Regardless of the presidential election results in the United States, the government is likely to unveil another round of stimulus to help the world’s largest economy weather the slowdown caused by the global pandemic. The spending surge is bound to reignite concerns over US fiscal health and the dollar’s value, which has benefited recently from risk aversion.
Several economies in Asia stand to gain, with emerging economies offering investors better returns, while stronger currencies in Indonesia, India, the Philippines and Malaysia should help improve their balance of payments, with an expected increase in capital inflows.
China, South Korea and Taiwan would also benefit as their economies gain ground after having kept Covid-19 under control.
Other than China’s economic recovery, US fiscal and monetary policies have the biggest impact on Asia’s investment and macro environment, as these policies drive US interest rates and the dollar’s value, affecting rate differentials and currencies in Asia.
espite the recent dollar rebound, its medium-term trend is bearish. Uncertainty over the speedy passage of a new stimulus package and a smooth presidential election have caused stock market corrections and stimulated dollar demand. But once fresh US stimulus measures are passed, concerns over US fiscal health and the dollar’s value will return.
Democrats and Republicans are likely to ultimately agree on terms for a new stimulus package, which is estimated to be worth around US$2.2-2.5 trillion.That would make the total US stimulus about 40 per cent larger than for the rest of the world, much of it likely to be financed by Treasuries and monetised by the Federal Reserve and banks’ purchases.
Once risk-aversion flows disappear in the next few months, the dollar could face a structural downturn due to excessive monetary expansion, the country’s twin-deficit problem – in budget and current account – and concerns that policymakers may fall behind the inflation curve.
Broad M2 money supply has jumped in the US by 23 per cent in recent months from a year earlier as a result of the fiscal and monetary easing measures launched to combat the Covid-19 economic slowdown. Aggressive government bond purchases by the Fed and the banking sector have essentially created money out of thin air and is likely to exacerbate the money supply situation for years.
The US deficit in its budget and current account have significantly expanded this year. In particular, the budget deficit has risen to just over US$3 trillion, about 15 per cent of gross domestic product. Economic modelling suggests that a soft budget constraint (coupled with a loose monetary stance) exerts depreciative pressure on a currency.
Adding fuel to the fire, the Fed’s recently announced “average inflation targeting” framework means it will at times let inflation run above the previous ceiling. If inflationary pressure emerges and the Fed refrains from tightening swiftly, real policy rates will drop, eroding the dollar’s value and its appeal to investors.
For emerging Asian economies, ultra-low US interest rates and a structurally weak dollar are positive for a number of reasons.
Given low global interest rates and inflation levels in most countries, the positive real yield – or returns minus inflation – offered in emerging Asia is attracting international bond inflows. Although Asian central banks have also cut rates, the region’s real yields remain positive.
Stronger emerging-market Asian currencies help to improve the region’s balance of payments by attracting capital inflows and reducing foreign debt burden. This is particularly beneficial to countries such as Indonesia, India and the Philippines, which have higher foreign currency debt and need international inflows to finance their current account deficits.A weaker dollar also reflects the performance of emerging markets compared to developed markets, and signifies stronger global trade flows. The dollar is only likely to weaken as the world economy gradually recovers from Covid-19 and global trade rebounds.
Two factors are important in driving macro performance in Asia: success in controlling the pandemic, and how the economy is positioned in an environment of low US rates and a weak dollar.
China, South Korea and Taiwan lead the region in having Covid-19 largely under control, allowing their domestic economies to recover and resume normal operations without excessive stimulus.
Meanwhile, India, Indonesia, the Philippines and Malaysia are better positioned to benefit from a weak dollar, which can help attract capital inflows and fund their current account deficits, considerably reduced by their smaller import bill this year.