Singapore - The roller coaster ride for Asian currencies,
which saw only the yen and yuan post significant gains for the year against the
dollar, is set to continue in 2012.
While Japan actively sought to stem the yen's rise - drawing
US criticism last week - China intervened to ensure the yuan ended the year at
a new high. Both currencies appreciated about 5% in 2011 against the dollar.
The opposite approaches illustrate a dilemma facing Asian
policymakers as they try to smooth out foreign exchange rate volatility, which
shows no sign of abating in the new year. If the currency is too strong,
exports get more expensive. Too weak, and imported inflation spikes and
domestic buying power fades.
Singapore and South Korea provide two examples of how
inflation can stay surprisingly high, even as declining global demand curbs
exports and saps growth. Both the Singapore dollar and the won slipped against
the greenback in 2011.
For Japan, which has been battling deflationary forces for
two decades, rising prices would be a welcome change. Three times in 2011,
Tokyo intervened in the currency market to try to weaken the yen, once with the
help of Group of Seven nations after the March earthquake and tsunami, and
twice unilaterally.
It was the solo moves that drew Washington's ire. The
Treasury pointed out in its December 27 report to Congress on world currencies
that the United States "did not support these interventions", and
said Japan would be better served by taking steps to increase the dynamism of
its domestic economy.
"The United States is saying, our recovery is dependent
on the dollar not becoming too strong," said Yukon Huang, an economist
with the Washington-based Carnegie Endowment for International Peace.
"It's worried that there will be a global move for
people to depreciate" their currencies, he said.
The twice-yearly currency report was mandated by Congress in
1988, when the trade imbalance with Japan was the main concern. More recently,
it has become a source of friction with China.
Even the critique of Japan in the latest report may have
been intended as a message for Beijing.
"The criticism (of Japan) is accurate but it's 20 years
old and resuscitated as cover," said Derek Scissors, a research fellow at
the conservative Heritage Foundation in Washington.
"It's so they don't appear to be picking on
China."
If Treasury determines a country is manipulating its
currency to gain a trade advantage, it can call in the International Monetary
Fund to press for a realignment.
Some US lawmakers, businesses and unions want Washington to
label China a manipulator, but Treasury declined to do so yet again in its
latest report. It did, however, mention China twice as many times as it
referred to Japan.
While there may be politics at play in the currency report,
a closer look at trading in China's yuan suggests Beijing may have earned its
reprieve this time.
Ending on a high note
The United States has long argued that a stronger yuan is in
China's best interest because it can help ease inflationary pressures and lift
domestic spending power.
China's central bank keeps the currency on a tight leash by
setting a daily midpoint and then allowing only a one-half percent move on
either side.
In the first half of December, the yuan traded limit-down
nearly every day, partly due to demand for dollars but also reflecting
increasing concern that China's economy will falter as export demand slows and
its housing market declines.
The People's Bank of China intervened on December 16 and again
on December 30 to prop up the yuan, traders told Reuters. That left the yuan up
4.7% against the dollar in 2011, even though China's exports have cooled over
the past six months and will probably slow even more in 2012.
The yuan's performance makes it more difficult for the
United States to claim China is intentionally weakening its currency to gain a
trade advantage.
"The argument gets weaker when China is moving towards
a smaller trade surplus," said Carnegie's Huang, who is also a former
World Bank country director for China.
Eyeing oil
Why would China favour a stronger currency now? It helps to
defuse political tension with the United States and discourage traders from
assuming the yuan is a safe one-way bet, and it can also neutralise imported
inflation.
China's annual inflation rate has dropped dramatically since it hit a three-year peak of 6.5% in July, but it is still above the government's target of 4%.
With oil trading around $100 per barrel even though the
world economy looks shaky, it would not take much of a shock to push prices
back up to the $115 level seen in May, which threatened to choke off the global
recovery.
This complicates currency policy across Asia.
Aside from the yuan and yen, most Asian currencies weakened
in 2011. South Korea, Indonesia and India stepped in to try to cap currency
volatility, but countries across the region seemed content to allow a gradual
decline.
That may change in 2012.
In Singapore, considered a regional bellwether because the
city state is so closely tied to the global economy, annual inflation spiked
unexpectedly to 5.7% in November.
Trade-dependent Singapore uses the exchange rate as its
primary policy tool, and has slowed the pace of appreciation to try to support
growth. But that leaves it vulnerable to imported inflation.
In South Korea, a measure of factory activity fell to its lowest in nearly three years in December, figures on Monday showed. Yet its inflation rate came in above the central bank's target. The Bank of Korea said last week that fighting inflation would remain the top policy priority in 2012.
This suggests Seoul may rethink the wisdom of allowing its won to weaken.
"We believe the government's tolerance for a weak won is waning," Barclays economist Wai Ho Leong wrote in a note to clients on December 30.