part0039

This is the chapter in which I want to focus on several countries in the Asia Pacific region. A region often ignored by currency speculators and investors. However, in these times of changing global dynamics, there are some very interesting opportunities on the horizon. And the place I would like to start is Hong Kong, which needs little introduction. It is now part of China but, until 1997, was a British Colonial territory before it was handed back.

Hong Kong is one of the most advanced economies in Asia and is renowned for its open approach to business. Strategically placed at the heart of Asia it offers a unique environment of freedom and stability, yet is in close proximity to the largest trading nations in the world. It is the ultimate springboard for companies of all sizes to launch their products and services into Asia and mainland China.

The economic landscape of Hong Kong is dominated by the services sector, which represents approximately 90% of GDP, of which financial services form a significant percentage, as most manufacturers have now moved their operations to mainland China.

The currency of Hong Kong is the Hong Kong dollar and is one that is tightly managed by the Hong Kong Monetary Authority, to the extent that since 1983 it has been contained in a tight range against the US dollar, trading between 7.75 and 7.85 HKD to the USD. This type of exchange rate regime is often referred to as a 'linked exchange rate' and ensures the band the currency trades in remains narrow.

The HKMA is, in effect, a currency board and central banking authority, but is also a government body with no remit to manage monetary policy. Its remit is to maintain the currency in a narrow range and to ensure it has sufficient foreign reserves to allow exchange for all holders of the home currency. All of this is reflected in the chart in Fig 14.10 which is perhaps not the most exciting if you're a currency speculator.

But times 'they are a’changing' for the Hong Kong dollar, as the issue for the HKMA and other currencies pegged in the same way, is the two speed economies that are now increasingly a feature of the global economic landscape. With Asia growing, and growing fast, while the US economy stagnates and only recently has begun to show signs of life.

In this scenario the FED is keen to maintain low interest rates, backed with sustained quantitative easing programs which help to support a weak dollar. Through the currency board, the HKMA has to maintain the peg within the range specified, ignoring (for the time being) the effects this is now starting to have on inflation and a potential housing bubble, all by products of 'so called', imported inflation.

Furthermore, Asian currencies have been strengthening, forcing the HKMA to intervene in order to defend the currency peg. This, in turn, has added further fuel to the fire of inflation which has now started to become an issue for the Hong Kong authorities who are increasingly locked in a cycle of repeated interventions and rising inflation.

Weakness in the Hong Kong Dollar has also been reflected in consequent strength of several Asian currencies, not least against the yuan and, with over 45% of imports coming from mainland China, this is also fuelling inflation as the cost of imported goods rises.

Finally, with low interest rates and cheap money, the Chinese are increasingly becoming property speculators in Hong Kong, driving prices higher, thus creating the classic conditions for a housing bubble. And one which has many parallels with the Japanese bubble of the late 1980's and early 1990's. To put this into context, property prices rose by 23% in 2012 in a country which already has some of the world's most expensive real estate.

Against this backdrop what options are available to the HKMA who are becoming increasingly frustrated by the actions of the Federal Reserve?

The first option is to free float, but this is unlikely. The second option is a widening of the band, which is possible. The third option, and one which is increasingly gaining some traction, is a re-peg to the yuan. This is under serious consideration, given the increasing importance the yuan is now taking on the world stage.

Of all the options the last is perhaps the most realistic, tying together Hong Kong and mainland China in a currency peg two neighbouring economies moving at the same speed, with close trading relationships. This may also trigger the ultimate demise of the Hong Kong Dollar. Whilst it is unlikely the Chinese will ever succumb to pressure from the West to allow their currency to float in a free exchange regime, there will inevitably come a point when the Hong Kong Dollar becomes redundant and is ultimately absorbed into the Chinese currency, and disappears from sight altogether.

Singapore is a small but strategically placed city island nation with the Singapore dollar as its currency. With its unique location on the major sea route between India and China, it is one of the smallest, yet most successful economies in the world.

Singapore is one of the great success stories of Asia, of which there will be many more in the next few decades, as in one generation Singapore has managed to transform itself from a developing country to a leading industrial economy at the heart of the Asian tiger economies.

This is very different from where it was in the 1960’s and, in many ways difficult to believe. In the 1960’s Singapore was struggling with the problems of high unemployment and an inability to sustain the economy.

This changed once there was a major restructuring of the education system. This has resulted in a highly skilled and educated workforce with an emphasis on mathematics and the core skills required in industry. Indeed, if the Asian success story could be encapsulated it would almost certainly include the emphasis on education and the thirst for knowledge, coupled with a personal desire to achieve a better standard of living.

This drive and motivation is further reinforced by ‘Tiger Mothers’ who push their children to achieve, and has been one of the key factors in the extraordinary transformation that is Singapore.

Whilst Singapore's economic transformation has been one of the iconic examples of the last century, the country has not been immune from global economic shocks, as in the late 1990's, Singapore, along with Hong Kong, saw their GDP growth drop from 4.5% in 1997 to -3.5% in 1998, as the effects of a sudden spike in oil prices took their toll. At the time this period was dubbed the 'Asian flu'.

This period recorded Asia's first drop in demand for crude oil since the early 1980's and was coupled with sudden currency depreciation and rising interest rates. What had begun as an attack on local Asian currencies, quickly escalated into a lack of confidence in the monetary systems, debt defaults and a freeze on foreign capital. All of this was reflected in the price of oil which fell sharply, as the twin effects of a reversal in growth in Asia, coincided with an increase in the oil supply from Iraq. At this point the oil price dropped to an unbelievable $12 per barrel at the end of 1998. A huge fall from the highs of mid 1997 which had seen oil prices test $21 per barrel.

The Singapore dollar is 'supervised' by the Monetary Authority of Singapore. The currency is managed against a trade weighted basket of other currencies of Singapore's major trading partners. The composition of this basket is always kept secret, and revised periodically to take into account changes in global economics and associated exchange rates.

Moreover, the band within which the rate is allowed to float is also kept secret. Here we have one of the more unusual exchange rate mechanisms. The Singapore dollar is allowed to float, but only within a range which is never disclosed and the underlying basket of currencies and their weighting is also never disclosed. So is there anything we do know about this currency which is shrouded in secrecy and mystery?

For an answer let's consider the chart in Fig 14.11 for the SGD against the USD which is a monthly chart and two elements are perhaps striking.

The first is the continued strength of the currency, at a time when every other country around the world (almost without exception) is looking for a weak currency, not only to protect their export markets, but also to drive some much needed inflationary pressure and growth into their economies. Singapore and the MAS, on the other hand, are happy to maintain a strong currency. Maintaining a strong currency appears to be their intent, preferring to keep inflation in check, to see import prices rise, and maintain a stable but healthy economy. This policy was recently further reinforced by the Trade and Industry minister who said:

"The strengthening of the Singapore dollar is a key macro-economic policy tool to keep inflation in check over the medium term,"

"The MAS recognises the need to strike the right balance between ensuring exporters are not unduly hurt by a stronger currency in the short term, and capping underlying price and cost pressures in the economy."

This is the balance the MAS is looking to maintain in its secretive policy of currency management.

The second point to note from the above chart is that it gives us clues on the bands the MAS are currently using. This can provide some perspective on whether, as a speculative trader, we can take advantage and what is clear from the above is currently the 1.2200 level appears to be the lower limit. The currency was allowed through this level briefly in 2011, before the MAS intervened.

This technical picture, notwithstanding, one of the characteristics of the Singapore dollar is that it is generally considered to be a safe haven currency. However, when investors and speculators are looking for better returns the Singapore dollar becomes a less attractive proposition, given the ultra low interest rates in Singapore.

Singapore does not have a central bank. Instead the MAS is tasked with controlling inflation and the economy through the exchange rate basket.

Interest rates are set by the local banks themselves using two widely used benchmarks as reference points. These are the Sibor or Singapore Interbank Offered Rate, and the Swap Offer Rate known as the SOR. Both of these rates are fixed by the Association of Banks of Singapore on a daily basis, and the Libor rate is just like any other – it is the rate at which banks lend to each other. The SOR on the other hand is effectively a measure of interest rates for commercial lending. It is these rates that form the basis for all other lending.

The Singapore dollar is also considered an 'exotic' currency, and therefore has many of the characteristics of other exotic currencies. Price action can be both relatively spiky and sluggish, with sudden moves occurring whenever the MAS step in to the market, which they do frequently.

The spread against the US dollar, which is one of the more liquid pairs, can be relatively wide, therefore the Singapore dollar is more appropriate for longer term swing or trend trading. The general bias for the pair is to the short side of the market, and the question with any managed pair, made more difficult with the Singapore dollar, is where the targets for the currency have been set in the short and medium term. This downside momentum is also helped by US dollar weakness which has been a feature of the last few years.

