As Emerging-Market Currencies Soar, Central Banks Stick to the Sidelines

By Saumya Vaishampayan Features Dow Jones Newswires

Emerging-market currencies have been on a tear this year. But the central banks that manage them have proven unusually happy to sit on their hands.

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The Korean won, new Taiwan dollar, Indian rupee, Russian ruble and Mexican peso have all advanced more than 5% against the U.S. dollar so far in 2017, bolstered by an influx of cash into emerging markets. Foreigners poured an estimated net $20.5 billion into emerging markets in May--the sixth consecutive month of net inflows--with the bulk of it going to Asian countries, according to the Institute of International Finance.

The rush of funds has pushed some currencies to eye-watering levels. The Indian rupee was at its most expensive on record at the end of April, according to its real effective exchange rate, which reflects a currency's value against several trading partners, adjusted for inflation. The new Taiwan dollar was at its highest in a decade, while the Korean won recently hit its richest level since 2008, according to the Bank for International Settlements. The Mexican peso and Russian ruble still look cheap compared with their long-term averages, despite their gains.

While the data for May aren't yet available, most of these currencies kept on rising against the U.S. dollar last month. The rupee slipped 0.3% against the greenback, but the muted decline likely leaves it at a still-expensive overall level.

Normally, strong currencies are a headache for emerging countries. Export-driven economies like Korea and Taiwan can find that their goods are less competitive globally. Countries like India that normally run current-account deficits can see them widen as imports rise. Rising currencies also hit corporate earnings, as money earned overseas is translated back into the stronger domestic currency.

But so far this year, most emerging-market economies have kept growing. The IIF recently lifted its 2017 forecast for emerging markets' economic growth to 4.6% from 4.4%, and now expects a rate of 4.9% next year.

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That is taking the heat off normally trigger-happy central banks.

"So far, I don't think these movements pose a threat to central-bank policies," said Aidan Yao, senior emerging Asia economist at AXA Investment Managers in Hong Kong, referring to currency gains in Asian emerging markets. "If the trend continues and shows a bigger detachment from economic fundamentals, then central banks will have to react," he said.

Besides encouraging economic data, central bankers are having to weigh the side effects of strengthening currencies with the unfavorable optics of currency intervention. U.S. President Donald Trump has frequently leveled accusations of currency manipulation against other countries, though he has yet to take any punitive action. Both Korea and Taiwan are on the U.S. Treasury Department's watch list for manipulation.

Few central banks have even commented on their currencies recently. Taiwan's central bank acknowledged in March that a stronger new Taiwan dollar "has put domestic financial conditions under strains," and said it would step in if capital flows lead to extreme volatility or disorderly moves.

Asian central banks have in the past been quite aggressive in intervening to slow currency gains, especially during periods of dollar weakness. That usually entails buying up foreign currencies, which boosts their reserves.

But there is evidence that they're now stepping back: foreign-exchange reserves in Taiwan rose just 1.2% in April from a year earlier, the smallest increase since November 2015, according to central-bank data. The pace of year-over-year reserve accumulation has slowed for India and Korea since a recent peak in the summer of 2014, when the dollar had been declining in the preceding months.

For sure, there are advantages to having a stronger currency. Debt denominated in foreign currencies becomes easier for governments and companies to repay. In India's case, the rise in the rupee is helping the central bank control inflation.

With central banks staying on their hands, and trends such as resilient growth in global trade continuing, analysts say emerging-market currencies' lofty valuations don't necessarily presage a pullback soon.

"For many emerging markets, the currencies can trade away from what the models would suggest as 'fair value' for sustained periods of time," said Sameer Goel, head of Asia macro strategy at Deutsche Bank in Singapore.

Write to Saumya Vaishampayan at saumya.vaishampayan@wsj.com

(END) Dow Jones Newswires

June 02, 2017 07:30 ET (11:30 GMT)