Asian currencies have taken a hit as regional stock markets have fallen out of favour with foreign investors, with the Taiwan dollar and Indian rupee expected to suffer the most from any further equity weakness.
Foreign investors have gone on their longest selling spree of South Korean stocks since October 1997 and heavy selling in Taiwan pushed shares there to a 14-month closing low last week.
Jitters about rising interest rates in the United States and Asia have hurt Asian stocks and ABN Amro says the US $4.8 billion of shares dumped in India, Korea, Taiwan and Thailand in October is the largest sum ever recorded in the four markets.
Against this backdrop, regional currencies such as the Taiwan dollar and Indian rupee have hit multi-month lows. This marks a dramatic change of fortune for these currencies, which at the turn of the year were seen as top picks.
Analysts say the impact of equity flows on Asian currencies should not be underestimated, with a strong correlation between the two in Korea, Taiwan, India and Thailand and to a lesser degree in Indonesia and the Philippines.
Gross equity market flows in Korea, Taiwan and India are now as large as total exports, says John Cairns, head of research at IDEAglobal in Singapore.
He estimates that US $1 billion worth of outflows from Korean or Taiwan stocks would see about a 0.4 percent fall in the Taiwan dollar and the won and about a 0.8 percent drop in the rupee.
The impact on the Indonesian, Philippine and Thai currencies was expected to be larger at about 1.7/1.8 percent given the relative size of the equity markets.
"The bottom line is that equity flows can and do have an impact," Cairns said.
"What we've seen is consistent outflows over the past month, especially in Korea, Taiwan and India. The trend is negative but you need to see sustained weakness in global stocks, a sustained rise in risk aversion to see further significant outflows."
SPOTLIGHT ON TAIWAN, INDIA:
The Taiwan dollar and Indian rupee are reckoned to be the ones to watch in terms of further equity outflows.
Worries about Taiwan's economy, a narrowing trade surplus and rising borrowing costs have all undermined Taipei's equity market.
Analysts at UBS say the Taiwan dollar does well when high risk appetite and a strong industrial cycle reveal a preference for high beta stocks, those with a strong correlation to the overall market, over defensive stocks.
But they say this environment is passing.
Equity flows helped push the Taiwan dollar to a 4-1/2 year peak against the US dollar in March and help explain the currency's move to one-year lows on October 24.
It was trading at about 33.64 per dollar on Monday, and is down about five percent from the start of 2005.
"The bets are still running a bit against the Taiwan dollar," said BNP Paribas senior currency strategist Thio Chin Loo.
"It has managed to keep below 34 per dollar but to see it gain beyond 33, say, needs sustained improvements on the stocks front and the trade balance."
India's benchmark 30-share BSE index meanwhile has been declining since it hit a record high in October.
From January to September, foreigners bought a net US $8.5 billion, equal to their purchases for all of 2004. But in October, they have pulled out about a net US $780 million.
Since outflows in recent weeks have not been too great, there is scope for further selling that could undermine the rupee, analysts say.
Citigroup's Asia local markets strategist, Cliff Tan, says the scale of the flows in India's equity market relative to the currency market are large enough to make a difference.
"We've had very strong offshore inflows into the onshore equity market and that has driven a lot of the price action," he said.
"Because some funds have grown tremendously large in a short period of time, particularly Japanese equity retail funds in India, the thought of them possibly panicking is a threat for the currency."
With the inflows in the market drying up, the rupee could be more vulnerable to further weakness in India's current account, analysts said.
The rupee is trading at about 45.10 per dollar, not far off October's 11-month low of 45.41.