Asia's dollar peg may no longer be helpful: Expert

Asia's dollar peg may no longer be helpful: Expert

TOKYO (Reuter): The pegging of Asian currencies to the U.S. dollar may no longer bring much benefit to regional economies, a leading Asian economist said yesterday.

Given the current regional currency crisis, Asia should look towards the yen as a counterweight to the dollar to ensure economic stability, C.H. Kwan, a senior economist at Nomura Research Institute, told Reuters in an interview.

"Given massive capital flows and highly volatile movements among major currencies, the forex policy of pegging their currencies to the dollar adopted by most Asian economies may no longer be consistent with economic stability," Kwan said.

More attention should be paid to the stability of Asian currencies against the yen, he said.

One of the main factors that forced Thailand's central bank to devalue the baht early this month was the fact that the country's export competitiveness weakened after the yen started falling in mid-1995, he said.

"Although the baht has been pegged against a basket of currencies in which the dollar carried great weight, the sharp depreciation of the yen since mid-1995 led to the baht's appreciation in trade-weighted terms," Kwan said.

For an emerging Asian country, macroeconomic stability depends more on its trade-weighted exchange rate than its exchange value against the U.S. dollar, he said.

To achieve macroeconomic stability, an emerging economy should try to stabilize its trade-weighted exchange rate by pegging its currency to a basket of currencies in which the major currencies carry weight consistent with the importance of a country as a trading partner, he said.

"Judging by this criteria, the weight assigned to the Japanese yen in the Thai reference currency basket was too low," Kwan said.

The yen's weighting was estimated to be around 10 percent in the currency basket before the introduction of a managed float system for the baht on July 2, he said. The weighting for the dollar was far greater.

Some Asian nations, such as Taiwan and South Korea, have already started to loosen their ties to the dollar.

By allowing their currencies to fall in tandem with the yen's decline over the last two years, South Korea and Taiwan had seen a sharp recovery in exports, he said.

Kwan said another lesson from the Thai crisis was that a developing country whose financial sector was still weak should not hurry to liberalize capital account transactions.

The establishment of the Bangkok International Banking Facility (BIBF) in 1993, which represented a major step in the liberalization of capital account transactions, has made it difficult for the government to control the inflow of funds.

BIBF, unlike other conventional offshore markets, was primarily engaged in so-called "out-in" transactions in which funds raised from non-residents were lent to residents.

The bulk of those funds ended up in speculative activity in the asset markets. When the bubble finally burst, the financial system was left with massive bad debt.

The baht tumbled to a record-low of 32.70 to the dollar on Thursday, having lost more than 20 percent of its value since the introduction of the managed float system.

Kwan said the baht devaluation should in time help boost Thai exports and suppress imports and, as a result, Thailand's current account deficit should shrink in the months ahead.

It should also favor inflows of direct investment from countries that use Thailand as an export base, even though the increased exchange rate volatility may deter foreign investors.

He said companies with liabilities denominated in foreign currency would find the repayment burden in terms of baht rising in proportion to the scale of its fall.

Foreign banks lending to Thailand in foreign currencies, such as the dollar and yen, would not suffer capital losses resulting from the devaluation. However, the default risk of their loans outstanding had increased with the growth in borrowers' debt burden, he said.