Finally the Singapore dollar can also be considered as a proxy for the Chinese yuan and the reasons are as follows.

First trading the US dollar yuan directly is almost impossible given the way the Chinese currency is managed and the pair is also highly illiquid. Therefore, for traders who want to take advantage of Chinese data, one option is to trade the currency of a country with a close relationship with China such as Singapore. Moreover, the consensus view (at least in the US) is that the yuan is under valued against the US dollar so buying a yuan proxy is one way to exploit this opinion.

Other yuan proxy currencies include the Malaysian ringett, the Korean won and the Taiwanese dollar.

This brings us neatly to the next country in our whistle stop tour of Asia Pacific, which is Taiwan and to examine how its economy and its currency fits within the Asian tiger economies. Just like Singapore, Taiwan has transformed its economy in the space of four decades to become the 19th largest in the world in terms of GDP.

To put this into context, in the early 1950's almost one third of Taiwan's output was from agriculture. In the second decade of the 21st century this is now below 3%.

Taiwan is now the place for leading edge manufacturing for high tech electronic goods. These now dominate Taiwan's export dependent economy, as much of its more traditional manufacturing of clothes and shoes has moved to mainland China.

This change of emphasis in its economy has not only led to an increase in living standards but also to an increase in overheads which is why many of these businesses moved to China, where manufacturing costs are lower.

Like other economies in the region, Taiwan was not immune from the Asian crisis of 1997, but in Taiwan’s case the effects were far less dramatic. For Taiwan, the crisis was little more than a pause point, where the economy drew breath, before moving on once the storm had passed. By contrast, Indonesia suffered badly with a 14% fall in output. However, in Taiwan, business continued much as before, with unemployment remaining low and, with significantly lower debts than some of its nearest neighbours, Taiwan remained in surplus throughout this period. This is testament to the banking system and an economy focused on exports.

However, Taiwan is not without its problems, some cultural and some economic. The cultural problems are well documented and revolve around its relationship with China. Whilst this relationship has improved, tensions still exist. Indeed China and Taiwan are often referred to as the 'two Chinas’, with China believing Taiwan is still part of its territories. This in turn creates problems internationally both diplomatically and in terms of trading agreements. Ironically, it was China that provided the strong demand that offset a fall in demand from the US.

The second problem for Taiwan is a lack of natural resources and, in many ways, the economic profile of Taiwan is similar to that of Japan. Taiwan's economic growth has been based on exports. It is one of the world's most export dependent economies, with Western consumers its major targets. As a result, in the financial storm that has engulfed the world in the first decade of the twenty first century, Taiwan has not managed to escape.

Not only has demand from the West fallen sharply, but exports to China also slumped, as Taiwan's export markets suffered a double blow. This has put pressure on consumer spending. In tandem with falling exports, rising commodity prices in particular oil, has resulted in imported inflation, which has become a major issue for the Central Bank, which has been forced to cut interest rates.

Finally, the strength of the Taiwan currency, the New Taiwan dollar, in particular against the South Korean Won, has impacted exports making Taiwan less competitive in the region. A heady cocktail which is an ongoing issue several years into this crisis, as the Taiwanese economy struggles to cope with the global slump in demand both from its nearest neighbours and from the West.

And now for a little background on the New Taiwan dollar, the economy and how the exchange rate is managed.

Although the currency of Taiwan is referred to as the ‘New’ Taiwan dollar this is something of a misnomer as the currency was actually introduced in 1949. It is the official currency of Taiwan which ( just to confuse) is referred to in many places as the Republic of China or the ROC.

The central bank is also denoted in this same way, and has the title of, The Central Bank of the Republic of China. Like all central banks it is responsible for managing the Taiwanese economy, primarily through the use of interest rates, although the bank is another with an interventionist policy, much like the Bank of Japan.

In the last ten years, central bank interest rates have remained relatively low, moving higher in 2007 to a peak of 3.38%, before falling as the effects of the global slowdown took hold, to settle at 1.87%.

As we have already seen, the countries of East Asia have adopted a variety of exchange rate policies, with Hong Kong adopting the currency board, Japan a free float, China a crawling peg, and the Singapore dollar a tightly managed float. The Taiwan New dollar can be considered as a free float although, as outlined earlier, the central bank will step in as necessary should the currency strengthen too much.

Such action is not restricted to Taiwan with many other countries in the region taking similar steps.

This is now increasingly becoming a bone of contention with the US starting to suggest major exporters such as Taiwan, Japan and China, are deliberately keeping their currencies undervalued, to protect their economies from the worst of the economic collapse. Furthermore, these actions now constitute 'currency manipulation' and violate some of the principle Articles of Agreement within the IMF.

Moreover and, perhaps even more interestingly, the US has also suggested the East Asia 'economic block' has entered into an unwritten agreement to maintain relative exchange rates in the region. A pact of exporters if you like, where one currency is not allowed to strengthen too much against another within the East Asian region, thereby ensuring exporters are able to compete on an equal footing, and one country does not suffer through the interventionist actions of another trading partner.

The fear in East Asia is deep seated and stems from the damage done during the Asian crisis of the late 1990's, and although Taiwan did weather the storm better than most, the fear of the consequences of a free floating exchange rate still remains. This is a common view in East Asia and, whilst many currencies in the region are classified as 'free float', they are in effect managed through an interventionist policy operated by the central bank.

This is certainly true with the New Taiwan dollar which is generally quoted against the US dollar as in the chart in Fig 14.12 which shows the monthly exchange rate movements over an approximate four year period.

The first point to note is that just as with the Japanese Yen and other major exporters, US dollar weakness is not something which is welcomed in the region, as it drives strength into the home currency. Indeed, the sudden volatile move lower in early 2012, was promptly supported with several interventions by the central bank, which helped to move the rate firmly from the $25.50 region and back towards a more comfortable $29.50.

This price level was duly maintained for the remainder of 2012 and into 2013. Whilst this is the exchange rate most often quoted and traded, this relationship is slowly changing, in part due to the changing dynamics of Taiwan's export markets. The US market was once the principle consumer of Taiwanese goods with over 50% of Taiwan’s manufacturing output going there. However, this has fallen sharply in the second decade of the 21st century to just over 10%, with China absorbing the slack.

As a result, the Taiwanese central bank has now shifted its focus for intervention away from the US dollar and onto the Chinese yuan, which has long been seen by Taiwan and other East Asian countries as the universal gear lever for the region. Or a speed governor if you prefer. As outlined when I covered China in detail, the tensions between China and the US are well documented in terms of their respective currencies, with the US authorities firmly believing the Chinese currency is deliberately undervalued to protect China’s export markets.

With Taiwan’s changing shift in export markets, China is now seen as far more significant and, in addition, it also gives Taiwan two further side benefits. First, the central bank policy of intervention is less aggressive, given the 'unwritten agreements' that exist between the East Asian countries and which bind them together both economically and socially. Second, this economic relationship helps to provide a bridge between the deeper social and historical divide between the two countries.

In this case, the implications for forex traders and speculators are very clear. The focus for this currency should be its connection to the yuan and not the US dollar. Moreover, as long as the Chinese currency continues to appreciate gradually, the New Taiwanese dollar is likely to follow suit. This broad principal can be applied to the other currencies in the region and, as competitive devaluation becomes ever more destructive, it will be more and more the case that countries will close ranks and protect themselves as a block, rather than be left to fight in the markets alone.

The region is a variant of the Eurozone if you like, where underlying social and historical differences have been put to one side, in an effort to protect business in the region as a whole. How long this 'entente cordial' will last is anyone's guess, but the motto at present is 'safety in numbers'. Whether the West likes it or not, the East Asian countries are closing ranks and acting in unison. With the memories of the Asian crisis still fresh in their minds, overt intervention coupled with loose currency pegs are the order of the day, and are likely to stay that way in the years ahead.

If there is one word which could be said to define the currency of Indonesia, that word would be volatile. Over the past few decades the currency of Indonesia, the rupiah, has crashed, recovered, been devalued, and even re-denominated. And yet, the country and its resilient people have somehow survived. But, moving to examine the currency to see what opportunities it presents for forex traders and speculators, let's take a brief look at Indonesia its history and economy.

In many different ways, Indonesia is an extraordinary country, not least in its economic history which has been turbulent, to say the least. However, in the second decade of the 21st century, the economy is once again leading the way in South East Asia, challenging the view that, over the last few decades, it has been described as 'the land of missed opportunities'.

By contrast, mid way through the second decade of the 21st century, the country has finally established itself as the largest economy in the region and, despite the growing pains associated with success and growth, Indonesia is now poised to take its rightful place on the world stage. Indeed, stability which is increasingly a feature of the economic landscape in the country, was reinforced in 2012 with both Moody and Fitch raising their credit rating for Indonesia to Ba1 from Baa3, investment grade. This is the same grade as for India.

