FRBSF Economic Letter
97-10; April 11, 1997
Dealing with Currency Speculation in the Asian Pacific Basin
Pacific Basin Notes. This series appears on an occasional
basis. It is prepared under the auspices of the Center
for Pacific Basin Monetary and Economic Studies within the FRBSF's
Economic Research Department.
In recent years, policymakers in the Asian Pacific Basin have paid increasing
attention to the possibility of the sudden depreciation of their currencies,
in sharp contrast to their traditional concern with currency appreciation.
This attention is a response to a number of developments, most notably:
speculation against the currencies of Hong Kong, the Philippines, and
Thailand in the wake of the Mexican peso crash of December 1994; uncertainty
on the part of some observers about the maintenance of the peg of the
Hong Kong dollar to the U.S. dollar after the July 1997 transfer of sovereignty
to China; and concerns voiced in the financial press about the sustainability
of relatively large current account deficits in some Southeast Asian economies.
The recent weakness of the yen against the U.S. dollar also has been a
contributing factor, as it potentially puts pressure on the currencies
of Japan's competitors to depreciate against the dollar.
Speculative attacks are a concern because a sudden large devaluation
may be inflationary. In addition, although a sharp devaluation may stimulate
the economy over time, in the short run, the sudden departure of investors
and losses of purchasing power associated with a speculative attack may
depress domestic demand and lead to sharp reductions in output. The problems
associated with speculative attacks have been starkly illustrated by Mexico's
experience after the peso collapse in 1994.
Partly in response to these concerns, exchange rate cooperation has
been high on the agenda of recent discussions of policymakers in the Asian
Pacific Basin, and central banks in the Asian Pacific Basin have committed
to support each other's currencies during periods of speculative pressure.
This Economic Letter briefly summarizes some of these recent
initiatives, and discusses alternative paths economies in the Asian Pacific
Basin may follow in pursuing exchange rate cooperation.
Discussing cooperation
Policymakers in the Asian Pacific Basin have discussed closer exchange
rate cooperation in a number of recent international meetings. Such cooperation
was one theme of the first governor-level Executive Meeting of East Asia
and Pacific Central Banks (EMEAP) in Tokyo in July 1996. Established in
1991 at the initiative of the Bank of Japan, the EMEAP comprises eleven
member central banks in the region (Australia, China, Hong Kong, Indonesia,
Japan, Korea, Malaysia, New Zealand, the Philippines, Singapore, and Thailand).
The high level of participation in the EMEAP and its broad mandate to
examine a wide range of issues has prompted speculation that it may play
a key role in managing joint responses to speculative pressures in foreign
exchange markets in the region, and that it could subsequently evolve
into an "Asian BIS." The BIS, or Bank for International Settlements,
is a Basle-based financial institution that has supported the activities
of the central banks of industrial countries since before World War II.
While it is probably best known for its recent contributions to the assessment
of bank risk and capital standards, the BIS also plays a role in the foreign
exchange swap arrangements among central banks of industrial countries.
To date, no concrete steps in such a direction have been announced by
the EMEAP, and speculation may have been dampened by the recent admission
into the BIS of a number of East Asian economies (China, Hong Kong, Korea,
and Singapore).
In early March 1997, at their first meeting, finance ministers of the
Association of Southeast Asian Nations (ASEAN) agreed to study the possibility
of setting up a regional mechanism to defend currencies against speculative
attack. They also agreed to review a 1977 ASEAN foreign exchange swap
arrangement expiring in August of this year. Under a foreign exchange
swap, a central bank exchanges domestic currency for foreign currency,
while at the same time agreeing to reverse the transaction after a predetermined
period. The total amount of the ASEAN swap arrangement is modest, up to
$200 million, although it is apparent that the amounts may be adjusted
to reflect changes in the global financial environment. By way of comparison,
the Federal Reserve's (reciprocal currency) swap arrangements with other
central banks range from $250 million with the Austrian National Bank,
up to $5 billion with the Bank of Japan and $6 billion with the Deutsche
Bundesbank.
The meetings cited above include only economies in the Asian Pacific
Basin, but countries on the other side of the Pacific also are engaged
in related discussions. Regional macroeconomic and exchange rate developments
were on the agenda of a meeting of senior Finance Ministry and Central
Bank officials held in Tokyo in early March 1997, which involved the U.S.,
Japan, China, Hong Kong, Singapore, and Australia. Similar topics have
been discussed by the finance ministers of the Asia Pacific Economic Cooperation
Forum (APEC), comprising 18 economies on both sides of the Pacific.
The set of recent initiatives that may have attracted the most attention
is the web of bilateral repurchase (repo) agreements undertaken by monetary
authorities in the Asian Pacific Basin, under which a country may exchange
U.S. dollar Treasury securities it holds for U.S. dollars from its neighbors
in order to support its currency. The first agreements were signed by
Australia, Hong Kong, Indonesia, Malaysia, and Thailand, and separately
by Singapore and Indonesia in November 1995. These were followed by announcements,
or signed agreements, by Hong Kong and the Philippines (December 1995),
China and Hong Kong (February 1996), Japan, Australia, Hong Kong, Indonesia,
Malaysia, Philippines, Singapore, and Thailand (April 1996), Korea with
Australia, Japan, Hong Kong, and Singapore (January 1997), the Philippines
and Thailand (February 1997), and Hong Kong and New Zealand (March 1997).
It is also worth noting that Hong Kong and Singapore now also may intervene
on behalf of the Bank of Japan in foreign exchange markets under an agreement
signed in February 1996.
