Various Southeast Asian currencies have hit their respective all-time highs in April this year, does this spell a predicament for the Southeast Asian economies? Find out more.

The Singapore Dollar has recently scored a nine-year high against the US Dollar in April, to close at high of S$1.5102. Across the causeway, the Ringgit also clinched a nine-year high of RM3.4205 against the USD in the same month. Malaysia had removed its peg to the USD from July 2005, sending the Ringgit on an uptrend since. Further up north, despite Thailand's military-installed government's attempts to prevent currency speculators from jacking up the baht to sky-high levels, the Thai Baht hit a nine-year high of BHT34.65 against the USD in March this year. How will this mounting trend of strengthening Southeast Asian (SEA) currencies affect the investors? We examine closer the relevant individual factors. (see Chart 1)

Chart 1: Movements of SEA currencies against the USD (Apr 2004 - Apr 2007)

Source: Fundsupermart.com compilations, Bloomberg

Appreciating currencies affect export-oriented economies most

An appreciating currency tends to affect a country's exports negatively, as it renders them more expensive to their importing countries. When this happens, consumers in the export market may turn to domestically produced goods and services or increase their demand for exports from the countries whose currencies are relatively less expensive. Generally, Southeast Asian economies are largely export-oriented, making it highly susceptible to currency movements. For instance, exports account for close to 60% of the Thai economy. When the demand for the exports of these countries slows down due to a more expensive currency, there will be a negative effect on their economic growth.

Over the past two years, although the SEA currencies have strengthened, we see that their exports are still on an upward trend in general (see Chart 2). Nevetheless, in February this year, Singapore's and Malaysia's exports took a sharp dip. This could be partly attributed to a slowdown in the demand for electronic products. In Singapore, electronic products account for a major portion of the economy's non-oil exports, at 46% in 2006. In Malaysia, 48% of its total exports in the same year are made up of electronic products.

Chart 2: Export trends of Singapore, Malaysia & Thailand (Apr 2004 - Feb 2007)

Source: Fundsupermart.com compilations, IE Singapore, Department of Statistics
Malaysia, Bank of Thailand

Of course, another possible reason for the dip could be seasonal, due to the Chinese Lunar New Year holidays in February, resulting in a loss of production days. In Thailand where there are no declared public holidays for the festival, exports during that period took an entirely different trend.

According to the chairman of the Kuala Lumpur-based American Malaysian Chamber of Commerce's (AMCHAM) electronics group, Wong Siew Hai, exports by 17 of its US member companies in Malaysia may increase between 7% and 8% this year. Up north in Thailand, exports are growing faster than expected in the first few months of 2007, prompting the Bank of Thailand (BOT) to lift its projections for export growth to between 9% and 12% this year, from a previous estimate of between 7.5% and 10.5%. Although exports are not going to grow at levels seen in 2006, they are not expected to decline in this year.

With the SEA currencies appreciating strongly against the USD over the past one year, exports might be hurt in the coming months, affecting the SEA economies. Fortunately, there are some mitigating factors which may cushion the impact on these economies when export growth slows.

Impact of export slowdowns alleviating

The US is a major export market for the SEA countries. An appreciation in their local currencies against the USD will definitely impact their export industries relative to the US. However, with the growing importance of China, India and the European Union (EU), the US now takes up a smaller portion of SEA exports (see Table 1).

Over the past 6 years, China and India have been experiencing strong economic growth, at an average rate of 9.1% and 7.3% respectively. As these economies grow, the demand for imported goods and services would increase, increasingly benefiting the export industries in the SEA region, as they now export more to these countries. This also implies that the impact of weak exports to the US will become softer over time.

Just in April, Thailand's Commerce Minister, Krirk-Krai Jirapaet, also highlighted the increasingly importance of the non-US markets to the Thai export industries. He opined, "Exports to new markets like the Eastern Europe, India and Australia still posted strong growth despite the gains in the baht."

Table 1: SEA exports to US, EU, China & India

Sources: Fundsupermart.com compilations, IE Singapore, Department of
Statistics Malaysia, Bank of Thailand

Another factor which has softened the impact of a slowdown in SEA exports is that many of the SEA governments have taken measures to counter falling exports by boosting their domestic consumption, attracting foreign investments as well as to emphasize on the growth of their respective tourism industries.

In the case of Singapore, for instance, the Monetary Authority of Singapore (MAS) expects growth in non-electronic manufacturing industries, such as the transport-engineering and biomedical, to continue at a "healthy" pace this year, albeit at a slower pace than 2006. With oil prices expected to remain high, the demand for oil rigs and rig conversion projects will keep the domestic offshore and marine engineering segment buoyant. Global leaders in this segment listed on the Singapore Exchange's mainboard, such as Keppel Corporation and Semcorp Marine Ltd, have a slew of orders to keep their shipyards busy till 2010. The construction industry will also be driving Singapore's economy with projects such as a downtown financial centre, two integrated resorts and the extension of the subway system underway.

