Monetary aides fret over Asian forex systems

Monetary aides fret over Asian forex systems

WASHINGTON (Dow Jones): The International Monetary Fund and some of its biggest financial backers are growing worried about what they say may be a tendency among recovering Asian economies to revert implicitly to fixed exchange-rate systems.

The recovery in East Asia has reawakened an old policy dilemma for the region's monetary policymakers, experts say: what must small, relatively open economies do to ensure they won't be destabilized by large and often volatile flows of foreign capital?

This year five crisis-hit economies -- South Korea, Indonesia, Malaysia, Thailand and the Philippines -- are expected to see capital inflows totaling US$5.3 billion, ending a three-year stretch of outflows.

Most of those countries have approached the dilemma in their usual way, according to monetary authorities in Washington: by feverishly buying or selling U.S. dollars to keep domestic currencies stable.

South Korea has engaged in a dollar-buying binge to keep its currency from appreciating. Its foreign reserves, as a result, stood at a record $85.25 billion two weeks ago.

The Institute of International Finance, an association of bankers, says the five crisis-hit economies are accumulating reserves at the rate of about $40 billion a year collectively, the fastest pace since 1992.

That trend has helped improve the countries' sovereign credit ratings, but it has also fueled worries among top international monetary regulators about the countries' long-term commitment to the economic reforms they undertook after the regional financial crisis in 1997.

Most of the countries, after all, abandoned fixed exchange- rate systems after the systems proved susceptible to devastating attacks from currency speculators.

They now call their systems "managed floats," meaning exchange rates fluctuate with market conditions amid only occasional central-bank intervention.

"This is a flirtation with more fixed exchange rates and it flies in the face of what the lessons of the Asian crisis were," said one senior official in Washington with responsibility for advising and consulting with Asian central bankers.

The official, who asked not to be identified, said that concern has been expressed informally to Asian monetary officials, most recently at meetings last month of the IMF and the World Bank.

Asian central bankers deny the flirtation: "We don't see it," said Rafael Buenaventura, governor of the central bank of the Philippines.

"The exchange rate has been allowed to float. If you look at the movements of all the exchange rates in the region, it's very consistent." He said an IMF team recently visited Manila and was "quite pleased...that we have not tried to manage our currency."

The IMF, however, has also expressed its concern publicly. Last month, in an annual report on the global economic outlook, the agency said Asian countries should "find the right balance between additional reserve accumulation through intervention and further gradual currency appreciations."

It said the countries can afford to allow their currencies to appreciate at least a little "before possible overvaluation becomes an issue."

Economists regard the currencies of most recovering East Asian economies as undervalued. But the undervaluation has been an important competitive advantage as the countries emerge from recession -- and they are loath to give it up.

The IMF expects economies throughout Asia to grow as much as 6.2 percent on average this year, but that growth will depend nearly entirely on exports.

Domestic economic activity remains weak in many countries: because the countries import little, regional current account surpluses have ballooned.

Some Asian central banks, as a result, have made exchange-rate stability their paramount short-run objective.

"I expect that for a considerable span of time we would find that at times, exchange stability would come first," Thailand's central bank governor, Chatu Mongol Sonakul, said in a speech in London last month.

"Later on, when things have settled down, there will be periods of volatility, and in those periods exchange-rate stability might have more importance than price stability, but over the normal period price stability would be the primary objective."

Asian central bankers say their attempts to stabilize currencies shouldn't be mistaken for a regression to fixed- exchange rates.

Fixed-exchange rates provide currency speculators a clear target, they acknowledge. But when currency stabilization efforts are more amorphous than that, they argue, speculators are actually deterred and economic order is maintianed.

"We, from time to time, provide liquidity to ensure there is an orderly movement of exchange (rates)," said Buenaventura, the Philippines central bank governor.

"But it's not setting any specific target. When you talk of intervention, it means you have a specific target in mind. When you talk of providing liquidity, it is to ensure that speculators do not take advantage of an exchange rate fluctuation. So there's a fine distinction between the two."

Some economists say such approaches are entirely reasonable, given that the regional economic recovery remains incomplete.

"Normal economic relationships have not yet been reestablished in these countries," said Greg Fager, director of the Institute of International Finance's Asia department.

"That's at least a year away. So I think the appetite to build reserves is quite understandable and healthy." Once the recovery is entrenched, he predicted, Asian currencies will move more freely.

But other economists are skeptical. "Korea -- and other Asian countries -- will lapse back into the old habit of managing the exchange rate on the basis of traditional 'rules of thumb'...necessary for export competitiveness," Australia's Macquarie Bank Ltd. said in a recent report.

That, it said, "would essentially reverse lessons learned from the 1997 crisis, effectively undermining corporate commitment to further reform and providing little incentive to adopt better management practices, such as hedging their foreign-exchange risks."

Carmen Reinhart, a professor of economics at the University of Maryland, said the move by Asian countries to "floating" exchange-rate systems was a move in name only.

History, she said, shows that emerging-market countries tend to dread both appreciations and depreciations of their currencies.

As a result, "the so-called 'demise' of fixed-exchange rate systems is a myth," she wrote in an article published this month in the American Economic Review.

"When circumstances are favorable (i.e., there are capital inflows, positive terms-of-trade shocks etc.) many emerging market countries are reluctant to allow the nominal (and real) exchange rate to appreciate," Reinhart wrote.

"When circumstances are adverse, the case against allowing large depreciations becomes, possibly, even more compelling" because "devaluations in developing countries have a history of being associated with recessions -- not export-led booms."