The full scope of these agreements has not been publicly disclosed.
However, one noteworthy feature is that the U.S. dollar, rather than the
currencies of participating members, is to be used to intervene in foreign
exchange markets. To illustrate, if an Asian central bank which has signed
a repo agreement with Hong Kong wants to intervene to prevent depreciation
of its currency, it can acquire U.S. dollars from Hong Kong to support
its currency by selling U.S. Treasury securities, with an agreement to
reverse the transaction (repurchase the security) at a mutually agreed
price and date. These repos enable the central bank to obtain U.S. dollar
liquidity at short notice. The mechanics are similar to the way the Federal
Reserve injects liquidity through open market operations; in this case,
the Asian country facing depreciation pressures would receive the injection
in liquidity from Hong Kong. The total size of the repo transactions depends
on the ceilings set in the bilateral agreement, or the amount of U.S.
dollar Treasury securities the country facing speculation has available
to sell, whichever is lower. For example, the announced ceilings for repo
agreements with Japan are US$1 billion each, so a country facing speculation
would have to have at least US$ 1 billion in U.S. Treasury securities
to reach that ceiling. As is well known, economies in the Asian Pacific
Basin have foreign exchange reserves that are large in relation to the
markets in their currencies.
As the transactions involve exchanges of U.S. dollar assets, these repo
arrangements differ from the swap facilities used by industrialized countries,
which involve the direct exchange of currencies. For example, if the Fed
wants to intervene to influence the dollar-deutschemark exchange rate,
it can swap dollars for deutschemarks with the Bundesbank, Germany's central
bank.
Why the interest in cooperation?
Consultations on exchange rate issues are common among the Group of
Seven (G-7) industrial countries, and among European countries, but they
represent a significant departure for the Asian Pacific Basin, where countries
have traditionally adopted monetary and exchange rate policies without
consulting their neighbors. One possible explanation for the change is
that in the past policymakers in the Asian Pacific Basin were concerned
largely with currency appreciation pressures. If necessary, these pressures
can be eliminated by allowing the money supply to increase, a course of
action entirely within the ability of an individual central bank. In contrast,
responding to depreciation pressures may require the use of foreign exchange
reserves, which central banks may prefer not to do. Cooperation among
central banks in this case may be helpful in reassuring financial markets,
which may help avert unwarranted speculative pressures.
Tolerating depreciation
In spite of this incentive for cooperation, there appear to be significant
differences in how much each monetary authority in the Asian Pacific Basin
tolerates currency depreciation, which can make it harder to determine
what criteria to use in cooperating. To illustrate these differences,
the figure shows the frequency of monthly exchange rate depreciation rates
against the U.S. dollar exceeding 40 basis points (5% annualized) in selected
East Asian economies, as well as in Australia and New Zealand, from January
1990 to December 1996. (Taiwan is included for completeness, although
it is not participating in these initiatives.) In order to focus on temporary
fluctuations, the average rate of change of the exchange rate over the
entire sample period has been subtracted. These average changes vary considerably,
ranging from appreciation of 2% to 4% (annualized) in Japan, New Zealand,
and Singapore, to depreciation of 3% to 4% in the Philippines and Indonesia.
The average change in the exchange rates of Australia, Hong Kong, and
Thailand is zero.
The figure suggests that
economies in the Asian Pacific Basin can be classified roughly into three
groups. In one group, comprising Japan, Australia, and New Zealand, exchange
rates are more flexible and "large" depreciations occur often,
40% to 45% of the time. In another group, comprising China, Hong Kong,
and Indonesia, such depreciations occur rarely, between 6% and 12% of
the time. The remaining economies are in a middle range where large depreciations
occur 30% to 40% of the time, which indicates a relatively high tolerance
for (temporary) depreciation. At the root of the differences illustrated
in the figure are differences in the approach to monetary and exchange
rate policy.
Alternative approaches
How will central banks in the Asian Pacific Basin cooperate in foreign
exchange markets, given apparently large differences in the tolerance
for currency depreciation? One possibility is that monetary authorities
in the region will opt to follow the approach of the G-7 industrial countries,
where intervention in foreign currency markets has been sporadic, designed
mainly to respond to "disorderly markets," whose emergence may
be unpredictable. In line with this, the conditions under which G-7 intervention
in foreign exchange markets occur are typically not spelled out in advance,
at least not publicly. Similarly, Asia-Pacific central banks' cooperation
in foreign exchange markets might focus on episodes of particularly strong
speculative pressure.
Alternatively, economies in the Asian Pacific Basin could follow the
European model of cooperation, which is more tightly structured. Prior
to speculative attacks in 1992-1993, intervention (and the credibility
of such intervention) kept European exchange rates within a relatively
tight band (2.25% from a central cross parity), although some flexibility
was allowed by setting a wider band for some currencies. However, a key
difference between Europe and the Asian Pacific Basin is that Europeans
have sought to coordinate not just intervention in foreign exchange markets,
but their exchange rate targets and their monetary policies as well. It
is too early to say if central banks in the Asian Pacific Basin will consider
such extensive coordination.
Ramon Moreno
Senior Economist
Opinions expressed in this newsletter do not necessarily reflect
the views of the management of the Federal Reserve Bank of San Francisco,
or of the Board of Governors of the Federal Reserve System. Editorial
comments may be addressed to the editor or to the author. Mail comments
to
Research Department
Federal Reserve Bank of San Francisco
P.O. Box 7702
San Francisco, CA 94120
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