Currency revaluation needed to ward off Asian inflation threat

Over the past three months, Asia has featured growth and inflationary trends, the growing realisation of unsustainable currency imbalances and the role that currency adjustments may play in combating inflation.

“Our basic argument remains that heightened inflation risk in the region, brought on by robust economic growth, could prove manageable through exchange rate management and through the acceptance of some currency revaluation against the US dollar,” says Hasenstab.

The US current account and trade deficits help support the belief that Asian currencies are undervalued against the dollar, adds Hasenstab. He points out that the US current account deficit reached $166.2bn (£92.35bn) in the second quarter of 2004, which is 5.7% of GDP. This was a 24% increase over the same period in 2003.

This deficit has been driven partly by the growth in the US trade deficit, which reached a record $55bn (£30.56bn) in June 2004: “As the US trade deficit widens, so the trade surpluses of Asian countries rise. For this period, China’s trade surplus with the US grew 27%, Japan’s by 12.5% and South Korea’s by 59%,” says Hasenstab. “These statistics are one measure that supports the argument of the undervaluation of Asian currencies and the overvaluation of the US dollar.”

He says Templeton remains overweight Asian currencies: “In our view, these currency positions provide an implicit global inflationary hedge and remain fundamentally undervalued.”

With industrial production growing 15.5% in the second quarter and inflation rising at an annualised 5.3%, Hasenstab cites the economic conditions in China as being right for the authorities to consider currency adjustment to help offset further rises in inflation.

He adds that the effects of a hard landing in China have been overstated: “A slowing of Chinese growth could easily be offset by growth in the US and robust domestic growth in the various countries in the region.”