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.