Asia FX Outlook 2023: Better positioned

For all the effort that goes into forecasting Asian exchange rates, the last year has shown that apart from some short-lived deviations, dollar strength was the principal driving factor and EUR/USD provided perhaps the best clue as to both direction and magnitude.

Within this period, there were times when other drivers took over – energy dependence was pivotal during the period immediately following the Russian invasion of Ukraine with the Indian rupee (INR) and Thai baht (THB) suffering badly while the Indonesian rupiah (IDR), Malaysian ringgit (MYR), and Australian dollar (AUD) outperformed. Then the differing inflation experiences, coupled with how much the respective central banks leaned against it, also held sway for a time. This saw the more interventionist economies (IDR, INR, PHP [Philippine peso]) which absorbed price pressures through fiscal buffers doing better at times compared to more market-oriented economies – such as the Korean won (KRW) – though this usually didn’t last. Then there were occasions when the more managed benchmark exchange rates of the region – chiefly the Chinese yuan (CNY) – would “reset” in response to local economic conditions and drag "satellite" currencies in north Asia along with it.

In the end, though, perfect foresight of where EUR/USD was going would probably have been a better indicator than a full understanding of any of these other factors, and looking forward to 2023 we see few reasons why this should be much different over the coming 12 months.

Our house view for EUR/USD still sees some near-term dollar strength, and for this reason, we anticipate there still being some more mileage in the weaker Asian FX story. But both the scale and duration of this residual USD-driven leg remain the subject of much debate. Any further aggressive USD appreciation could see the current account surplus economies of the region outperforming their peers (see chart). External balances across the region have been damaged by this year’s energy price spikes, although compared to the Asian Financial crisis in 1997, the region as a whole is still in a much healthier position with respect to external balances, FX reserves, and import cover (see also here).

At some point though, and possibly after some further Asian FX weakness, a number of factors will start to swing in the opposite direction. Local factors include:

• While still somewhat subdued, China’s economy will be in better shape in 2023 than it was in 2022. There are some tentative indications of a more nuanced approach to zero-Covid, and this may be amended further following the two sessions in March.
• The property development sector will still likely be a shambles, but its drag on the economy will be trending towards zero or small positives from the substantial negative in 2022.
• Either of the factors above may free up more fiscal resources at the local government level to push growth along.
• Across the rest of Asia, without a renewed energy price spike, local inflation rates should begin to moderate, allowing for some easing of policy rates and recovery of demand.

Inflation already looks to be peaking in some economies and this trend is likely to spread. And while it may mean that policy rates can begin to be cut, the currency-relevant fact will be that negative real policy rates will shrink, and that could allow for some further currency strength.

However, when the turn comes, how much further it has gone before this occurs, and how rapidly it reverses course, will be determined by a wide range of local and international factors, and remains the subject of considerable speculation.