- Energy import costs are lifting inflation and straining budgets and FX reserves.
- JPY is hit by low rates, slow BoJ normalisation, and rising energy import costs.
- CNY faces mixed forces: trade surplus on the upside; tariffs, property, and energy on the downside.
- IDR is under pressure despite commodities gains and BI rate hikes; more adjustment is needed.
- INR faces headwinds from trade exposure, inflation, and equity outflows.
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COMMENTARY: External shocks and FX adjustments
The ongoing energy shock has led to inflationary pressures to rise, current account of energy importers to worsen, budget deficits of those controlling local fuel prices to widen, and financial market volatility to rise. Particularly, bond and currency markets have been under focus as public finances and central bank reserves have been strained. The ongoing currency market developments are however not solely due to the energy shock; additional drivers play across geographies.
Take Japan, for example. The yen has been under pressure, as short-term interest rates remain too low given the burst of inflation in recent years. In real effective terms, the currency is more than 30% below where it was in 2020, good news for Japanese exporters, but bad news for imported inflation. Despite a hot equity market, capital flow has been a net negative, and the BoJ’s slow move toward policy normalisation has been less than satisfactory for the markets. Add to that the ever-rising energy import bill, the yen’s softness is well contextualised. Japan however needs to look at the geopolitical lens. The US, keen to improve its trade deficit, would not look kindly on a major trading partner’s relentless currency depreciation.
China, also under pressure from the US to appreciate its currency, had been contrarily guiding the RMB the opposite way in recent years, although lately there has modest appreciation. Substantial reliance on energy imports notwithstanding, the burgeoning trade and current account surpluses lend readily into currency appreciation tendencies, although periods of external shock (US tariffs) and domestic headwinds (property market) dent sentiments time to time. We don’t think China-US trade frictions are over, which may nudge the authorities to lean toward a stronger RMB.
Indonesia, given its commodities riches, should be a winner, benefitting from high price of industrial metals and energy. And yet, financial market investors have been lukewarm, many taking their investments out of the country. A temperamental policy environment, reliance on refined energy imports, and repressed inflation have manifested in the rupiah coming under pressure. Bank Indonesia has commenced raising the policy rate, but would likely have to go much further.
Then there is India, where the rupee has depreciated sufficiently in recent months to cause a degree of alarm among market participants. Reliance on the Middle East with respect to both imports and exports, a stock market facing selling pressure due to AI disruption, and incipient inflation pressures have caused a myriad of headwinds for the INR.
Strikingly, since 2020, the cumulative real effective depreciation of the IDR, INR, and CNY are almost identical. IDR and INR are more recent entrants to the dynamic, but the picture covering this decade underscores the point that neither policy makers nor market participants need to panic. There is a common external shock at play, on top of country-specific idiosyncrasies. Some FX sell-off and some monetary tightening are par for the course, in our view.
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