Forex Fundamental Analysis 081112

Dear Friends,

A number of you have been asking me whether it is time to buy Aussie Dollar. As I do trade Forex, I have decided to invest some time to research the "fundamentals" of key countries. Here are some useful information for you to consider before you "invest" in your favorite currencies: -

Countries       USA  Japan  China   GER     UK   Russia  Aust   NZ     SG  Malaysia
-----------------------------------------------------------------------------------
US$'Billion
GDP          14,499  5,059  4,149  3,707  2,730  1,682  1,041   128    185   216
Trade Bal      -826     81    309    324   -177    171    -10    -2     42    40
Current A/C    -588    188    368    263    -73    109    -45    -9     32    29
Reserves         71    954  2,033    112*   24*    594     34    15    170   125
External Debt 5,466  8,620    421  2,317  1,289    412  1,032    59     26    56

Population(m)   304    127  1,331     83     61    142     21     4      5    28
Net Reserve   -5395 -7,666  1,612  -2205  -1265    182   -998   -44    144    69
Net R/C (US$k)  -17    -60    1.2   -2.7    -21    1.3    -47   -11     29   2.5
GDP / Capita     48     35    6.1     35     36     16     39    27     43    14

Notes
Data extracted from October / November 2008 EIU Reports unless otherwise stated.

112* - Extracted from earlier EIU Report. Current Reports do not show International Reserves any more.

24* - UK Foreign Reserves data is not disclosed in EIU Report. Thus, data was extracted from CEP News website http://www.economicnews.ca/cepnews/wire/article/155590

Most of the External Debt Data is a computation result of Percentage of GDP. Also, it is possible that the data reflects only the Government Foreign Debt and not the total Foreign Debt of the country. This means that the Total Foreign Debt could be larger than the statistic here.

Net Reserve is my own terminology which is a computation of the Reserves less the External Debt.

Net R/C means Net Reserves divided by the Total Population. If the Net Reserve is positive, then the Net R/C will also be positive, and reflects the average Reserve net of the External Debt per Person. If the Net Reserve is a negative figure, it means the country owes more than it owns, and thus, the Net R/C figure reflects the average amount of Debt per person that the country owes.

GDP / Capita is measured in terms of US$'000.

UNDERSTANDING THE NUMBERS

The correct data for External Debt should include ALL Foreign Debt, both Government and Private Sector. However, I have a feeling that the data extracted includes only the Government portion of the External Debt. Thus, I will treat the External Debt as Government Debt.

Foreign Reserves & Government Debt

One of the most important things to understand is that Foreign Reserves of a country is NOT the amount of reserves owned by a Government. Instead, it is the total Foreign Reserves owned by everyone in the country, from foreign corporations, individuals, to the Government.

For example, Japan is a unique country with a strong Foreign Reserve Position of US$954 billion. On the other hand, the Government Debt totals US$7,666 billion. It is important to note that whilst the Debt is owed by Government and therefore, the Japanese taxpayers, the Foreign Reserve is probably owned by entrepreneurs like Akio Morita (Sony), etc.

What is very interesting is that we normally expect a developed country to be stronger in terms of the country's financial statistics, i.e. namely its Net Reserve. However, the data above shows that Developed Countries i.e. USA, Japan, UK, Germany, Australia, and even New Zealand, show a Net Debt Position.

The only Developed Country in the table that shows a Net Reserve Position is Singapore. On the other hand, China, Russia and Malaysia have a Net Reserve Position.

Why? Possibly, it is because entrepreneurs / business corporations in the Developed Countries tend to invest in other developing countries. This is known as Foreign Direct Investment. FDI.

The FDI Outflow is recorded in the Balance of Payments merely as an Outflow, and is usually no longer tracked after it has flowed out, possibly because there is no way of knowing when this money will ever return to its origin country, if ever at all. Sometimes, the money is lost due to business losses, whilst at other times, the money actually generates good returns on investments, but is recycled as FDIs into either the same investee country, or other developing countries.

In any case, a comparison of the Net Debt per Capita sratio with the GDP per capita, which is the average income per person, shows that the situation is not as alarming as initially observed based on absolute balances.

The only exceptions that need to be monitored much more closely are the Japanese and Australian situations, where the Net Debt per Capita has exceeded the GDP per Capita.

