South Korea is showing its uncanny knack for timing with its planned new steps to curb capital inflows, just ahead of its star role as host of the upcoming G20 meetings — which are likely to be dominated by discussions of “currency wars“.
G20 finance ministers, meeting from this Friday in the South Korean city of Gyeongju, are trying to lay the groundwork for the November summit of world leaders in Seoul. Their key concern is averting a round of competitive devaluations by countries hell-bent on shoring up their own tentative economic recoveries.
In that context, recent moves by Korea and other nations are really just the beginning of what many see as a new front in the so-called “currency wars” — fuelled by an increasingly interventionist approach towards capital flows among emerging market economies, particularly in Asia and South America.
As the FT reported last week, Seoul is moving to counter the recent strengthening of the won against the US dollar. While details of the measures have yet to be confirmed, analysts said they may revive a withholding tax on foreign investors’ bond holdings, and impose further limits on currency forward trading.
Seoul’s move followed Thailand’s decision earlier this month to reimpose a 15 per cent witholding tax on foreign bond holdings, while Brazil has recently doubled the tax on foreign investment in its government. It also follows Brazil’s move to toughen up a tax on foreign ownership of bonds and of course, the much-repeated warning by Brazilian finance mininster Guido Mantega of an impending round of ‘currency wars’.
As currency strategist Marc Chandler asks on Credit Writedowns, where does it all end?
While we have downplayed the talk of “currency wars” (since we are not seeing competitive devaluations), we do acknowledge that capital control measures do have an element of “beggar-thy-neighbor” in them. That is, if Brazil is taking measures to ward off hot money by raising the IOF tax, where does the foreign money go? Presumably to other EM countries that have a better risk/reward matrix. But then those countries will struggle with their own currency strength and will thus be tempted to take Brazil-type measures too. That is where we may be headed, with more and more countries expected to erect capital controls to help limit currency appreciation.
As long as the US, eurozone, Japan, and the UK are running loose monetary policy, there is not much policy-makers as a group can do to discourage this fundamental and liquidity-driven trade. As a result, it appears that most countries are willing to continue taking unilateral measures.
If the trend remains against the dollar, says CLSA strategist Christopher Wood, more actions will come sooner or later from Asian policymakers to try and discourage capital inflows.
Writing in the latest issue of his client newsletter Greed & Fear, Wood says it’s way too premature to worry about capital controls, or an asset bubble in Asia. Rather, incremental moves will only be made after further gains in currencies and asset values.
Concludes Wood:
Such a policy context will not end the Asian bull story. Rather it will only slow down and thereby extend the path to an asset bubble… True, Asian policymakers can crush asset bubble risk by raising interest rates aggressively and letting their currencies float. But it is unlikely in the extreme that Asian markets will be hit by such proactive tightening. In a world where US interest rates remain at zero, all sell-offs in Asian and emerging markets are buying opportunities. While asset prices in Asia are, in due course, going to become REALLY expensive.
Then of course, there’s always the matter of semantics — when is a ‘capital control’ a ‘capital control’? As Temasek Hedge recently observed:
Proof that Thai leaders have also attended the same night communications diploma school as Kim Jong Il and Barack Obama, the finance minister [of Thailand]… has declared that Thailand’s recent decision to deploy a 15% tax on foreigners holding Thai government and state-owned bonds is nothing more than a “withholding” tax, and really really not capital controls in disguise. Never mind the fact that Hot Money inflows into the country of the Hot Asian have pushed foreign holdings in Thai bonds to 10% of total, 2.5x more than a previous record of 4%.
But really, Thailand needn’t have worried about the nomenclature: the IMF itself has come out to endorse capital controls as a legitimate short-term policy tool, years after the very same IMF made Malaysia an international pariah by declaring the Mahathir Mambo as shortsighted and stupid. Sheer hindsight brilliance from PhD scholars who actually believe everything they read in a Lipsey & Steiner paperback.
Related links:
Currency wars: ‘The crisis is upon us’ – FT Alphaville
Arvind Subramanian: US cannot win the currency wars alone – FT
Emerging markets at risk from a gigantic bubble - FT
Martin Wolf: How to fight a currency war with China – FT