Phyllis Papadavid, Director of Research and Advisory at Asia House, assesses the implications of the strong US dollar for Asian economies.
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- Disruptive financial dynamics could increasingly unsettle Asia’s resilience given the breadth and persistence of US dollar strength.
- Dollar denominated debt levels and US monetary policy will buffet borrowing costs in Asia. Local currency depreciation is also likely prompt higher local interest rates.
- Higher dollar debt, large import shares (including for energy) and accelerating inflation will be key markers of vulnerability: China, Japan and Vietnam look exposed.
Disruptive dollar dynamics will re-shape Asia’s 2023 outlook
Economic risks for 2023 have grown more acute, both in advanced and emerging economies. Asia is no exception. Vulnerability to shocks and their persistence and breadth will remain heightened in 2023 and will be catalytic in reducing global growth. Approximately one third of the global economy is likely to be in contraction in 2023 (IMF, 2022), fuelling the likelihood of a sub-two per cent global growth rate.
Chief among the global triggers will be financial developments in the US. The increase in US interest rates – coupled with US dollar strength – will bring about multifaceted changes in Asia’s economies. Those with high US dollar debt burden, high usage of the US dollar as a trade invoicing currency, and those that have high imports as a share of their economy, will shoulder more pronounced economic impacts in 2023.
US dollar strength may benefit Asia’s exporters in the form of resilience (and some cases hyperbolic growth) in US import demand, which has been buoyant and has coincided with US dollar strength post-COVID-19. And yet, the context that frames US dollar strength is unlikely to be beneficial for Asia and will limit competitiveness impacts from domestic currency depreciations.
Pathways for Asia’s dollar dependence
Dollar dynamism will be driven by its status as a safe haven currency1 with global markets in risk aversion. Its strength is also likely to be complemented by comparatively greater monetary tightening by the US Federal Reserve.
Asia’s dollar dependence could take shape in the following ways:
- Asia’s currency depreciations may not boost competitiveness or exports. Resource exporters, such as Indonesia, have seen a boost to bilateral trade. However, import price inflation (including from elevated energy prices) is likely to accelerate, making Asia’s production inputs more costly. Imports play an essential role in facilitating Asia’s industrial growth and productivity (Pane and Patunru, 2022) suggesting that cost increases could constrain competitiveness into 2023.
- Asia’s currency reserve accumulation will continue to slow and reflect, in part, increased currency intervention (Adler et al., 2021), as with Japan, China, India, Thailand.2 Asia’s currency depreciations have not been disorderly, but have marked multi-decade (and record) lows against the US dollar. The good news is that Asia’s policy buffers still have room for manoeuvre even though using reserves comes at the cost of foregone investment.
- Dollar debt and US policy will buffet borrowing costs in Asia. Global bond markets tend to transmit investors’ risk aversion from one economy to the next (Chami et al., 2020). Rising dollar debt and global risk aversion could hamper Asia’s access to finance. Additionally, in Asia, currency depreciation typically links to a widening of the sovereign bond spread (Lee et al., 2021), suggesting a three-way link between US dollar funding, domestic liquidity conditions and financial shocks.
Asia’s vulnerability to systemic dollar risks
In the months ahead, Asia’s economies that hold US dollar denominated debt, that are comparatively more open with high import shares, or that have accelerating inflation, will be worth watching. On this basis, Vietnam, China and Japan look to be more exposed to systemic downside risks. Asia will show resilience; its resource exporters are likely to continue to fare well and as a region, it will be a driver of global growth. And yet, the breadth of shocks – including a peak in inflation in 2023 rather than in 2022 – and continued risk aversion– suggests red flags for the outlook.
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1. Safe haven currencies, or assets, are typically in higher demand as a store of value during times of global financial volatility; this link has predominantly been exhibited by the US dollar (Doroodian and Caporale, 2000).
2. This is notwithstanding positive valuation effects from a stronger US dollar.
Adler, G., Chang, K.S., Mano, R.C., Shao, Y. (2021), “Foreign Exchange Intervention: A Dataset of Public Data and Proxies” IMF Working Paper WP/21/47, International Monetary Fund.
Chami, R., Cosimano, T.F., Rochon, C., Yung, J., (2020), “Riding the Yield Curve: Risk Taking Behaviour in a Low Interest Rate Environment” IMF Working Paper, Volume 2020: Issue 053, 13 March 2020, International Monetary Fund.
Doroodian, K., and Caporale, T., (2000), “Currency risk and the safe-haven hypothesis” Atlantic Economic Journal, 28, 186-195.
IMF (2022), “Countering the cost-of-living crisis” World Economic Outlook Report October 2022, International Monetary Fund, Washington DC.
Lee, J., Rosenkranz, P., Ramayandi, A., Pham, H., (2021), “The influence of US dollar funding conditions on Asian financial Markets” Asian Development Bank, No. 634., March 2021.
Pane, D.D., Patunru, A.A., (2022) “The role of imported inputs in firms’ productivity and exports: evidence from Indonesia.” Rev World Econ (2022).