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."