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.