The Federal Reserve is forcing Asia to kick its addiction to hot money. The prospect of higher U.S. interest rates had made the region’s dwindling trade surpluses look an increasingly dangerous habit. Though markets may be turbulent, pricier local money or cheaper currencies will improve the trade balance for most Asian countries.
For the past decade, Asia’s trade surpluses have kept the region’s financial systems lubricated with dollars without piling up foreign debt. But those surpluses have narrowed, increasing the reliance on fickle overseas capital. As recently as the third quarter of 2012, Asia outside Japan was still running a cumulative trade surplus of almost 1.5 percent of combined GDP. By the first quarter of this year, that had turned into a small deficit.
Sliding currencies should help reverse the trend. Take Malaysia, which on Aug. 21 reported a second-quarter current account surplus of just 1 percent of GDP, down from 11 percent in 2010. The Malaysian ringgit is down 11 percent against the dollar since the beginning of May. Provided the economic recovery in rich nations does not stall, a more competitive exchange rate will improve the trade balance. The same logic applies to other Asian nations.
The adjustment will not be pain-free. Sliding currencies and higher rates will squeeze indebted companies, especially those that have borrowed in dollars. Moreover, weaker exchange rates can cause inflation, though cost pressures are muted everywhere except India and Indonesia. Inflation in Thailand is at a 44-month low of 2 percent.
There are two exceptions. In Indonesia, large spikes in the minimum wage as well as a recent increase in subsidized fuel prices are pushing up inflation expectations. To reduce its annual current account deficit of 3.2 percent of GDP, Jakarta needs to raise interest rates, which it has kept too low in an effort to cling to 6-percent-plus GDP growth.
India, where the current account deficit is now 4.8 percent of GDP, is the other outlier. New Delhi now needs to restructure its economy by reining in consumption and public spending and encouraging investment and exports.
The rest of Asia, however, should find it less painful to resist its hunger for foreign capital. Fatter trade surpluses are the way to do it.