This is the seal of approval Indonesia has sought for so long and with it will come prosperity, growth and foreign investment, which will all create further growing pains. However, they are a measure of the remarkable transformation from the catastrophic effects of the 1997 Asian crisis, which decimated the economy in two short years. This is sometimes referred to as the Second Great Depression, since the effects in Asia were just as dramatic and devastating as the Great Depression in the US in the early 1930's.

However, to step back in history for a moment. It was following the second World War the economy of Indonesia started the long process of recovery. But with little foreign investment, progress was slow, as recession followed recession.

A significant change came in 1967 when Suharto was elected acting President and the following year in 1968 became President, a position he held for 31 years, until forced to resign under a tide of rising opposition following the Asian crisis.

Whilst the debate about his presidency continues today, what is hard to argue is Suharto did achieve economic growth, political and economic stability and, perhaps most importantly, brought discipline to the economy. He restored the inflows of Western capital which provided the basis for industrial expansion. As a country with a vast wealth of natural resources, including coal, oil and tin, exports rose, bringing wealth to the country as oil and commodity prices rose throughout the 1970’s and 1980’s.

However, as with other commodity based economies, Suharto was keenly aware of the dangers of relying on commodities, which at the time accounted for over 60% of earnings from overseas. The dangers also included the associated price volatility and consequent impact on the currency and economy.

Economic reforms were therefore introduced and designed to stimulate investment and growth in non-commodity based markets, including the financial services sector which until the early 1980's had been heavily regulated. Deregulation began in 1983, allowing for greater freedom for private banks, who since then had been tightly regulated in the control of lending and competitive credit.

With cheap money came prosperity and economic growth, but it also laid the foundations for the Asian crisis. Superficially the banking system appeared controlled and regulated but, beneath the surface, corruption was rife at every level, with the flaws duly exposed as the crisis hit the country.

Whilst some countries such as Taiwan weathered the storm in 1997 and 1998, Indonesia's economy collapsed, along with its corruption riddled banking and financial infrastructures. Contagion from Thailand soon spread in the region as panic stricken investors tried to sell currencies in favour of the US dollar. The devaluation of the Thai baht, which had triggered the collapse, meant that Thailand's exports were suddenly cheap, forcing other countries in the region to devalue to keep pace.

Indonesia's currency, the rupiah, was badly hit and eventually the authorities were forced to devalue by almost 90% in a matter of months, a devastating move. The effect on the economy was savage and in 1998 the economy shrank by almost 14%. The timing of events could not have been worse with the rupiah having just been floated on the foreign exchange markets a few weeks after the initial problems in Thailand began to unfold. Until that point the currency had been pegged to the US dollar.

Over the following two years the currency plunged from the float value of 2,700 to the US dollar, to an exchange rate of almost 16,000 to the US dollar towards the end of 1998, as the crisis finally started to abate.

Meanwhile, international confidence in the country and the currency evaporated, along with the public who abandoned the banking sector. Export markets ground to a halt, owing to lack of credit, and overseas customers cancelled orders as confidence in the country collapsed. The final nail in the coffin was a downgrade from the rating agency Standard and Poors who moved Indonesia to a CCC rating, followed in 2002 by a further move lower to 'selective default'.

There were several reasons why Indonesia was hit harder than most but, looking back, the crisis was not only a defining period for the country, but also in many ways created the platform and springboard for its eventual sustained recovery and move to a stable and economic powerhouse of South East Asia.

The primary reasons for the collapse were largely the failure of both the political and financial systems. Moreover, the recent economic reforms that had been put in place, also played their part and, whilst these caused immense pain to the country in the short term, in the longer term they provided the cornerstones of Indonesia’s economic success.

The reforms which were implemented at the time of the crisis included government policies designed to encourage structural changes in the way Indonesians viewed the world and business opportunities.

The policies were essentially created to develop an export driven economy and reduce dependency on imports. An improvement in productivity was also targeted so that competitive and market led products could be sold to overseas customers. In addition, the chief aim of the reforms was to reduce Indonesia’s dependency on commodities as a primary source of overseas earnings.

The timing of these changes could not have been worse, as they were coupled with the float of the currency. This left Indonesia completely exposed to the full force of the Asian Crisis which crippled the economy for several years, battering it with soaring inflation and rising unemployment.

However, from the ashes that remained, Indonesia rose phoenix like, with a strong and stable political system, a disciplined and regulated financial market, a motivated and dynamic workforce and an environment which encouraged business to develop overseas markets. The major changes were in the banking and political areas, but the legal structure was also radically amended and updated, with the banking sector in particular made more transparent and accountable.

But, it has to be said all of this would not have been accomplished without help from the IMF, which provided the necessary funds to keep the country afloat. In return for the bailout package Indonesia implemented the above changes, along with other reforms. These included trade reforms in the wholesale and retail sectors, which were opened up to foreign investors. Investment restrictions in the palm oil industry were lifted and government contracts opened up to overseas bidders. Restrictive marketing arrangements in both the manufacturing and agricultural sectors were also removed.

These changes provided the foundations for recovery, which has now seen Indonesia become a shining star in the region, with economic GDP growth running at between 4% and 6% per annum. In the first decade of the 21st century Indonesia’s growth was the third fastest behind only China and India in the G20. Now, with an investment grade credit rating, the country is poised to lead the world.

As mentioned, the Indonesian currency is the rupiah which has been a free floating currency since 1998. The currency is managed by the Central Bank of the Republic of Indonesia in a traditional role.

Where the bank is perhaps less traditional is in its intervention, which is frequent and clear. The problem for the bank however, like many others around the world, is in balancing economic stability with controlled inflation in the face of increasing capital flows from overseas driven by exports and investment.

This, in turn, is reflected in the management of the economy where the blunt instrument of interest rates is used once again. In the case of Indonesia this instrument is a double edged sword.

In raising rates to control inflation, this only attracts speculators to the currency seeking out higher yields and, just like other commodity currencies such as Australia and New Zealand, this is one of the constant battles the central bank has to fight. In other words, the carry trade is always an ever present threat.

In the period from 2005 to 2013, interest rates had fallen from a high of 12.75% to the current level of 5.75% and, even at this low level, still represents a very attractive rate to yield starved investors from overseas. This rate is also highly attractive to the ever present currency speculators keen on searching out currencies for trading the carry trade.

And herein lies the problem for Indonesia and other countries in Asia and Latin America. Whilst inflows of overseas currencies are generally seen as a positive sign for the economy and was one of the principle drivers of the economic changes following the crisis of 1997, these same flows can move out just as quickly, making the currency extremely volatile.

In addition, these sudden surges are not conducive to a stable economy, and evidence of this can be found in the Indonesian government bond market where ownership of these bonds has doubled in the last few years, with over 30% now held by overseas investors, keen to take advantage of the higher returns.

The problem for the central bank, is that in raising interest rates to control inflation, will only lead to yet more inflows, adding further upwards pressure to the rupiah. More pressure will trigger further rises in interest rates, and further inflows. This in turn makes exports increasingly expensive and uncompetitive.

A vicious circle which can be explained as follows.

Strong capital inflows from overseas are welcome. They raise the levels of investment in the country and encourage economic growth, so are considered a positive benefit for the country. However, one of the unwelcome side effects is that these inflows tend to strengthen the home currency. The inflows from overseas lead to a build up of foreign exchange reserves as these are used to buy the home currency. The domestic base expands accordingly, but without any corresponding increase in production.

In other words, there is an excess of money chasing too few goods and services and a bubble is created. This adds further pressure on the home currency which adds to inflationary pressures. This in turn puts pressure on the bank to control inflation by raising interest rates. Higher interest rates attracts more inflows of overseas money thereby creating an upwards cycle which is difficult to control. And, whilst there are ways to control this cycle, in practice these measures often result in further upwards pressure on the home currency.

In the case of Indonesia, the approach taken by the central bank is to intervene, and to intervene regularly, selling the rupiah for US dollars to prevent it rising too quickly, in order to protect its exporters from a strengthening currency. If this all sounds very familiar it should, since the same approach is taken by Japan, China and many other countries in an effort to protect their export markets. However, for countries such as Indonesia the problem is even more tricky.

Not only is the Bank trying to protect Indonesia’s export markets, but they are also trying to keep inflation under control. Keeping inflation under control means higher interest rates which, in turn, simply results in additional flows of overseas money.

However, the bank has now intervened so heavily in the past few years there are growing concerns the bank itself may need an injection of capital from the government to prop up its balance sheet.

All of this is summed up rather neatly in the chart in Fig 14.13 which again is a monthly chart over a four year period from 2009 into 2013.