What does this mean? Let's look at it this way. How long does it take for you to save exactly the amount of money you earn in a year? For example, if the GDP per Capita of a Japanese is US$35,000 per year, how many years will it take him / her to save US$35,000?

If he / she saves at the rate of 10% per annum, then the answer is 10 years. If the person only saves 5% of his income, then it will take him 20 years to save a whole year's salary. Thus, a situation where the Government Debt per person exceeds the Average Income per person, is much more critical than most situations where debt constitutes less than 33% of the Average Income.

In a country like the USA where the savings rate is minimal, then, any amount of debt can be alarming. This is why some people accuse the USA of being a bankrupt nation which spends more than it can earn, year after year.

Assuming Americans start saving at the rate of 2% of their annual salary, it will take 17 years to settle the debt, excluding interest payments. This assumes that there is no more additional Government Debt incurred from hereon, which is NOT the case.

Current Account Surplus as a Key Driving Force

Theoretically, a country with a Net Current Account Surplus should experience a strengthening of its currency against a country which has a Net Deficit. This means that Malaysia, with a Current Account Surplus of US$29 billion compared to the Australian Current Account Deficit should experience a strengthening of the Ringgit compared to the Aussie Dollar (AUD) in the foreseeable future.

This is based on the assumption that both Current Account performance will persist in the foreseeable future of the next one to two years.

Other Key Driving Forces

Other Key Driving Forces that affect the strength of the currency are: -

1. Interest Rate Differential
2. Unwinding of Carry Trade / Short Term Hot Money Flows
3. Long Term FDI Flows
4. Flight to Safety, if there are concerns over the Political & Social Stability of a particular nation.
   

Malaysian Ringgit vs Aussie Dollar Case Study

We will take the Malaysian Ringgit vs Australian Dollar situation as a case study.

Australian Central Bank (RBA) Interest Rate has come down from a very high 9%, and is falling rapidly, whilst the Malaysian Bank Negara rate remains stable at around 3% to 3.5% throughout the last few years. This means that Interest Rate Differential is narrowing between Australia and Malaysia, and this points to a potential strengthening of the Ringgit.

For the last few years, the Aussie Dollar has been one of the darling currencies for the Carry Trade. The Carry Trade is a strategy where one buys the Aussie Dollar, and puts it in a high yielding deposit. With the Aussie Dollar strengthening, coupled with a higher interest rate, the Carry Trade was one of the most important "investments" for the last few years.

However, in the last few months, the Australian Economy has suffered a change in trend for the worse. Consistent with the fast weakening economy, and the lowering of the interest rate, and the rapid devaluation of the Aussie Dollar, "investors" rushed to unwind their Carry Trade investments.

I am not convinced that the unwinding can be completed within a few months when the inflow took a number of years. Thus, the Unwinding of the Carry Trade provides a Short Term Outlook of a continued weakening of the Aussie Dollar against currencies that did not experience a huge inflow of such Short Term Hot Money. In fact, the Ringgit also experienced an outflow of US$20 billion in Hot Money, in August 2008, which was when the Malaysian Government considered reinstating the repegging of the Ringgit.

Such a statement should not have been made public without a careful study, and in fact, after the study, the Malaysian Government decided against reinstating the Ringgit peg, but the damage is already done - some people lost confidence in the Ringgit, and opinions of a weakening Ringgit formed in the minds of Malaysians, rightfully, or wrongfully, thanks to the Government's ill conceived announcement.

Theoretically, the Malaysian Ringgit should strengthen against the Aussie, but practically, even some Malaysians are worried about political and social stability, and is suspicious of sudden Government proposals like repegging of the Ringgit. This causes outflows of money out of Malaysia, resulting in the selling of the Ringgit.

The last factor is the FDI Flows, which Malaysia is experiencing a NET Outflow. Although FDI Inflows is steady at US$5 billion per annum, the repatriation of profits by MNCs (Multi National Corporations) exceed the FDI Inflows, and thus, there is a net outflow. This is a key driving force that counters the strengthening of the Ringgit, but is already accounted for, in the Current Account Surplus, i.e. Malaysia is still in positive territory, despite the Net Outflow.

Thus, from a Fundamental Perspective, I expect the Malaysian Ringgit to strengthen against the Aussie Dollar for the foreseeable future.

Since the Kiwi usually moves in tandem with the Aussie Dollar, and the New Zealand Economy is somewhat corrrelated to the Australian Economy, I expect a similar strengthening of the Ringgit against the Kiwi (NZD) in the next one to two years.