In Malaysia, we see that the government is also stepping up on government spending in economic development projects such as the "9th Malaysian Plan" which amounts to RM200 billion over a period of five years, as well as the relaxation of financial and property regulations to attract more foreign investors. The Bank Negara - Malaysia's central bank - also mentioned in March, that new oil fields and a tourism campaign will also help boost the country's economic growth.

The Thai government, using a different strategy, loosened its monetary policies with a 100-basis-points cut off its benchmark interest rate so far this year, to spur investments and domestic consumption. All these policies seek to increase the Thai economy's ability to weather export slowdowns, by elevating the roles of domestic consumption, private investments and government expenditures in its economy. This will help cushion the economy from negative impacts, should there be a slowdown in its export sector.

A stronger currency has its merits too

A stronger currency is not all bad news. An obvious advantage of a stronger currency is that it can import the same quantity of goods by spending less of its local currency. In that event, imports will also show an increasing trend as they now appear cheaper.

In the case of Malaysia, where capital goods and intermediate goods accounted for about 13% and 80% of Malaysia's imports respectively as of February this year, a stronger currency actually helps the Malaysian manufacturers, because it helps to reduce their import costs. Rising imports of capital goods will allow its economy to achieve productivity growth, benefiting the economy over the longer term. To the Malaysian government, imports can be differentiated into intermediate goods, capital goods and consumption goods. Intermediate goods refer to the inputs to production, while capital goods are those which are used in the production of other goods.

Chart 3: Crude oil price trend (Jan 2004 - Apr 2007)

Source: Fundsupermart.com compilations, Bloomberg

From another perspective, a higher-value currency also keeps imported inflation low. To countries like Singapore and Thailand which are net importers of oil, when the oil prices rise, consumers will have to spend more to consume oil, adding to the countries' inflationary pressures. One method to keep these inflationary pressures in check will probably be to allow the local currency to appreciate. As seen in Chart 3, the prices of oil have been increasing for the past couple of years. In this light, governments of countries which are net importers of oil may have viewed an appreciating currency as necessary to keep inflation at bay.

Upward Pressure To Unwind

All this while, SEA economies have pursued an export-driven development model which capitalizes on a weak currency. When the exchange rates are kept lower than where they should reasonably be, exports become cheaper and imports appear dearer. This supports the export industries and protects the domestic manufacturers from foreign competition. The accumulation of massive foreign exchange reserves denominated in the USD is often treated as circumstantial evidence of government manipulation, as the Asian central banks would probably not disclose their actions of intervention. The accumulation of the USD occurs when a country's local currency is sold in exchange for it - this props up the value of the USD. The increase in the levels of tolerance of some SEA governments to allow the progressive appreciation of their currencies could be positively viewed as their stronger confidence in their respective economy's growth.

Interest rates are one important factor that may draw in foreign monies, resulting in the further strengthening of a country's currency. However, in the case of Malaysia, inflation has stayed at moderate levels, and this has enabled it to maintain its interest rate unchanged for the past eighth consecutive occasions. In Thailand, the interest rate has been lowered by 1% so far this year; this has helped to rein in the speed of currency gains, to some extent.

Looking forward, with inflationary pressures expected to stay tamed, SEA central banks would have less pressure to raise interest rates, making it less attractive for foreign investors to park their monies in these countries. This is expected to relieve some upward pressure on these currencies.

Our Views

There is no doubt that appreciating currencies will most likely have a negative impact on SEA exports. As such, we will continue to monitor this phenomenon. However, we see that the impact of this on the economic growth of the SEA countries may not that negative after all.

Governments in the region have been trying to grow less reliant on export-oriented growth, shifting their attention towards stimulating domestic consumption. As a result, the US has become a less important export market, compared to SEA economies such as China, India and the European Union, which have now taken up an greater portion of their exports. With less likelihood of an interest rate hike, the appreciation of the SEA currencies will proceed at a more gradual pace, going forward. These suggest that the impact of stronger SEA currencies on the growth of these economies may be limited.

With strong economic growth expected to continue in the Southeast Asian region, and the valuations (based on estimated 2007 earnings) of key markets like Singapore, Malaysia and Thailand currently at reasonable levels (PEs at 18.1X, 17.4X and 8.7X respectively, as at end-April 2007), investors may wish to gain exposure to these countries via a fund which invests in SEA equities. A possibility may be our newly-chosen recommended fund for the Southeast Asian region: the Legg Mason Southeast Asia Special Situations Trust.

A point to note, however, is that as the fund invests mainly in developing countries within Southeast Asia, a higher level of volatility may be expected, compared to more well-diversified Asia ex-Japan funds. Investors are advised to include the fund under the supplementary portion of their investment portfolios.

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