Throughout 2009, 2010 and for much of 2011, investors and speculators were bullish on the rupiah, buying and investing for better returns and yield. Then towards the middle of 2011, sentiment changed towards the currency, triggered by concerns the central bank would be looking to cut interest rates.

Initially, there were two rate cuts, the first from 6.75% to 6.5%, followed by a second and deeper cut in November 2011, which saw the rate fall to 6.00%. A further cut followed shortly after in 2012, to 5.75%.

This action neatly encapsulates the problems for the central bank which is constantly walking a tightrope of trying to support exports, deliver a stable economy and a stable currency whilst simultaneously keeping inflation in check and trying to protect the currency from attack by currency speculators.

It is a fine balance to strike and, for forex traders, the issue is whether interest rates are likely to rise in the medium term, attracting money flows back into the country with a consequent reversal in the current downwards trend against the US dollar.

Much will depend on whether there is an escalation in competitive devaluation (aka currency wars) and, in an increasingly competitive world, central banks are constantly under pressure to protect their home markets. Japan and China are classic examples, Indonesia is now another. If it is to maintain growth and remain competitive with its nearest neighbours, the bank has little room for manoeuvre.

The problem is made worse for the bank with Indonesia’s huge market share for base commodities such as coal and tin, along with palm oil. Indonesia dominates the market for thermal coal supplying over 30% of world demand and since the accident at the Japanese nuclear plant, demand for coal is set to increase in the short term, as many governments delay plans to implement nuclear fuel as an energy solution.

Indonesia's market share for tin is even higher at almost 40% of world demand, an extraordinary percentage. The country is also rich in bauxite, copper, gold and silver. The problem with coal and tin, is that it is difficult to increase these markets in any meaningful way, given the dominant market share already commanded. This simply adds to the problems for the bank. Whilst rising commodity prices are good for major exporters such as Indonesia, this is reflected in inflation and, whilst the country is a net exporter of base commodities including oil (although now in decline), it is a net importer of basic soft commodities such as rice, and other staple foods. It is these prices which feed through into inflation, so starting the cycle once again.

This then is Indonesia – a fascinating country in every respect and the key to trading its currency is to understand the complex relationship between the central bank, inflation, interest rates, its export driven economy which is underpinned by commodities, along with the sentiment of the carry trade speculators. As always, with an 'exotic' currency, there are plenty of opportunities, but like many others, the moves in the currency can be volatile. Profitable positions can change quickly, and losses mount up fast.

One solution is to try to understand the broader economic picture and from the price chart determine a view on the bank's future policy. It’s not easy, but I hope the above has at least provided a flavour of the country and its currency.

In many ways Malaysia is similar to Indonesia in terms of its rich natural resources, and also in the economic transformation the country has made since the Asian crisis of 1997. Once again, this is a country that has weathered the current storm and is now another star performer in South East Asia. However, the question many are asking is for how long, as Malaysia has a cloud on the horizon, which could potentially see this Asian tiger stumble.

Over the last decade domestic demand and government spending on large capital projects, such as the new transit system which links Kuala Lumpur and Iskandar, one of the country’s largest industrial zones, have been the primary drivers of growth.

However, government spending on these major projects has come at a price, and it is a price yet to be paid, as the government’s deficit grows larger each year. This structural deficit has the potential to undermine further growth. So much so that in 2011, Fitch, one of several credit ratings agencies, cut the country's rating from A plus to A. The cut was over concerns the deficit is likely to continue and, taken together with the longer term view, with falling exports, the deficit may just run out of control. At 52% of GDP it is currently one of the highest in Asia after India and Pakistan.

Furthermore, whilst Malaysia has revolutionised its economy, in much the same way as Indonesia, it still retains a valuable and important export market in soft commodities. Palm oil, a valuable resource is now grown in an increasingly sustainable way, with Malaysia the world's largest exporter and Indonesia running it a close second. Whilst the economy has undoubtedly been transformed, palm oil and other commodities including oil and rubber still underpin the export market with all the associated volatility this brings to the economy, the country and its currency.

Unlike Indonesia, the success story that is Malaysia has been based on some very simple principles and, as a result, it has managed to survive the Asian crisis better than most. It has weathered the storm, rebuilding and moving forward. As a country, it has one of the most open economies in the world, with very few barriers to doing business internationally, and it was only as the crisis took hold that temporary exchange controls were introduced. These controls were subsequently removed once the storm had passed. This philosophy of openness also applies to Malaysia itself which has a diverse mix of cultures and religions, all of whom coexist, enjoying the economic prosperity that growth and stability has brought to the country.

Second, the transportation and infrastructure in the country is world class, with the government spending heavily on airports, roads, rail and ports. Whilst this has had a direct impact on growth and local employment, the deficit is now approaching unmanageable proportions. This massive spending spree was one of the catalysts of growth in the 21st century, as the country emerged from the crisis.

Third and, perhaps most importantly, the country has managed to avoid many of the volatile currency flows suffered by other Asian countries, as inflation has generally remained low and within a defined range. This is reflected in interest rates which, in the last ten years, have moved between 3.5% and 2%, thereby avoiding many of the problems associated with high interest rates that are an ongoing problem for Indonesia and others in the region.

Moreover, Malaysia has never suffered a balance of payments crisis in its history. Even at the height of the Asian crisis, Malaysia was one of the few countries to reject help from the International Monetary Fund and, despite seeing a sharp contraction in GDP in 1998 of almost 8%, the country bounced back in 1999 with GDP growing by almost 6%.

Finally and, perhaps in sharp contrast to Indonesia, the political and financial systems were tightly regulated and controlled, which is reflected in the economy and which, for the most part, has been stable and well managed.

But, as I said earlier, the wind of change is now blowing through the country and, whilst the first decade has been good with GDP growth strong year on year, unlike other economies in the region, Malaysia has yet to make some of the changes necessary to continue to sustain this growth in the longer term.

As a country, Malaysia is rich in natural resources. These resources have been well managed, with palm oil and rubber two of the key exports and, to a lesser extent oil and natural gas. Like Indonesia the country has developed an alternative export market based on electronics. However, one of the problems for the country now, is that with an increasingly wealthy population, and labour costs rising, it is becoming difficult for Malaysia to compete with lower labour cost economies in the region and elsewhere.

This is an issue seen in the flow of workers between Indonesia and Malaysia, as Indonesians now enjoy their own prosperity with the numbers of migrant workers falling sharply. This has added to the problems for Malaysia's manufacturing sector. However, the government is now taking action, by dramatically increasing its spending on research and development, along with building the educational programs to ensure Malaysia has a highly skilled labour force capable of competing and attracting foreign investment.

One of the most significant changes in the last decade has been the introduction of the ETP or Economic Transformation Program, This was introduced in September 2010, and is a plan designed to help the country become a high income nation by 2020. One of the key sectors in the plan is managing and developing the palm oil sector, with major improvements in both the production and onward processing, whilst also focusing on growing the crop in a sustainable way for the future.

These are some of the challenges facing Malaysia in the next decade, and to this list we could also add the share of exports that go to the stagnant US and European markets. However, the problem that dwarfs all others in the next few years is the government deficit which is now massive and fast growing. This is the price that has had to be paid to develop country.

Furthermore, as successive governments come and go, spending continues to maintain growth and prosperity in the country. But, at some point, this deficit will have to be addressed before it becomes an unmanageable problem for the country. Only in 2012 the government announced the launch of the Tun Razak Exchange, a vast project which is designed to replace and expand the Kuala Lumpur financial district, which on its own is expected to generate over half a million new jobs once the project begins.

This is a massive project which will propel the financial district onto the world stage and make a bold statement that Malaysia has arrived. Put alongside the equally impressive projects of the Petronas refinery, Menara Warisan, Petrochemical Integrated Development and, of course, the Mass Transit Railway, it is easy to see the statement that Malaysia is making to the rest of the world.

The question, of course, is whether the economy can sustain such massive government spending, and whether the deficit now being built will eventually prove too much to bear.

The currency of Malaysia is the ringgit which, up until the Asian crisis, was in fact a free floating currency. The year that everything changed for the currency was 1997 and, like many other Asian currencies, it was speculative pressure driving the currency lower which was the problem. Foreign investors took fright, moving their money out with the ringgit dropping sharply in value against the US dollar, and moving from a rate of 2.50 to a low of 4.80.

Bank Negara, the central bank was forced to step in, and duly imposed capital controls to stem this flow whilst simultaneously pegging the ringgit to the US dollar at a rate of 3.80, which remained in place until the peg was finally removed in July 2005. The move was triggered by China removing its own dollar peg, with Malaysia following suit just hours later.

Since then the currency has been run under a 'managed float' regime by the bank, with the government stating that 'the ringgit will be internationalized once it is ready'.