S$ vs the Ringgit

As for the Singapore Dollar (S$), it has always been the history of the two countries that the S$ will always strengthen against the Ringgit, and there is no reason to believe that this Long Term Trend will change in the foreseeable future of the next one to two years.

S$ vs US$

The future of the S$ against the US$ is not so clear. Until the last few months, the S$ had strengthened strongly against the US$, and within two years, the USDSGD exchange rate fell from 1.52 to 1.32. However, within a short period of time, this long term trend was reversed, to the extent that the exchange rate is now back to the 1.50 level.

Why? Two reasons. The first is that the Monetary Authority of Singapore (MAS) had been adopting a policy of fighting inflation by strengthening its currency. When the S$ strengthens, this means that Singaporean consumers will pay less S$ for the same goods. Although this policy defrayed some of the inflationary pressures, nevertheless, Singaporean consumers felt the inflation strain.

Since inflation is easing, and no longer considered a serious threat in a rapidly weakening economy, it would seem that the MAS has changed its policy stance and has allowed the S$ to weaken, consistent with the basket of currencies that MAS monitors against the US$.

I do not know the exact composition nor the exact formula of the basket of currencies weightage, and it would not seem to matter in the next one to two years. Why?

Because the key currencies of the world, except for the Japanese Yen, and the Swissie (Swiss Francs CHF) are all weakening against the US$, mainly because of the unwinding of Carry Trade, the sales of non US assets and repatriation of funds back to US, and the "acute" shortage of US$ in the world, possibly as a result of the losses arising from investments in US Assets which have depreciated quite substantially since.

Interest Rate Differentials are narrowing rapidly, as the ECB (European Central Bank), the BOE (Bank of England) and the RBA (Royal Bank of Australia) reduce interest rates on a frantic basis, in REACTION to a exponentially deteriorating economy.

This, coupled with the fact that the European, British and Australian exports are slowing dramatically, the earning of US$ by these countries are also slowing. Thus, from an economic perspective, the future of these countries and their currencies are tied to the US Economy. In view of this correlation, one wonders if the Euro, the British Pound or the Aussie has any chance of strengthening against the US$, despite the economic problems faced by Americans.

Given the above scenario, would the Singapore MAS still want to maintain a peg against a basket of currencies?

One argument is that the Singapore MAS wants to devalue the S$ to spur the manufacturing exports which have been facing slowdown pressures for half a year now.

This makes sense, but in my personal opinion, the more important objective for MAS and the Singapore Government is to implement an effective strategy to grow Singapore out of the impending and likely to be severe economic recession.

How can Singapore grow itself out of a recession? How can the Singapore Government ease the economic pains on Singaporeans by encouraging job growth?

Obviously, the only key solution is Government Spending. Fortunately, the Singapore Government has been financially prudent in managing its strong economic growth years, and now, it has the money to spur the economy with infrastructural improvement projects.

As Singapore imports most of its needs, any Government Spending on Infrastructure Projects are likely to involve high import values. This is especially so, when even sand needs to be imported from Indonesia, while it imports plain water from Malaysia.

Thus, it would seem the appreciation of S$ will soften the cost of living for Singaporeans, while reducing the cost of imports for construction of infrastructural projects. Also, with a million foreign workers (work permit holders and permanent residents), there is a lot of capacity for Singapore to shrink in terms of Unemployment.

In any case, I cannot in my mind comprehend a situation where

• the currency of a country with minimal foreign debt, enjoying current account surplus, with one of the world's strongest foreign reserves, and possibly the highest Reserve per Capita in the world, will weaken against
• a country with an extremely high Foreign Debt, with the world's worst Current Account Deficit which is irreversible in the foreseeable future.

In my mind, the S$ must strengthen against the US$ in the longer term future of the next one to two years. This has been the trend of the S$ against the US$ since year 2002, and there is no reason to see why this Long Term Trend will change in the foreseeable future, although, in the Short Term, the various reasons for the US$ rally as mentioned above may continue to prevail.

Lastly, please be reminded on the Liability Exclusion Clause, which is at the top of my blog page, i.e. that the final trading decision is yours, and I will not be responsible or liable for any losses you may incur from whatsoever reason. :)

Best wishes,

Ooi

© Copyright of Praesciens.blogspot.com, 2008