US dollar war chests swell in Asia as central banks ‘learn from the past’

Central bank holdings of foreign currencies in Asia’s fast-growing emerging economies hit US$5.82 trillion last month

China’s foreign-currency holdings rose to their highest level in five years in May on the back of a weaker US dollar and increased portfolio inflows

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Asian central banks are preparing to meet any shift from US Fed chairman Jerome Powell (above) with a wall of currency firepower. Photo: AFP

Published: 1:30pm, 16 Jun 2021Updated: 1:38pm, 16 Jun 2021

Asia’s emerging economies have accumulated their highest level of foreign-exchange reserves in seven years, offering a powerful buffer against market volatility if the US Federal Reserve changes course.

Central bank holdings of foreign currencies in the region’s fast-growing emerging economies hit US$5.82 trillion as of May, their highest since August 2014. When China’s cash pile is stripped out, emerging Asian central banks’ reserves stood at an all-time high of US$2.6 trillion.

While some of the gains reflect US dollar weakness and bumper exports, policymakers are deliberately preparing their defences, said Nicholas Mapa, an economist with ING Groep NV in Manila.

“Emerging economies are definitely learning from the past by war-chesting,” Mapa said. “They’re all the more aware of the eventual reversal in the monetary policy stance of developed market central banks and the potential repercussions that may arise from a Fed taper or eventual rate hike.”

While the Fed is expected to maintain a dovish outlook when it meets this week, economists say the accelerating recovery in the United States means the central bank will need to signal a policy turn sooner than anticipated. Central banks in South Korea and New Zealand have already said that their improving economies may eventually justify higher interest rates.

A signal from then-chairman Ben Bernanke in 2013 – that the Fed would begin winding down asset purchases – sent shock waves through Asia, in an episode that came to be known as the “taper tantrum”. Foreign investors fled and bond yields shot up, forcing central banks to burn through their defences to protect their currencies. Rising yields have historically triggered currency volatility and driven up borrowing costs in the region.