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Falling FX reserves fuelling the crisis in Asian countries

When it comes to foreign-exchange reserves, few stories frighten Asia quite like the news of the crisis in Thailand.

Bangkok’s devaluation in July 1997 triggered the Asian financial crisis. The government and the Bank of Thailand were forced to abandon the US dollar peg and precipitously devalue the baht as their foreign currency reserves dwindled.

Twenty-five years later, the second largest economy in Southeast Asia isn’t nearly tumbling into a replay of that disaster. In spite of this, Bangkok is once again at the epicenter of a trend drawing more and more attention to global financial markets: the rapid depletion of currency reserves by central banks in developing Asia.

The foreign-exchange reserves of emerging Asian central banks have dropped precipitously, raising fears that this may limit market interventions to stem currency losses against the powerful dollar. Standard Chartered reports that the Emerging Asian Market  (excluding China) has the lowest reserves cover since the global financial crisis of 2008, at about seven months of imports that may be financed with foreign-exchange assets. An increase from about 10 months at the start of the year to as high as 16 months in August indicates a weakening of emerging country firepower to defend currencies.


Which country sees the biggest drop in FX reserves?

The ratio of Thailand’s reserves to GDP has fallen to its lowest point in the region. Malaysia is next, followed by India. Generally speaking, says economist Divya Devesh of Standard Chartered in Singapore, rising Asian economies, barring China, are sitting on their lowest piles of reserves since the 2008 Lehman Brothers collapse. The drop in FX reserves has a dramatic effect on the financial markets as well.

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The number of months’ worth of imports that can be financed with current foreign-exchange assets is a key indicator for the bank. As a proportion of GDP, Thailand witnessed the largest decline, followed by Malaysia and India, according to statistics collated by Bloomberg.

Reserves cover roughly nine months of imports for India, six for Indonesia, about eight for the Philippines, and seven for South Korea, Standard Chartered said. Due to the Federal Reserve’s aggressive policy tightening, capital has been relocating back to the United States, putting pressure on the dollar and forcing central bankers throughout developing Asia to rely on reserves to defend their currencies.

Raising the stakes, the dollar is growing at the quickest rate vs the Japanese yen in 24 years, up about 26% this year. Gains against the Chinese yuan of approximately 9.6 percent.


What to Consider

As the US dollar rises, partly due to the Federal Reserve’s rate increases in Washington, considerable downward pressure is being exerted on Asian currencies. Weaker ability to protect currency values in the face of declining reserves.

Many Asian currencies have reached record or multi-year lows, and any sign of a slowing in market interventions may aggravate losses for these currencies. If Asia’s exports are threatened, central banks may switch their priority from managing imported inflation to enhancing export competitiveness, which might mean a move from dollar sales to purchases.

Reserves have dropped by around $81 billion and $32 billion in India and Thailand, respectively, this year, making them two of the most active countries in terms of foreign exchange (FX) intervention. Reserves declined by $27 billion in South Korea, $13 billion in Indonesia, and $9 billion in Malaysia.

Economist Lauren Gloudeman at Eurasia Group believes the PBOC “would be more concerned with moderating the pace of depreciation and keeping expectations constant than defending a precise level for the currency rate” as the yuan approaches the psychologically crucial 7 to the dollar level. The efficacy of its defenses, however, “may be bolstered if depreciation predictions coincide with significant capital outflows or depletion of reserves.”

According to Gloudeman, “China’s FX reserves continued to plummet to their lowest level in over four years” in statistics released only last week. In addition, August was the ninth consecutive month of portfolio outflows, as reported by the Institute of International Finance. In addition to that, an economist stated that if countries want to avoid worse consequences it’s time to react more seriously and take specific measures.

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