Win some, Lose some
The Wall Street credit crunch and the unwinding of leverage on carry trades may end the appreciation of emerging markets’ currencies

The past five years have seen an unprecedented rise in capital inflows in the emerging markets. The commodities boom, cross-border speculative capital, forex deregulation, carry trades and the liquidity boom have all enabled emerging markets currencies, bank deposits and local bonds to become highly profitable investment vehicles for GCC investors. Yet, the Wall Street credit crunch may dampen the bullish sentiment and the unwinding of leverage on carry trades may end the synchronised appreciation of emerging markets’ currencies. There will therefore be both winning and losing EM currencies in 2008.

The Chinese Yuan
In the Pacific Rim, the most critical international financial equation is the Chinese Yuan-US dollar cross trade. The Peoples Bank of China and the Politburo are engaged in a serious attempt to combat the inflation virus in the Middle Kingdom, having understood the lessons and ghastly implications of the June 1989 Tiananmen Square massacre all too well. The PBOC hiked the reserve requirement ratio for Chinese banks for the tenth time to 14.5 per cent in December, its first 100 basis points hike in four years. Moreover, protectionist sentiments in the US Congress in an election year emphasise the need for a tighter monetary policy to arrest the asset bubble in the Shanghai A share market and Chinese real estate. An inflation surge caused by a rise in meat prices, bank credit growth and the removal of gasoline subsidies all make it imperative that the Peoples Bank will countenance a faster pace of Yuan appreciation in 2008. As the Chinese inflation rate surges to 7 per cent and GDP growth accelerates to 10 per cent in the endgame to the Beijing Olympics, it is quite possible that the Chinese Yuan will rise as high as 6.8 to the US dollar.

The rise in the Chinese yuan, of course, will have a bullish impact on proxy currencies like the Singapore dollar and the South Korean Won, quite possibly the most undervalued currencies in Asia. Singapore has replaced Hong Kong as the private banking and wealth management hub of the Far East and booming construction, property, aviation, shipping, tourism and finance sectors have all led to a classic 8 per cent tiger economy growth rates. As inflation and real estate values rise in the Lion City, the Monetary Authority of Singapore (MAS) will allow the Singapore dollar to appreciate at a faster rate against its hard currency basket. This suggests that a 1.38-1.40 target for the Singapore dollar against the greenback by mid-2008 is not unrealistic.

The Philippines Peso
Apart from the Chinese Yuan, the Philippines Peso is a classic candidate to rise against the US dollar. The Philippines Peso is the best performing currency against the US dollar, due to the US$15-billion surge in remittances, the macroeconomic success of President Gloria Macapagal Arroyo’s fiscal policies, the anti-inflation policies of the Bangko Sentral Pilipinas (BSP), the momentum of privatisation in the embryonic call centre/BPO revolution and the wild bull run in the Manila stock market. I can envisage additional appreciation of the Philippine Peso to 40 as the foreign exchange market realises that President Arroyo will not be overthrown by rebel military officers and that Manila has signed a peace deal with Moro rebels in Mindanao, improving Philippine’s country risk.

The Indian Rupee
The Reserve Bank of India has engineered a successive pre-emptive monetary tightening to combat rising inflation. Moreover, the Wall Street credit crunch and slowdown in the EU means a softer Indian macroeconomic growth, as bank credit declines from 30 per cent to 20 per cent. The RBI still believes that the balance of risk in India is higher inflation, not slower growth. So, I believe the Indian central bank will be loath to cut interest rates prematurely, meaning the interest rate differential will continue to support the Indian Rupee. From cellular subscriber growth to cement prices to tourism arrivals and the Sensex, India’s economic metrics are stellar. I believe the Indian Rupee will remain well bid against the dollar and trade in a relatively narrow range between 41-38.

The Kuwaiti Dinar
In the Arab world, I am bullish on the Kuwaiti Dinar, the only GCC state that has abandoned the dollar beg peg in favour of a currency basket. The Kuwaiti Dinar could well appreciate to 0.25 KD against the dollar by the year 2008 but is vulnerable to a fall in crude oil prices, a greenback rally against the Euro and Sterling, or any political issues between the government and Parliament, including on the acrimonious issues of foreign concessions on Project Kuwait.

The Moroccan Dirham
The Moroccan Dirham should appreciate against the US dollar, supported by FDI in real estate, textiles, offshoring services and tourism. However, Morocco is vulnerable to a slowdown in the Eurozone and pressures from exporters on the Bank Al Maghreb for a lower, more competitive exchange rate. Yet, I doubt if the Moroccan central bank will countenance a devaluation or an abandonment of the current managed float system because it would boost debt service cost on its external debt and the local inflation rate. The Moroccan Dirham has benefited strongly from its Euro-dominated FX basket and should be anchored by the high Euro-dollar FX rate.

The South African Rand
The South African Rand has been a major beneficiary of Chinese demand for industrial metals, the surge in gold and platinum, the liquidity and risk appetites in emerging markets, high money market rates, a credible central bank and President Thabo Mbeki’s pro-business fiscal orthodoxy and support for FDI. Yet political, economic and financial storm clouds could trigger a depreciation of the South African Rand from its current level of 6.7 to as high as 7.8-8 against the US dollar in the next 12 months. The leadership contest between Mbeki and Jacob Zuma for ANC party leadership could mean political instability and succession risk for the South African Presidency for the first time since the fall of the apartheid regime and Nelson Mandela’s election as the first black President. Zuma’s power base is in the townships, the trade unions and the South African Communist Party. Moreover, economic growth rates next year could well fall if gold and platinum prices decline, the agriculture drought deepens, the Reserve Bank’s monetary tightening and interest rate hikes have an impact on consumer spending. The South African consumer is dangerously overleveraged, with net household savings below zero. The trade deficit is 6 per cent of the GDP, making South Africa vulnerable to loss of international investor confidence and risk aversion. Politics, risk, the trade deficit, and gold prices are all flashing a bearish SOS on the South African Rand.

The Russian Rouble
It is likely that the appreciation of the Russian Rouble will continue even after the March 2008 Presidential election. After all, inflation is over 12 per cent, far above the IMF target of 8 per cent. The central bank will rely on the Russian Rouble appreciation to offset inflation pressures as labour markets are the tightest since the fall of the USSR and gas markets are deregulated. With US$500 billion in hard currency reserves, Russia has emerged as one of the biggest creditors to the Euromarkets. Thus, the Rouble could well rise 6-8 per cent against its Euro and dollar basket next year.

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