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Asian Developments Drive Currency De-Risking

January 26, 2017 | Multi-Asset

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Two developments in Asia have caused us to recently change our currency strategy, and both fell outside of fundamental valuation considerations.

First, India abruptly withdrew two banknotes, which between them accounted for more than 80% of the money in use in the country's highly cash-based economy. New banknotes were introduced, but with restrictions on availability and convertibility. This was partly logistical and partly intentional as a push to increase bank-account penetration.

We were concerned that the economic impact of the move, which was designed to also counter informal and illegal transactions and cash piles, would lead to a sharp temporary contraction in India's rapid growth rate.

We were concerned that the economic impact of the move would lead to a sharp temporary contraction in India's rapid growth rate.

So, we reduced our long exposure to the Indian rupee (as well as the Indian equity market) in the immediate aftermath of the announcement. Since then, however, we have seen limited impact from the removal of the bank notes on India's economic data. Additionally, incoming information suggests the bulk of the currency holdings not exchanged for new notes have been successfully converted to bank deposits. We, therefore, have begun to re-build our long exposures in both the Indian rupee and Indian equity market.

The other development was Malaysia's government acting to curtail offshore banks from market-making in the ringgit. This is not a market over which the Malaysian authorities have direct control, but they can nevertheless influence it via relationships with foreign banks involving domestic Malaysian asset holdings. The government's rationale was to limit the impact of what it regards as speculative selling of ringgit, which it views as contrary to Malaysia's interests.

While we agree with the Malaysian government that the ringgit is fundamentally undervalued and weakness is not justified over the medium term, reducing liquidity may be counterproductive, as it may cause offshore investors to exit ringgit-denominated assets.

Accordingly, we reduced long exposure to the currency, and to better navigate the now-poor liquidity in offshore forward contracts, we have switched the smaller ringgit exposure into short-duration local-currency fixed income.