Most consumers notice currency values, or exchange rates, when they travel abroad. One year you may find yourself feeling wealthy upon entering a foreign country, but the next year you may find yourself “shortchanged” at customs. How are these exchange rates set, and how do these rates impact trade within Southeast Asia?
Currency Market Basics
Before we cover international trade, let’s explore how and why exchange rates change. There are two basic models to consider: Currency values which are pegged and currency values which are floating.
In a country where exchange rates are pegged, the Central Bank works aggressively to maintain a stable exchange rate between their home currency and a foreign currency. In some countries, this may be a one-to-one relationship between the home currency and a foreign currency. In other countries, it may be a ten-to-one relationship.
For the majority of pegged currencies, this exchange rate is set against the U.S. Dollar or the European Dollar (i.e. the Euro). These central banks influence their domestic exchange rates by buying or selling their home currency in order to tighten or expand their money supply. Lower supply of money leads to higher value of the currency. Higher supply leads to depreciation relative to foreign currencies. China is a major economy whose currency, the Yuan, is pegged to the U.S. Dollar.
With floating currencies, the central bank takes a hands-off approach to exchange rates and care more about controlling their domestic interest rates. The central bank allows the open market to determine the value of their home currency relative to foreign currencies. The value of floating currencies come down to basic supply and demand.
Factors which can increase the demand for a currency are any activities which require foreigners to buy the currency. This can happen as a result of international trade or increased investment opportunity within a country.
The supply side can get a little bit more complicated, as central banks are charged with printing money. In a strict floating currency country, the central bank will regulate its internal interest rate and money supply to regulate its domestic economic conditions. There are few countries in the world which operate as true floating rate currencies, where the central bank is completely hands-off. In the United States for example, the central bank operates a pseudo-floating currency model, but will intervene at times to increase or decrease the money supply.
The Singapore Dollar
In Singapore, the Monetary Authority of Singapore uses a “managed float policy” to guide the value of the Singapore Dollar. Under this structure, MAS allows the Singapore Dollar to trade within a range of values against an undisclosed basket of currencies. In this way, the strategy is partly pegged and partly floating. The approach is more rigid than is found in the United States, but much more fluid than the approach used by China.
How Exchange Rates Impact International Trade
So how does the value of the Singapore Dollar impact trade? Let’s take the example of trade between Singapore and China. This is a very practical example, as China is the leading trade partner with Singapore accounting for roughly 14% of Singapore’s annual export.
The chart below shows the value of the Singapore Dollar, relative to the Chinese Yuan since 2011.
In 2012, one Singapore Dollar was worth five Chinese Yuan. By January of 2015, one Singapore Dollar was worth just 4.4 Chinese Yuan, a difference of 12%. For a Singaporean traveler visiting a pub in Shanghai, the impact was quite minimal. With the average price of a beer in China around 10 Yuan, the difference in the price of a beer for a Singapore traveler between 2012 and 2015 was just SG$ 0.27.
The impacts can be significant, however, for firms that make large purchases from China or take large loans from Chinese banks. During this time the value of the Singapore Dollar depreciated by 8% against the Chinese Yuan (inverse of the 12%). Below are two examples of how this would have played out:
- For a Singapore business who purchased SG$ 1,000,000 of Chinese goods in 2012, the cost would have increased to S$1,080,000 in 2015.
- For a business which paid SG$ 10,000 in interest to a Chinese bank each month during 2012, its interest payment would’ve increased to S$10,800 in 2015.
Both of these examples highlight the primary way exchange rates impact trade. As a currency loses value, it becomes more favorable for trade partners to purchase goods and services. As a currency appreciates in value, it becomes less favorable for international partners to make these purchases. It may seem counter-intuitive, but it is for this reason that many countries have worked to decrease the value of their home currencies since the 2008 financial crises. Lower currency values mean more export business, higher growth for a country’s businesses, and more income for its citizens.
Latest Trends in Asian Currencies
So how have the currencies been behaving recently? Below, we have prepared a graph that illustrates the percent change in the value of USD against major Asian currencies since January 6th 2013. Because it calculates the % change since Jan 6th 2013, this graph starts from 0% change in 2013. For instance, we can see that the USD has appreciated by about 40% against the Indonesian Rupiah since 2013.
As you can see, this graph shows two trends for the last few years. First, most Asian currencies have been depecreiating against the USD in the last 5 years. This largely reflects the currency war that central banks have been waging against one another in order to protect their export industries. As an emerging market, many of the Asian countries are heavily reliant on export industries (i.e. manufacturing) to grow their economics, and cheaper currencies are a major tool to make a nation’s products cheaper than other nations’. Sadly, the net effect has been that everyone’s currencies have devalued, effectively negating the stimulative effect that exchange rates could have on exports.
Secondly, the depreciation against the USD has been accelerating since beginning of 2015 and end of 2016, as the US Federal Reserve began to raise its interest rates. As the US began to raise interest rates while other countries continued to cut or maintain their low interest rates, investors have been more incentivized to buy the dollar: the opportunity to earn higher interest by holding US bonds may seem more attractive than holding near-zero rate bonds in currencies that continue to devalue. As Yellen herself has indicated possible further rate increases in 2017, this trend is likely continue in the foreseeable future especially given that Asian economies are not particularly healthy (and thus has more impetus to keep their exports competitive).
The article Currency Valuations and Implications for Trade in Southeast Asia originally appeared on ValuePenguin.
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