Asian central banks are running out of ammunition to fight their currencies` biggest rally since 1998, paving the way for Korea, Taiwan, Indonesia, Thailand and India to help lead foreign-exchange performance next year.
JP Morgan Chase & Co.`s index of Asian currencies has risen 5.6 percent since its strongest two quarters in 11 years began March 31. Of 34 currencies ranked by Bloomberg forecast surveys, the won, Taiwan dollar, rupiah, baht and rupee will be among next year`s dozen strongest, median estimates show.
The currencies are rising even as policy makers sell them, amassing record reserves on concern that too much appreciation will slow export-driven recoveries. Investors are fueling the rallies by seeking greater returns outside the U.S., where near- zero interest rates have made the dollar a favorite to sell in so-called carry trades.
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"The money`s going to keep on flowing into Asian currencies, and central banks can`t continue to accumulate reserves indefinitely without some major side effects," said Simon Derrick, the London-based chief currency strategist at Bank of New York Mellon Corp., the world`s biggest custodian of assets.
"They have to let their currencies rise."
In the past month, five of Asia`s currencies were among the top 10 emerging-market performers against the dollar.
The rise has been propelled by an unprecedented net $47 billion that flowed into equities in India, Indonesia, the Philippines, Korea, Taiwan and Thailand in the last three quarters.
Speculation that Asian countries will raise interest rates as their economies outpace the West is also boosting their currencies.
The central banks now find themselves in a conundrum. They can let inflation accelerate as they flood their economies with local currencies sold for foreign cash. Or they can raise interest rates to keep prices in check and become even more attractive as carry-trade investors use money from countries with lower borrowing costs to buy Asian financial assets.
Some governments are trying to soak up the local cash they`ve printing by selling short-term local-currency debt, a process known as sterilization, but there aren`t enough buyers for the bills to finish the job.
"The depth of financial markets in these currencies is not large enough to issue the bills to mop up the excess liquidity," said Bilal Hafeez of Deutsche Bank AG, the world`s largest currency trader.
"That`s going to cause inflation unless they raise interest rates and let their currencies appreciate further."
Even after the won rallied 33 percent from an 11-year low on March 6, it remains undervalued by 56 percent against the dollar, second only to Mexico`s peso among 16 currencies in the Organization for Economic Development`s purchasing power parity gauge. It`s even more undervalued against the euro and yen, also second to the peso.
Bets on continued foreign-exchange strength in Asia may lose money if governments impose restrictions on their currencies` use.
Korea plans to restrict state-controlled companies from taking out dollar loans because foreign currency borrowed from local banks is helping drive up the won, a Ministry of Strategy and Finance official said last week, declining to be identified because the move hasn`t been announced.
Asia is more dependent than the West on exports, which become relatively pricier as the currencies of overseas competitors or customers weaken.
"It takes a relatively large change in Asian exchange rates to have an impact on export volumes," Peter Redward, head of emerging markets research for the region at Barclays Plc in Singapore said.
"As for exporter profitability, it clearly has an effect, but appreciation typically happens when global demand is accelerating and prices of exports are rising, such as now."
