Asia wrong to raise interest rates: Economist

Asia wrong to raise interest rates: Economist

HONG KONG (Reuters): Asian countries such as Thailand were
mistaken in raising interest rates to fight speculators and
defend their currencies, Nobel laureate and economist Merton
Miller said yesterday.

"The Bank of Thailand's first mistake was to try to fight off
the speculators by raising interest rates and tightening market
liquidity," Miller told 600 people at an Asia Society lunch in
Hong Kong.

It may seem natural to raise interest rates to punish
speculators by raising the cost of borrowing the currency to sell
it short, said Miller, who won the Nobel Prize for economics in
1990.

"But even though the cost looks horrendous, sometimes 100
percent or even 1,000 percent on an annualized basis, it comes
down to just a pinprick on a daily basis compared to what
speculators hope to make from even a modest devaluation, let
alone 50 or 60 percent," Miller said.

Asian countries have been pummeled by a currency crisis
sparked by the sharp drop in value of the Thai baht last year,
which led governments to raise interest rates in a bid to ward
off speculators.

"Raising interest rates not only does not substantially
discourage the speculators, but it can be shown to enrich those
who have already sold the currency short in the forward exchange
market," he said.

"Southeast Asia banks and firms were not simply borrowing
short and lending long, but were borrowing short in one currency
-- typically the dollar or the yen -- and lending long in
another, to wit the local currency," he said.

"If, therefore, a country's exchange rate falls substantially
relative to the dollar, the cost of renewing or rolling over
these short term floating rate dollar or yen loans can become
very high in local, real terms."

Thailand's central bank also failed to reveal the true amount
of the nation's foreign exchange reserves, triggering a massive
loss of confidence and capital flight, Miller said.

"The Bank of Thailand, which was fighting the speculators in
the forward market by taking a long position to offset the
spectacular short positions, could, for a while at least,
continue to show substantial amounts of foreign currency reserves
on its books, even though, in effect, it had already committed
those reserves in the forward market."

Currency speculators knew that the Bank of Thailand's foreign
currency reserves were not what they were reported to be and sold
short in the forward market, he said.

Hong Kong had been able to buck the tide because people had
not yet lost confidence in their government and its promise to
maintain the value of the Hong Kong dollar, pegged to the U.S.
dollar at a rate of HK$7.8.

Instead of boosting interest rates, Hong Kong authorities
should signal their support for the peg by offering a public
insurance policy to compensate people for any losses suffered in
the event the local currency was de-pegged.

China should do the same to reassure its citizens it would not
devalue the yuan, Miller said.

Miller said the real culprit for Southeast Asia's financial
crisis was the low and falling value of the Japanese yen, which
also meant a rising dollar.
Asian currencies linked to the dollar seemed overvalued and
attracted speculative attack.

Miller did not say what Asian governments should have done to
ward off speculators. But he called for a reduced dependence on
banks as suppliers of capital to industry by expanding the number
of market alternatives to bank loans, such as issuing junk bonds.