The managed float is against a basket of currencies and, just like Singapore, the constituents which make up the basket are always kept secret and never revealed leaving traders and speculators to guess at where or when the bank will intervene. This quote from the Bank Negara website reveals little :

“The ringgit will be allowed to operate in a managed float, with its value being determined by economic fundamentals. Bank Negara will monitor the exchange rate against a currency basket to ensure it remains close to fair value.''

Therefore, as currency traders and speculators what conclusions can we draw from the above, using our knowledge of the economy, the management of the currency and the broader global picture?

The first thing to note about the Malaysian economy and, as a consequence the ringgit, is that unlike many other currencies in the region and similar countries in Latin America, the word stable really does sum up Malaysia.

The economy has not been subject to violent swings, other than during the Asian crisis, and growth has been steady and built on changes in market focus, excellent management of existing resources, and considerable and ongoing investment in the country.

Inflation has been benign over the last two decades and, as a consequence, interest rates have remained within a relatively tight range, and are certainly not high enough to attract speculative attacks from the carry trade. This picture of a stable economic environment looks set to continue, and the only major questions for Malaysia are the deficit and its dependency on US and European markets which remain sluggish.

Fig 14.14 is the monthly chart for the ringgit against the US dollar for a view as to where the currency may be heading in the short to medium term. As we can see from the chart, between 2009 and 2011, the ringgit strengthened against the US dollar as the US currency weakened with quantitative easing helping to drive the pair lower. Since then the pair has traded in a narrow range moving between 2.9000 to the downside and 3.2000 to the upside, with the pair trading at 3.0936 at the time of writing. But where next for the ringgit?

First, I expect to see the currency appreciate against the US dollar in the longer term for several reasons. First, and by no means least, is the investment now going into major infrastructure projects which will provide positive support for the economy as well as a possible buffer against any short term shocks in the market.

Second, the economy is well managed and growing at a steady pace with both internal and external growth.

Third, with the government’s commitment to spending, plus its longer term outlook for change and development of its natural resources, the home consumer market is likely to remain buoyant.

Short term, the ringgit may come under selling pressure due to the potential exit of hot money. A view backed in a recent research note from Alliance which said:

"With the steady rise in the foreign holdings of equity and governments' debts post global financial crisis, any negative shocks such as political uncertainty, Euro debt crisis and US fiscal cliff may trigger risk aversion, leading to sudden outflow of funds,"

Finally, of course with interest rates in the US likely to remain ultra low for some years yet, this can only help to provide some upwards momentum to the ringgit.

Moving forward, I believe we can expect to see the currency continue to trade in the current range, but with an upwards bias, probably back towards the 2.9200 region and perhaps a little lower.

Remember, that on the chart the ringgit is quoted as the counter currency, so when the ringgit is strengthening, then the currency pair (USD/MYR) will be moving lower.

Much will depend on any intervention from the central bank, who will be keen to maintain the currency in the current range, as the bank continues to create an environment for growth in a stable and well managed economy. Inflation is expected to remain between 2% and 3%, with interest rates in a similar range between 2.5% and 3.5%, so unless there is some unexpected shock to the market, or a sudden change in investor sentiment, the outlook for Malaysia and the ringgit looks rosy.

But, and it is a big but, as the deficit grows ever larger, how long before the elephant in the room can no longer be ignored, and this could ultimately signal longer term weakness in the currency as we move towards the end of the second decade of the 21st century.

The Philippines is another fascinating and beautiful country in South East Asia, which has suffered at the hands of both external and internal forces, but has somehow managed to survive, prosper and grow, along with the other countries in South East Asia.

The Filipinos are nothing if not resilient, taking everything that is thrown at them, in their stride, and fighting back, stronger and more determined to succeed. This resilience is now starting to pay off, with the country poised to move dramatically up the league table of world economies. And, if the current trend of economic growth continues, according to Goldman Sachs, the Philippines is forecast to be the 14th largest economy in the world by 2050. This is a staggering statistic given the recent history which has seen the country crippled by corruption, internal conflicts and economic instability. Despite these destructive forces the country has survived and rebuilt its economy. There is still a long way to go, and problems still lie ahead but, as we will see shortly, the foundations are slowly being put in place to provide the springboard which will propel the country into the top 20 economies in the world.

In terms of geography, the Philippines is an archipelago of over 7,000 islands, lying on the fringe of the South China Sea. Pristine and idyllic, it is divided into three main island groups, Luzon, Mindanao and the Visayas. And herein lies one of the many problems for the country – the region is volcanic in origin and therefore always subject to natural disasters, including earthquakes, floods and hurricanes all of which are part and parcel of daily life.

Historically, the Philippines has had many masters over the centuries. First came the Spanish in the 16th century, followed by the United States three centuries later whose occupation lasted until independence in 1946 leaving the country with a US style constitution. Prosperity followed with sustained economic growth until the imposition of martial law in the early 1970’s under President Marcos.

His corrupt and repressive regime led the country into a long and painful period of economic stagnation, and ultimately into a deep and damaging recession during the 1980’s. The term that was coined at the time was 'crony capitalism', with Marcos at the centre of a spider's web of nepotism, raping the country of resources and wealth. This despotic president was finally replaced by President Aquino who started the rebuilding process. Aquino was followed by President Ramos, who is now widely regarded as the catalyst for the change having laid the foundations for the economic success that is finally coming to the Philippines. His presidency lasted from 1992 to 1998 and, during that time he was responsible for eradicating corruption in many areas of political and administrative life, the deregulation of many of the major industries, opened up competition, and reformed tax collection.

At the heart of this rejuvenation of the country lay the Philippines 2000 program, which was the cornerstone of the Ramos philosophy and is seen as the greatest legacy of his time in office. Privatisation lay at the heart of the plan, with monolithic and bloated state owned enterprises moving out of public hands. These included Philippines Airlines, the Philippines Long Distance Telephone Company, and several large power plants. Coupled with this, the government began investing in major construction projects, creating jobs, growth and attracting overseas investors to the country. At the same time VAT reforms were introduced, raising the rates from 4% to 10%. Finally, and perhaps most importantly, peace and stability were finally achieved on the island of Mindanao.

The Philippines 2000 plan helped to kick start the economy back into life, with rapid growth following between 1994 and 1997, ahead of the Asian crisis. It was largely as a result of the Ramos changes, that the country was able to emerge relatively unscathed from the crisis. Like Malaysia, the Philippines too was able to avoid the crippling effects of the Asian crisis and for very similar reasons.

Whether by luck, planning or simply fate both countries had been involved in restructuring their economies and in a sustained period of reform prior to the crisis which helped to lessen its impact.

Nevertheless, shortly after the collapse of the Thai baht, the trigger for the Asian crisis, the Philippine peso also came under pressure against the US dollar, falling from a rate of 26 at the start of the crisis in 1997 to 38 by mid 1999, continuing lower at the start of the 21st century, before moving to 54 by 2001. Initially, the Philippine central bank attempted to defend its currency by raising interest rates and pumping $1.5 billion of foreign reserves into the system. However, on July 11th the bank threw in the towel, and like other Asian countries left the peso to float free, whilst simultaneously tightening monetary policy, and strengthening the banking system to ride out the storm.

A further factor which also helped to buffer the Philippines came from its own people. The Filipinos are a migrant workforce and, if the latest figures are to be believed, almost 30,000 a day leave their homeland to work overseas in a variety of markets.

Once overseas these workers remit their earnings back home, generating their own source of overseas earnings for the country. Latest estimates suggest this revenue is as high as 10% of GDP, an astonishing figure. It also goes some way to explain why the Philippines was better placed than most to weather the storm of the Asian crisis.

Unlike many other Asian countries, its overseas income was not the 'hot money' of investors seeking out high yielding assets before leaving equally quickly, nor was this money investment dollars. Instead, this was revenue from real Filipinos, simply sending money home to their families which, as a consequence, helped to support their country at a time of crisis.

This remains a unique feature of the currency and its strength or weakness in relation to the US dollar, which we will examine shortly. No other country in the world has this 'home grown' pipeline of overseas earnings. In addition, these earnings are not subject to vagaries in export markets, nor are they subject to pressure from competitive markets, or changes in the economy. Instead, it is a guaranteed source of overseas earnings which is stable and consistent. And will remain so until the dynamic changes, which is entirely possible, over the next decade.

For the time being, however, it is one of the unique benefits to the economy which has helped to propel the Philippines back onto the road to recovery, assisted by the government which is also developing and delivering the policies and plans of President Ramos.

