Capital controls a plus for emerging, frontier currencies?

Following on the heels of Bank Indonesia, which set a one-month minimum holding period for investors, South Korean regulators recently set limits on banks’ currency-derivative positions.  The Economist points out that far from making the country’s currency market less stable, however, South Korea’s introduction of capital controls may not only ease pressure on the Bank of Korea to keep benchmark rates low, but also could help tame a historically volatile currency.  Volatility has stemmed not only from the relentless, accommodative monetary policy from the world’s largest central banks in the U.S., Japan and Europe, but also from fervent de-leveraging from local and foreign banks during the Lehman debacle and, more recently, the European debt crisis, as overseas investors pulled money en masse.

Per Businessweek, Indonesia’s rupiah and South Korea’s won were Asia’s top two performers last year, rallying 16 percent and 8 percent respectively against the dollar, but this year, the won has been the region’s biggest loser, dropping 4.9 percent to 1,216.40 per dollar as of a week ago (the rupiah had risen 2.4 percent this year to 9,167).  But with the recent yuan decision coming from China (which likely had far more to do with combating inflation than any kind of Geithner-inspired capitulation), analysts are bullish won going forward, and have a further arrow in their quiver if volatility indeed proves lessened (the currency rose on the day of the news).  Barclays, for instance, predicted a 2.5% appreciation in the KRW earlier this week.  And to the extent that it can keep some form of its hitherto ‘highest beta in EM Asia’ status, capital controls aside, that number may ultimately prove to be on the conservative end.