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Currency market movements and impact on Indonesia SINGAPORE - Currency markets are attracting considerable attention from international investors and politicians. In particular, investors are showing increased sensitivity to stories that investors (particularly central banks) may reduce holdings of U.S. assets. The dollar has recently exhibited vulnerability in stories that China or Middle Eastern government's may switch their holdings of U.S. dollars into some other. Even if denied, the effects of these stories often linger in the currency markets.

This sensitivity to speculation about central bank actions reflects the importance of central banks to the funding of the U.S. current account position, and the sheer scale of the U.S. borrowing need. At the end of last year the U.S. current account deficit hit 7 percent of GDP, which means that the United States needs to find US$1.72 million of funding every minute of every day.

In 2004, according to the Bank for International Settlements, the accumulation of dollar assets by central banks accounted for roughly 80 percent of the U.S. current account deficit funding need. Clearly, concerns about the pace and direction of central bank reserve accumulation is something that will impact currency markets.

In this environment, it seems realistic to suppose that the structural bias of the U.S. dollar is towards further weakness -- not just against currencies like the Chinese Renminbi, but against other OECD currencies as well. If central banks scale back their role in the foreign exchange markets, someone else (i.e. the private sector) must move to fill the void (for one thing all economists can agree upon is the fact that the balance of payments will balance, and a current account deficit will be funded).

However, there is a price that must be paid for funding the U.S. current account position, and the price is likely to be cheaper U.S. assets (in order to attract in the required capital flow). While the dollar price of U.S. assets could, of course, decline it seems more likely that it is the dollar that will move -- making U.S. assets cheaper to foreign investors.

If the dollar does continue to decline, how will that affect Asia and Indonesia? For Asia generally the scale of the moves involved are unlikely to do serious damage to Asian competitive advantage. Of course, companies may well prefer it if the dollar were stronger against their national currencies, but they should have sufficient control over their costs as to be able to offset the consequences of the dollar's move.

Moreover, with many commodities still dollar denominated (for now at least) there is likely to be some beneficial impact on raw material costs. For Indonesia specifically the idea of a generally weaker dollar need not necessarily translate through into a stronger rupiah. The recent strength of the Indonesian currency may give way to a little weakness, as there is some suggestion of "carry trade" activity in the foreign exchange markets.

As global interest rates rise this suggests the prospect of some downward pressure on the Indonesian currency, in spite of the general backdrop of dollar weakness. In terms of the scale, this is likely to be little more than a 5 percent move from recent levels. That sort of shift is (of course) nothing out of the ordinary in currency market terms.


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Posted in Economy @ 16 May 2006 07:04 CET by Jeroen · 'Blog' RSS feed · permalink






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