Whilst GPD declined to 0.6% in 1998, the economy bounced back in 1999, growing by 3.4% and into the first decade of the 21st century, with year on year growth steady and rising between 4% and 5% per annum. Indeed, as the global financial crisis of 2008 took hold, it was once again the overseas income from Filipino workers which came to the rescue, with growth slowing to just over 1%, before bouncing back once again in 2010 to 7.3%, a 34 year high in the economic history of the Philippines. Since then, the country has gone from strength to strength, building on the strong platforms put in place almost 20 years ago.

In July 2012, the Standard and Poors ratings agency lifted the country's debt rating to just below investment grade, an extraordinary achievement when one considers it was only thirty years since the worst excesses of the Marcos regime. This rating is now at its highest level since 2003. But there's more good news.

In the first quarter of 2012, according to the central bank, the GDP growth rate was 6.4%, outperforming every country in the region, other than China. What is perhaps even more extraordinary, given the history and what this nation has had to suffer over the decades, is that in 2012, the Philippines pledged $1billion to the IMF bailout fund for Europe. An ironic twist, given the IMF helped to bailout the Philippines in the 1980's. However, what this also demonstrates is the strength and stability that has been built by the central bank which now has over $70 billion in reserves.

However, is this growth sustainable and, if so, what impact will it have on the currency? How will the central bank and government create the economic environment which will allow the Philippines to move into the top 20 economies by 2050?

The good news for the government is that once again the solution is likely to come from its own people. Not only is the Philippines diaspora remitting ever increasing sums back to the country from overseas, the population at home is also increasing fast. And it is this combination of the overseas and domestic economies which are seen as the drivers for future growth.

By contrast, many countries in Asia have a working age population which is declining in number, which will present huge problems in the future, as these countries will be forced to attract workers from overseas. For the Philippines this is not an issue, as it has over 60% of the population in the 15 – 64 age group.

Furthermore, with the birth rate rising, it has a pool of workers able to sustain the current growth levels in the future. Indeed, with one of the highest birth rates in Asia, current forecasts suggest the population could double within three decades.

As always the danger is that should the dynamic growth suddenly stall, this could leave the country with a huge problem in the future. However, the advantages are clear – as other countries see their own labour costs rising, the Philippines will remain extremely competitive due to the sheer number of workers joining the labour market.

The key for the government and the central bank is to ensure all these workers have jobs in the future, and benefit from the wealth and increasing standards of living which will come as a result. This will be a fine balancing act, as the country already has the highest unemployment in South East Asia. And is one of the reasons the workforce is a migrant one and leaving to look for work.

However, whilst the rate is relatively high at over 7%, it is in fact at a record low for the country, and the lowest for over 30 years. The challenge now, with an increasing birth rate, is to ensure economic growth continues at the current pace to ensure that unemployment rates are maintained at low levels in the future.

To see how the government, its central bank and currency are likely to respond to this challenge it may be useful to consider the Philippines current markets together with what is on the horizon.

At present, the key markets for the Philippines is in commodities and, in particular agriculture, which has been the backbone of the export markets for many decades. However, this sector has always under performed in terms of GDP, despite employing over 35% of the workforce it only contributes around 13% to GDP and the reasons for this are twofold.

First, a lack of investment in the infrastructure and irrigation to support this key sector of the economy, and second, many of these markets are essentially labour intensive, so the key for the future is to scale up these operations and to add value by converting the basic foodstuffs into an alternative product. The Philippines is currently the world's largest exporter of pineapples and coconuts, and whilst rice is an important crop, ironically the country is a net importer.

The Philippines is also rich in minerals and geothermal energy sources, along with natural gas but, once again it is the lack of investment in infrastructure which has seen this export market under perform. Exports of minerals have remained flat for the last decade, largely due to legal issues surrounding the overseas ownerships of mines, coupled with concerns over environmental issues. In a recent court case, the law was upheld which should allow the Philippines to see inward investing in its mining infrastructure and a growth in its export markets for base commodities in the next few years.

Under Benigno Aquino's leadership the Philippines in now starting on an ambitious plan, in much the same way as Malaysia has done in the last decade. Since the start of his presidency the government has committed to major capital investment programs in all areas, including mass transportation, water supply systems, improved roads, upgrading of ports, so important to the country's ship building industry and, of course schools, to educate the workforce of the future. Spending on these projects is expected to be in the region of $5 billion a year through the remainder of his term, which will then provide the foundations for growth, along with a vibrant domestic economy coupled with strong employment prospects.

To cater for the growing tourism industry and business travel, the government is also proposing to spend heavily on its airports, either upgrading or building new, and in the last few months two major projects have already gone to tender to develop the Bicol and Central Mindanao airports. Three other projects also in the pipeline include the New Panglaro airport, the Mactan-Cebu International Airport Passenger terminal building and the NAIA Expressway project Phase 2.

Whilst capital projects are visible and high profile, other sectors of the market are also receiving attention with the services sector top of the list. This has been one of the major success stories of the Philippines of the last decade. Overseas companies have increasingly been outsourcing their call centre operations, and one of the primary beneficiaries has been the Philippines. With a highly educated, reliable and skilled workforce with excellent language skills, the market has been growing exponentially, and is now a key part of future growth for the country. This sector has grown rapidly and is often referred to as BPO or Business Processing Outsourcing.

The government is also relaxing many of the rules concerning the gaming industry which is one of the fastest growing sectors in Asia, and has recently awarded licences to overseas operators for four major new casinos in the Manila bay area.

All this growth could not have been achieved without stability. Economic stability and currency stability are in place, and with the recent Standard and Poors rating approval, this can only help to attract further investment from overseas, to a country which is increasingly seen as a safe and secure place to do business, which brings us to the central bank and the currency.

The central bank for the Philippines is the Bangkok Sentral ng Pilipinas, and is responsible for delivering a stable economic environment for growth, using the primary tool of interest rates to control inflation, currency flows and money supply. Over the last twenty years, the economy and its associated economic indicators, has been transformed from highly volatile in the late 1980's and early 1990's to one that is benign, stable and manageable.

For evidence of this we need look no further than interest rates. In December 1990, the interest rate reached an eye watering all time high of 56.6% in just twelve months from 8.6%, before falling just as fast the following year. Since then the rate has fallen consistently lower and, in the last ten years, rates have continued to decline from a high of 7.5% to a modest 3.5%, a record low for the country.

This picture of stability is also reflected in inflation with the headline rate falling year on year, despite a spike in 2008, is now running at a modest 3% in 2013, which is at the low end of the Government’s inflation target range of between 3% and 5%. In fact, the forecast rate for the next 3 years is 4%.

The problem for the bank, as with many others in the region, is once again walking the tightrope of inflation, exports, interest rates and currency flows and, in the last few months the bank, along with others in the region, has been forced to introduce currency controls on some of the more sophisticated instruments, namely currency forwards, where currency prices are agreed on futures contracts.

Currency forwards are simply agreements to buy or sell an asset, in this case a currency contract, at a set price at an agreed future date. These are cash settled in dollars and are favoured by many investors as the funds don't have to be deposited or registered locally. The Philippine central bank is not the only Asian country to impose these regulations with the Koreans also adopting a similar policy.

And the principal reason for this is currency strength in the Philippine peso.

Since the Asian crisis of 1997, the Philippine peso has been allowed to free float against the US dollar, one of the Philippines primary export markets, but the history of the currency against the dollar can be summed up in one word. Weakness. Through the decades the rate has gradually broken 10, then 20, and during the Asian crisis, it weakened again moving above 40, before finally peaking at 56 at the start of the 21st century.

Since then the pair has been on a reverse journey, with the peso gaining in strength against the dollar, and as we can see in Fig 14.15 is now starting to test the 40 level once again.

Strength in the peso is now becoming an increasing concern for the central bank and, in particular, the risks this poses to the export markets which are now delicately poised to benefit from the massive government spending.

Further development of exports, is a key plank of future growth, and inflows of overseas capital are helping to strengthen the peso. In addition, the continued remittances from Filipinos working overseas is also adding to the problem, which can be clearly seen here in the chart.

The problem for the central bank is also the continued and sustained weakness of the US dollar. With US interest rates set to remain low, and quantitative easing also playing its part as major exporters look to protect their home markets with a weak currency, this is simply adding to the problem.

But that's not all. With low interest rates and confidence rising, the property market in the Philippines has been booming in the last few years in both the private and commercial sectors, raising the spectre of a housing bubble fuelled by cheap money.

The good news for the bank is that with currency reserves at a record high and with the ratings agencies all giving their seal of approval, the outlook is extremely positive.

The bad news however, is that with a strong or strengthening currency come a variety of other problems. But why is the peso getting stronger and how is the central bank likely to react?

The first, and perhaps, most obvious reason, is continued weakness in the US dollar. Whether overt or covert, deliberate or otherwise, the US has a weak currency at the moment and, like many other countries, will want the currency to remain weak for the foreseeable future. The second reason is the continued and relentless funds from overseas Filipino workers which continue to grow year on year, and constitute a significant share of GDP.

