pump money into the economy, Chicago Fed President Charles Evans was quoted as saying the central bank should do much more to spur the economy.

And in a surprise move, Japan pulled interest rates on the yen back to zero on Tuesday and pledged to pump more funds into an economy struggling to compete while the currency remains close to a 15-year high against the dollar.

The euro gained 7.6 % versus the dollar last month as Fed easing speculation hotted up. Europeans are worried they will be saddled with an overvalued currency, stifling recovery, because they have few tools to contain the euro’s rise.

France, which takes over the presidency of the Group of 20 major economic powers next month, has put reforming the international monetary system at the top of its agenda, hoping to draw China into multilateral talks on currency coordination.

Your currency, our problem!

It’s the silly season for currency interventions . Last week, Guido Mantega, finance minister of Brazil warned an ‘international currency war’ has broken out. As Brazil’s central bank scrambled to buy close to $1 billion a day for almost two weeks — about 10 times its daily average — Mantega was only voicing what many governments have already expressed privately. That for all the calls for collective action and bonhomie displayed at various G20 meetings, when it comes to ground realities , it is each country for itself!

So, what’s new about that? What is new is that unlike in the past when ‘currency intervention’ was always a developing country refuge, a third world stratagem that first world countries eschewed, this time round, first world countries are nothing loath to join the game.
Last month, Japan joined Switzerland in intervening in the foreign-exchange market. As the yen surged to a little short of 90 to the dollar, the strongest in 15 years, the central bank, fearing a strong yen, would jeopardise recovery , sold an estimated $20 billion yen. The last time it intervened to sell yen in the foreign-exchange market was in 2004, when the yen was around 109 per dollar.

It is not the only one. The Swiss central bank has been intervening to prevent the appreciation of the Swiss franc against the euro for close to six months now. The last time it intervened was in 2002. The Japanese and the Swiss are not alone. South Korea, host to the next G20 meet, has shown as much alacrity in intervening to keep the won weak; so have Taiwan and Singapore.
In the developing world, meanwhile, currency intervention has become much more frequent. China, an old hand at the game, has been joined by Brazil, the Philippines , India and Malaysia, to mention just a few. The danger is if intervention becomes the norm, rather than the exception , the resultant ‘currency war’ will not leave any winners. Worse, it will mean goodbye to any hopes of rebalancing the world economy.

Why is that important? Because as long as the global economy remains perilously unbalanced, the next crisis is not far away. Orderly currency realignment is, therefore, critical to rebalancing . But that calls for coordinated action by the major world economies (read G20) — not haphazard, beggar-myneighbour intervention of the kind that seems to be the fashion now.

The reason is simple. Cheap money policy in the US that causes the dollar to weaken against other currencies will help boost US exports and rein in the US current account deficit. Provided no country intervenes! So, left to itself, this realignment in currency values is a part of the remedy the world is seeking.
But this is where the catch lies! China , the world’s largest exporter, continues to suppress the value of the renminbi . In the pre-crisis days, when economic growth was strong, most countries were prepared to look the other way and restrict their response to jaw-jaw . Not any longer! Today, as countries struggle to remain competitive in the global market, many seem to have decided to copy the Chinese. Hence the proliferation of currency interventions aimed at making currencies cheaper in order to boost exports.
THE problem is this ‘if you can’t beat them, join them’ philosophy could be catastrophic for global recovery. As each country looks to its own backyard, it is going to become much more difficult to reach a consensus on currency realignments . Exactly 25 years ago, the major global economic powers could hammer out the Plaza accord that led to an orchestrated weakening of the dollar, a resurgence of the US economy and a corresponding decline of the Japanese.

That was possible back in the 1980s as the US was the unchallenged economic superpower. Today, such a onesided accord would be almost unthinkable . South Korea, the host of the upcoming G20 meeting in November, is reluctant to even highlight the issue on the agenda, partly out of fear of offending China, its neighbour and main trading partner.
Yet, there is no getting away from the need for some kind of coordinated action . A situation where every country intervenes against its own currency in the foreign exchange markets in a spirit of competition rather than cooperation is not a zero-sum game. Smaller, lesscompetitive countries like India are bound to get hurt more.

