United against speculators

United against speculators

The conclusion of an interlocking set of bilateral repurchase
agreements between the central banks of Australia, Hong Kong,
Indonesia, Malaysia and Thailand in Hong Kong on Monday should be
welcomed as a contingency program to cope with speculative
attacks on currencies. The repurchase agreements, usually called
repos, enable the participating central banks to raise foreign
reserves from each other against their respective holdings of
U.S. government securities. The repos thus allow the central
banks to increase liquidity without liquidating their securities
holdings.

The repos therefore mainly serve as a tool of monetary
management to cope with an emergency situation, such as the
speculative attacks on the Indonesian rupiah, the Malaysian
ringgit and the Thai baht early this year. They are called
speculative attacks because the run on the three currencies in
January were completely unexpected in view of the sound economic
fundamentals of the three countries. The speculation at that time
was triggered by the financial crisis in Mexico whose similarity
to the three Asian countries lies in the fact that they are all
emerging market economies.

Given the increasing globalization of the financial markets
whereby a currency is vulnerable to strong pressures from sudden
massive capital inflows or sudden capital flight, such an
alternative source of liquidity is indeed essential. Indonesia's
central bank, for example, was reportedly forced to draw on
almost $1 billion of its foreign reserves to extinguish the
speculation against the rupiah early this year.

The repos are especially important for Indonesia whose rupiah
has often been hit by speculative attacks. This year alone, for
example, the rupiah has undergone three waves of speculative
attacks mostly because of negative rumors about the economy and
balance of payments situation.

Bank Indonesia's repos with the central banks of Australia,
Hong Kong, Malaysia and Thailand on Monday and with the Monetary
Authority of Singapore earlier on Saturday could serve as
additional emergency backup to cope with any run on the rupiah.

Nonetheless, as we stated earlier on this column, the repos
are only a contingency arrangement. That means they are effective
only to cope with currency volatility caused by speculative
attacks. Put another way, the repo facility serves only as a fire
engine.

The most important thing is to prevent the emergence of any
speculative attacks on the rupiah. Such speculations are usually
set off by jitters about the condition of the economic
fundamentals. Such jitters are generated mostly by rumors which
in turn arise mainly for lack of up to date information on key
economic indicators.

However, the best defense against currency speculation is the
maintenance of sound macro-economic management and consistency in
upholding the principles of the market economy. Any
inconsistencies, however short-term they may be, may provide the
wrong signals which in turn could set off a wave of speculation
against the rupiah. The central bank and the Monetary Board are
required to be extra careful especially now because all
indicators point towards a significant increase in the current
account deficit this year.