Third, GDP is strong and growing fast, and through the end of the first decade of the 21st century was running at between 3% & 5%, with astonishing growth in 2012.

Next comes the ratings agency 'seal of approval' which will attract further overseas investors and foreign earnings, adding to current inflows. The bank is also adding its own fuel to the fire with the large foreign reserves it has built up itself, and additionally is also in the habit of ‘making the most' of any economic fundamentals which point to growth and prosperity. This is not to say they are untrue, but perhaps are given a little extra gloss from time to time.

Finally, low inflation, whilst welcome, also plays its part.

In addition, to the above elements there is also a further dynamic which plays in the Philippine peso and that's the state of the US economy. Unlike many other Asian countries, the Philippine’s largest trading partner (and also their largest investor) is the US and not China which currently ranks third. Therefore, if the US economy is weak with low interest rates, money tends to flow into higher yielding assets such as the peso. Conversely, if the US economy is doing well then demand for exports grows, fuelling inflation and raising interest rates with a similar effect. So, a double whammy if you like.

All of these effects are compounded by the unrelenting flow of money from overseas Filipino workers remitting their hard earned incomes home. Whilst this continuous flow is an ever present driver of peso strength, it is also recognised by everyone, including the central bank, that without it, the country would almost certainly not have survived. Indeed, these workers are often referred to as the Philippine’s economic savours.

Of course, for the bank, and private companies, there are benefits in a strong peso, which makes paying off the debts from foreign investors significantly cheaper. Imports too become cheaper, but all of this has to be balanced against the effects of a strong currency on exports and the inflow of overseas currencies from Filipino workers. A strong peso makes it more expensive for these workers to support the families left behind, which is why the bank pays such close attention to this phenomenon. It cannot afford to damage its valuable export markets, nor drive up the costs of supporting the families left behind by their overseas workers, and the reason for this is very simple.

Whilst the Philippines is booming and looks set to become one of the rising stars of the region, it still has one major problem, namely poverty. Recent reports suggest between 30% to 35% of the population live below the poverty line, with a further 15% only marginally above this level. This is a frightening figure which belies the wealth of the country and apparent success, and is the conundrum the government now faces and will have to address. Therefore, the government and the central bank not only have the current high poverty levels to address, but also the future impact of a birth rate that is likely to accelerate. And herein lies the problem.

If the economic growth that is planned is unable to keep pace with the birth rate and absorb an increasingly skilled workforce, this could increase poverty levels still further. This is the danger the authorities in the Philippines now face. The bank and the government both seem to have the will to succeed, and are investing in the capital projects, infrastructure and education that will create the basis for future growth and prosperity of the country.

The problem, of course, is the peso and the global economy. The Philippines has many different drivers which will then all play out in the peso. Managing these sometimes conflicting forces is not easy, so the central bank is constantly vigilant. At the current level of 40 pesos to the USD and below, expect to see the bank intervene to prevent further strength in the short term, and avoid the problems such strength will bring. In the last few years the currency has moved from 50 down to 40, but any further strength is likely to set the alarm bells ringing at the bank. With their reserve coffers full, they certainly have the fire power to intervene but, as always, it is a tightrope they and other banks have to walk. But in the longer term, ironically it may be renewed strength in the US dollar which ultimately drives the pair higher.

With the Philippines the stage is now set, and the benefits that have flowed to so many other countries now look set to flow here. The bad times appear to be over as the country prepares to take centre stage in a new world order, something which its long suffering people will welcome with open arms.

The final country I would like to consider in South East Asia is South Korea, which is yet another of those countries which has transformed itself in the last 50 years, and now ranks in the top 12 of economies in the world.

It is one of the starkest reminders, if any were needed, that whilst South Korea has been been transformed into an industrial powerhouse of the world, and continues to remain so, its nearest neighbour North Korea has descended into totalitarianism and poverty. However, it is impossible to consider South Korea without mentioning North Korea since their relationship continues to impact the currency markets.

Again we need a short history lesson which starts with the invasion of South Korea by the North which led to a damaging and destructive war, leaving several million dead. Following the signing of the armistice in 1953, both countries rebuilt, and ironically, in the short term, the North was more successful than the South largely due to support from Soviet Russia. And, it wasn't until the 1960’s the South, supported by the USA, began to develop more quickly, with GDP growing fast in the 1970’s and 80’s.

Despite the fact the country was not a democracy, the changes implemented were both sweeping and fundamental, and laid the foundation stones for South Korea's continued and unrelenting growth in the second decade of the 21st century.

Under the then government led by Park Chung Hee, exports were hailed as the future for the country, and today the country is one of the world's leading export driven economies. In the 1970’s currency reforms were introduced, along with changes to the banking and financial systems to underpin growth with policy changes directed at the promotion of heavy industries, chemicals, consumer electronics and cars.

With the changes in the banking and financial sectors, the manufacturing sector grew rapidly as South Korea began to dominate all sectors of the market, becoming increasingly reliant on exports for the economic miracle to continue.

Whilst South Korea had chosen a more liberal approach, true democracy was not achieved until 1987, finally replacing the military with a democratic system with the driving forces being the new, young middle classes of the country, whose prosperity had its roots in the economic revolution of the 70’s and 80’s. The democracy was further cemented in place with the appointment of Kim Dae Jung to the presidency in 1997, a defining year which coincided with the Asian crisis.

For the North, the contrast could not be more extreme. With the collapse of the old Soviet Union, economic collapse has followed and, coupled with natural disasters, lack of investment and a country ravaged by a corrupt and increasingly isolated dictatorship, North Korea’s decline has continued ever since.

But how did South Korea fare as the Asian crisis took hold? The short answer is that initially, better than most, at least superficially. However, it is at this point that the concept of the 'Chaebol' came into play, and what had apparently seemed to be growth built on solid foundations was suddenly revealed to have been built on sand, with a consequent collapse in business, the economy and the currency.

As in any successful economy there are always large and successful international companies run by powerful family groups or as they known in South Korea ‘Chaebol’. These are often seen as a key part of a country’s success. Consider Fiat for example in Italy, Walmart in the US, the Tata group and Marriott Hotels. All still owned and run by family members. These companies are so large and so iconic they become an integral part of the culture as well as the economy of the country. In the case of South Korea, however, from the 1960’s to the start of the Asian crisis, the chaebol was a lot more, and in many ways was an accident waiting to happen. One classic example was Daewoo.

Daewoo was founded in the early 1960’s, as indeed many of these companies were, as the country struggled to recover from the rubble and destruction of the Korean war. But from humble beginnings in textiles, Daewoo grew to become one of Korea's many iconic companies.

From this small start, the company expanded and grew through the 70's, 80's and 90's adding shipyards, car plants and electronics manufacturing to its rapidly expanding empire. However, following the Asian crisis the company went bust, spectacularly, owing over $80 billion dollars.

The founder, fled the country but was later arrested. A fate other business owners also suffered. Some survived, but many failed, and it took the Asian crisis to bring down the pack of cards which revealed for all to see, the extent of corruption and financial mismanagement that had allowed these companies to become so large, so quickly.

At the heart of the problem was the willingness of each government to lend vast amounts of money to these companies, on extremely favourable terms and with virtually no guarantees. This was done, in general, for political or other favours. These loans were made from state owned banks and to companies that were seen as the future of Korea.

To compound the problems, no formal accounting was ever requested with double booking of orders a common practice in order to inflate company values and turnover. Profits were over stated, costs under stated and, in addition, the chaebols helped each other to falsify values by the interlocking of shareholdings and false invoicing between themselves, all under pinned by vast loans of cheap money provided by the state.

Corruption was endemic, fraud the standard, and transparency was a word no one understood or could even spell. Then came the Asian crisis which exposed all the corruption, the falsified accounts and the over extended borrowing that had created the illusion of success. In creating the illusion overseas investors had also been sucked in, investing billions of dollars in what was considered to be financially strong, dynamic and well managed organisations diversifying and expanding into ever more broader markets.

The first to fall was Hanbo Steel followed soon after by Sammi Steel, then Jinro Group and, in the summer of 1997, the Kia Group which collapsed with debts of almost $400 million. As panic ensued, international investors tried to move their money out fast, but with a currency that was collapsing like many others in the region, this put an impossible strain on the banking system and bankruptcies followed.

The banks refused to renew loans, and with the major banks running short of foreign reserves, further pressure was applied as the Korean currency followed the downwards spiral of all the other Asian currencies, which up until late 1997 it had managed to avoid. As a result, whilst other currencies weakened dramatically, the won only fell marginally and, in relative terms to others in the region, was in fact appreciating, and impacting exports.