Moreover, intervention comes at a cost. In the Indian context, accumulation of foreign exchange reserves and release of additional liquidity into the system adds to domestic liquidity, neutralising the RBI’s efforts to tighten liquidity to rein in prices. The additional liquidity could be sterilised but sterilisation , too, has a cost since the domestic rate of interest is usually higher than the return on foreign exchange reserves.
Non-intervention is not an option either ; not in a scenario where more and more countries are intervening. An undue appreciation of the rupee vis-à-vis other currencies is bound to hurt exports and in turn, hurt employment.

So where does that leave us? If both intervention and non-intervention are bad, what is the only option that remains ? Global cooperation! For the moment , however, coordination seems further away than ever. In a fresh signal that it is each country for itself, last week the US House of Representatives passed a Bill to allow levy of countervailing duties on imports from China in order to compensate for the weak renminbi.
In a globalised world if each country behaves like John Connolly (who once famously retorted ‘our currency, your problem,’ to a European delegation worried about the impact of a cheap dollar on their exports) and starts a competitive devaluation of its currency, the resultant fallout will soon encompass the whole world.

If the slogan of the forthcoming G20 meet in Seoul, ‘shared growth beyond crisis,’ is to be realised, the G-20 must act before it is too late. Before the cocky ‘our currency, your problem’ approach that seems to colour every country’s approach today gives way to a humbler but truer ‘your currency, our (collective) problem’ view, that should inform our 21st century world! 

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Asian Currencies to Strenthen

By Andrew Freris (Senior Investment Strategist ASIA, BNP Paribas)
* Expect nearly all Asian currencies to appreciate versus the dollar till year-end 2010 and beyond
* The renminbi will rise, at best, very modestly versus the dollar, the rest is politics
* Stronger Asian currencies will partially insulate the economies from the cost of higher food

On a year-to-date basis, the best performer is the Malaysian ringgit (11 percent) followed by the Thai baht (9.5 percent) the Singapore dollar (6.6 percent) all the way to the U.S. dollar pegged Hong Kong dollar which theoretically has a very limited range to move (7.75 - 7.85 percent).
The renminbi has moved very modestly by 2 percent and on the basis of non-deliverable forward (NDF) may move another 1.8 percent during the next 12 months.
The reasons for this strengthening trend are various:
-- Strong external balances both in terms of trade and current account surpluses as registered in the broadly continuing accumulation of forex reserves in the region. Exports growth is strong even in the cases where the trend has clearly peaked
-- Strong regional growth. Although most Asian economies are now registering decelerating 2Q10 GDP growth, in absolute terms the pace is robust and will be maintained
-- Perhaps most importantly, Asian interest rate differentials versus the dollar can be expected to widen in the next 12 months. It is clear that the U.S. will not raise short-term interest rates possibly for another 12 to 18 months.
Indeed the Federal Reserve is now poised for Quantitative Easing (QE) Mrk II which will keep longer term rates and yields firmly down.

As half of the major Asian central banks are now raising official rates (India, South Korea, Taiwan, Malaysia and Thailand), the local interest rate differentials versus the dollar are widening and will keep doing so as the rest of the Asian central banks will eventually join in.

Hong Kong has no option but to follow the Fed. Singapore, which has no interest policy, has allowed the Singapore dollar instead to appreciate, the equivalent of a rate hike while China has imposed very tight credit restrictions on property lending but without hiking rates -- yet.

The writing is on the wall. For at least the next 12 months Asian rates will continue to rise with dollar short-term rates pinned to near zero thereby strengthening the local currencies

THE CASE OF THE RENMINBI
There was a return to the pressures from the U.S. for the renminbi to appreciate. The Chinese are resisting this possibly, politically-motivated initiative (U.S. Congressional elections in November) as there is no clear evidence by how much is the renminbi undervalued and if its appreciation would help at all the U.S. economy where exports in total are less than 10 percent of GDP, with exports to China representing possibly about 10 percent of that total.
The renminbi is likely to continue to rise, but at a glacial pace, versus the dollar.


(The above article is not intended to be a financial advisory. Readers must seek specific advice from experts before making investment decisions.)