However, the won could not avoid the inevitable, and duly succumbed, falling heavily towards the end of 1997. Finally, to add further to the maelstrom, a presidential election was in progress at the same time, with the front runner, Kim Dae Jung sending confusing messages to investors on economic and fiscal policy and merely adding to the panic.

As the won tumbled, so pressure increased before finally on the 18th December 1997, the IMF agreed a bailout package of $60 billion. However, the bailout came with some very tight strings. At the time of the bailout foreign currency was leaving the country at a staggering $1 billion per day. Korea came close to default and had this happened, the shock waves would have reverberated around the globe.

However, what is perhaps even more extraordinary is the IMF debt was repaid in just three years, and three years ahead of schedule, a remarkable achievement given the financial state of the country in late 1997. Like many other Asian countries caught up in the storm, rapid changes were implemented and in Korea, as with many others, it was the financial sector that saw the most radical changes, with the country forced to implement the conditional changes of the IMF bailout fund.

However, for Korea and Koreans, the crisis changed many things for ever. Prior to the crisis and its devastating effect, unemployment had been almost unknown, running at just under 2%. Jobs were plentiful and one of the complaints from industry prior to the crisis was the problems it had in finding more workers to meet demand. In addition, many of these jobs came with a complete package of benefits, including housing and education. The culture was one of cradle to grave employment and care. All of this changed as the storm of the crisis took hold and jobs, which were once plentiful, became scarce. Those Koreans with jobs were considered to be lucky, even though salaries were cut and benefits removed. Nevertheless, the crisis hit Korea hard, and yet somehow it survived and recovered, with growth returning to an astonishing 10% in 1999 and 9% in 2000.

Following the implementation of the IMF reforms, coupled with credit and import restrictions, and with the government promoting the import of raw materials and technology in place of consumer goods, Koreans were encouraged to save rather than spend in the first few years of the 21st century. This is one of the many legacy sentiments from the crisis. Growth steadied at around 4% annually and in 2004 the country joined that elite group of economies which exceed a trillion dollars. A transformation of staggering proportions and an extraordinary testament to the South Korean people.

Since these torrid times the economy has grown steadily and, despite a contraction in 2008, has continued to grow to propel the country ever higher up the list of world economies. However, the country is not without its problems.

The Chaebol companies still dominate the country, its economics and its politics, and as each election comes and goes, the old rivalries and animosities are ignited once again. Companies such as Samsung, Hyundai, and LG generate around 50% of GDP, with critics suggesting these state endorsed giants are not good news for the country longer term, as they squeeze the small to medium size companies out of business.

Indeed, these companies are also seen as fanning the flames of inequality, which is increasing the divide between rich and poor. However, what is interesting is that for many Koreans, these companies are no longer seen as the shining stars of the country and its export driven market, but as elitist, inward looking, self indulgent and self serving. Furthermore, redistribution of wealth back to Koreans who are helping to build these companies, does not seem to be part of their longer term plans, so Korea now seems increasingly divided. And, with a rapidly ageing population, these companies need to reassess their attitude to their workers. Korea is in stark contrast to the Philippines, which has a rapidly growing birth rate and a bright future. By contrast, Korea has a labour market rapidly running out of workers, and this is one of the major challenges the country faces for the future.

So, having considered the background and underlying issues of the country and its history, how does all of this play out economically and, more importantly, with the South Korean currency, the won.

South Korea, like Japan, is an export dominated economy, with the same problems as Japan and the same view, namely currency strength or currency weakness will always be viewed in the light of the export market. Just like the Japanese yen, a strong Korean won will make exports more expensive overseas, as well as making goods less competitive against the other major competitors in the region.

Furthermore, just like Japan, the country is reliant on imports of base commodities, in particular crude oil and rare earth metals. Rising commodity prices are reflected in rising prices which adds to inflation, in the longer term. This is the battle the central bank of South Korea (Bank of Korea) faces on a regular basis.

As the world’s fifth largest importer of crude oil, Korea’s economy is extremely sensitive to changes in the price of oil. Rare earth metal prices are also extremely important as they are used in a wide variety of exported goods from cars to consumer electronics, and with China now effectively controlling this market, and driving prices higher through supply restrictions, this is likely to hurt Korea in the medium term, and certainly not engender any warm feelings towards China.

But what of the South Korean won, a currency which can best be summed up in one word – volatile. Indeed the currency has recently been described as the VIX currency, an association with the Volatility Index which is well deserved, and the question therefore we need to address is, why is it so volatile?

However, first things first. The won was free floated in December 1997, following the IMF bailout as this was one of the conditions of the loan. The currency had to be allowed to float in the market, along with other currencies in the region, and has remained so ever since. The central bank does intervene in the market from time to time, but no more than the Bank of Japan, or any other central bank.

However, the currency itself has some peculiar characteristics all of its own. The first of these is its extreme volatility, a volatility usually associated with an exotic currency. And not one representative of an export led economy of the stature of Korea.

The second characteristic is that it behaves in an inverse way to the Japanese yen in terms of changes in the global economy. When the economy is weak and demand is sluggish, as has been the case in the last few years, the Korean won tends to weaken. This is good news for the country and, in particular for the Bank of Korea, as no intervention is required to weaken the currency in order to maintain a competitive edge. This is very different to the Japanese yen, which works in the opposite way, growing stronger when economies are struggling and weaker when markets are buoyant. Needless to say the Japanese find this extremely annoying, that whilst the Bank of Japan has to intervene constantly, the Bank of Korea does nothing and simply waits for its currency to weaken automatically. And the reason for this quirk is interest rates.

Whilst interest rates in Japan have effectively remained at zero for the last 15 years, those in South Korea have varied between 5.25% and 2% and currently sit at 1.5%. As a result, South Korea is a magnet for overseas investors and speculators with huge inflows of currency into the country when the economy is strong, and equally large outflows when global economies are weak. Good returns in a stable and safe economy are sought out with money pouring into the bond markets from overseas as a result. This is something the Japanese cannot offer and, whilst their economies are equivalent in terms of strength and export led, the Japanese have no such returns to offer, with their own currency seen as either safe haven, or as a funding mechanism for the carry trade.

However, it is not all good news for the Bank of Korea, as this constant ebb and flow of massive currency reserves not only gives the won its 'volatility' tag, it also leads to higher inflation in terms of imports, with imported inflation. Therefore, if the currency weakens too far the bank intervenes. And it has plenty of cash with which to do so, with a reported $300 billion plus to play with.

The volatility for the won ( KRW ) is clearly evident on the weekly chart in Fig 14.16 which is against the US dollar.

Therefore, whilst weakness in the currency is welcomed it is limited by intervention. So too is currency strength and, in the early part of the second decade of the 21st century, this is now the issue the central bank is facing, as global markets slowly recover. The primary drivers once again being investor speculation of an economic recovery with inward flows into the country as a result.

Like other countries in the region, currency derivatives are the issue, and the Bank of Korea has recently suggested restrictions may be imposed on currency forwards, to prevent further speculation.

And herein lies the problem for the Korean authorities and its currency. First there is the volatility issue which remains an ever present threat. In the last ten years, the won has seen some extremely volatile price moves, first in 1997, then again in 2008, and followed by a third bout in 2011, all driven by speculative investment flows. Moreover, volatility has also increased further by the quantitative easing of both Japan and the US, with US dollar weakness driving the pair lower, and the won strengthening as a result. This makes the won extremely sensitive to shifts in market sentiment and this is also reflected in the principle stock exchange the KOSPI – Korea Stock Exchange, which is equally sensitive and volatile.

Second, is the protection of the precious export markets which are the cornerstone of the economy. Whilst a weak won is good news for the ship builders, the technology companies and car manufacturers, if it is too weak imported inflation becomes the issue. Rising inflation leads to higher interest rates with consequent inflows of capital raising the prospect of volatility in any sudden changes or market shocks. Conversely, a strong won is unwelcome for exports.

Finally, it’s not just about remaining competitive in the global markets, it is also about managing the won against the other Asian currencies. This was a feature at the start of the Asian crisis. As near neighbour currencies weakened, the won held firm, in other words strengthening in real terms, thereby making Korean exports less competitive against those of Japan, China and other major exporters.

Whilst currency controls provide some answers to the problems for the Bank of Korea, they are not the complete answer, and intervention and interest rates remain the key 'levers' of currency management. However, the characteristic of the Korean won is well entrenched and unlikely to change soon, so the term the 'VIX currency' looks set to remain a feature for some years to come.

For the Korean people, the past two decades have seen many changes, with many more likely to come. It is the social and cultural changes where the real stresses and strains lie in the future.

The country has transformed itself from an autocracy to a democracy, from war to peace, and from poverty to wealth. It is a country that has arrived on the world stage and, whatever obstacles it may face in the future, is likely to remain there for decades to come.