Description
This is a document describes exchange rate regimes and the road ahead of asian crisis.
Exchange Rate Regimes: The Road ahead of the Asian Crisis The Asian Crisis of 1997/98 forced a host of South-East and East Asian countries to move towards a flexible exchange rate regime under IMF pressure. However, there have been observations that these countries are reverting to their pre-crisis practices of maintaining soft-peg to US dollar while retaining the official tag of “Free-Floating” regimes. In this section we are attempting to crystallise the de-facto exchange rate regimes of a host of South-East Asian countries (Indonesia, South Korea, Thailand and Malaysia) by performing a battery of volatility tests and creating a “Flexibility Index” in this process by comparing the data with some benchmark countries. The Bipolar view: In recent years a new theory of “Bipolar View” has gained ground .According to this view countries increasingly face the choice between a “Hard Peg” exchange rate regime, e.g. a currency board, or a free-floating regime. The choice of a middle ground in the form of a “Soft Peg” is thought to be no more viable since it is supposed to make a country more prone to financial crises.1 A “Soft Peg” is defined as “exchange rates that are currently fixed in value (or in a narrow range of values) to some other currency or basket of currencies, with some commitment by the authorities to defend the peg, but with the value likely to change if exchange rates come under significant pressure” (Fischer, 2001, P. 3). More and more countries are abandoning their intermediate exchange rate regimes and adopting a “corner solution”, as seen in Figure-1.
The percentage of total number of IMF member countries having intermediate exchange rate regimes has gone down significantly in the previous decade. A whooping 62% of IMF members used to have a soft peg exchange rate regime in 1991, which has come down to 31% at the end of 2002. On the other hand free floating regimes registered an impressive growth In the same period almost doubling from 23% to 43%. Hard peg regimes also registered a modest growth of about 10%2. Thus an actual trend of a “vanishing middle” can be observed. The reason, as Fischer (2001, P. 9-13) argues, is that soft peg systems have proved to be nonviable in the longer run, especially for countries that are open or opening to international capital flows. If and when such a system breaks down, it causes serious economic damage to the economy, for a few years at least. Laxity and False Perception of Stability: Once a pegged arrangement has been in place for a few years, a false perception arises that the exchange rate won’t change ever, leading to reduced risk perception while borrowing in foreign currencies and "eliminating" the need to hedge. Thus when a crisis does occur, its effects are unusually severe. Though principally it is possible to put regulations in place limiting the foreign exchange positions of banks, but it is difficult to enforce such regulations in a period of stability (Fischer, 2001, P. 10). Moreover these transactions are profitable and hence attractive and it would be a loss to ban such transactions in a period of stability. Impossible Trinity The goals of having a fixed exchange rate, capital mobility and a monetary policy dedicated exclusively to domestic considerations – simultaneously – are referred to as an impossible trinity, since a domestically oriented monetary policy is not compatible with fixed exchange rates (Fischer, 2001, P. 10). Such attempts of reaching the “magic triangle” are practically doomed to fail”. The question arises: why can’t domestic monetary policy be used effectively to maintain the fixed exchange rate arrangement? Fischer (2001, P. 10-11) sees the root cause of the problem in the inconsistency of the political system – “if the option of changing the exchange rate is open to the political system, then at a time when the short-run benefits of doing so outweigh the costs, the option is likely to be chosen”. Futility of Capital Controls Imposing capital controls is sometimes suggested as a way out and to protect the exchange rate from the effects of unwanted capital flows. But this is problematic on many counts. Imposing capital controls on outflows would scare the potential investors and affect the capital inflows, drying up the foreign investment 3. Besides controls on outflows have to be very extensive to prevent loopholes. If domestic policies are “fundamentally inconsistent with the maintenance of the pegged exchange rate”, then even such controls can not prevent devaluation (Fischer, 2001, P.12). Apart from that controls generally lose their effectiveness in the longer run. Fischer suggests, instead, a tax on short-term capital inflows and shifting of “the composition of capital inflows towards longer-term investments”. Since most of the developed economies do have open capital markets, it can be reasonably assumed that this system is helpful for the growth and that most of the emerging market economies are interested in that system. Besides most of the
developed and emerging market economies are members of international accords on free trade, such as WTO (World Trade Organisation) and capital controls would be problematic to apply. Proponents of the bipolar view argue that the only way out of the trouble faced by soft peg regimes is offered by the corner solutions. The countries ought to either let the exchange rate float freely, so that the currency does not become a target of speculative attacks. Alternatively the monetary authorities could go for a very hard peg making institutional commitments that “both constrain and enable monetary policy to be devoted to the sole goal of defending the parity” (Fischer, 2001, P. 6). Classifying Official Exchange Rate Regimes in South East Asia Before beginning with the characterisation of prevailing de facto Exchange Rate Regimes in the Southeast Asian countries of Indonesia, Korea, Malaysia, and Thailand, it is useful to have a glance at the officially stated positions of these countries. Since many central banks routinely declare a position that is somewhat different from their actual practice, a de facto classification by the IMF is also provided. Indonesia Indonesia describes its exchange rate system as a “free foreign exchange system”, that it claims to be following since 1970.10 On the other hand Bank Indonesia has put certain restrictions on free movement of currency, e.g. on forward sales of foreign exchange to non-residents, in order to reduce exchange rate volatility (IMF EAER, 2002, P.444). The IMF classifies Indonesia’s exchange rate regime as “Managed floating with no pre-announced path for the exchange rate” (IMF EAER, 2002, P. 444). Korea South Korea has adopted a “free-floating exchange rate system” since December, 1997.11 Earlier it had followed several different exchange rate regimes, e.g. a fixed exchange rate system until 1980, a multiple-basket pegged exchange rate system from 1980 to 1990 and a Market Average Exchange Rate System till 1997, in which the exchange rate was allowed to move within an upper and a lower limit around each day's basic exchange rate. In December 1997 Korea shifted to a free floating regime. The foreign exchange market has been liberalised, allowing participants to buy and sell spots, forwards and foreign exchange swaps. The ceiling on foreign investment in Korean equities and money markets has been abolished. The IMF classifies Korea’s exchange rate regime as “independently floating” (IMF EAER, 2002, P. 505). Malaysia After experimenting with managed float in 1998 vis-à-vis an undisclosed basket of major trading partners’ currencies, Malaysia has adopted a fixed peg exchange rate regime since Sept. 1998 and has introduced a wide range of capital controls, removing all legal channels of transferring Ringgit abroad, or vice versa (IMF MRED, 1999, P.23) in order to insulate the monetary policy from external volatility. The IMF classifies Malaysia’s exchange rate regime as a “conventional pegged arrangement”, whereby the Ringgit is pegged against the US dollar at RM 3.8 per $1 (IMF EAER, 2002, P. 576). Thailand The Bank of Thailand declares to be following a “managed float” policy since July 1997. It claims to let the value of the Baht get
determined by market forces, on the basis of supply and demand, in both on-shore and off-shore foreign exchange markets and to let the currency move in line with “economic fundamentals”. It however reserves the right to intervene in the market, if necessary, to prevent, what it calls are, excessive volatilities and to achieve its economic policy targets of enhancing flexibility and efficiency in monetary policy implementation,15 and to improve supervision of foreign capital flows. The IMF classifies Thailand’s exchange rate regime as “Managed floating with no preannounced path for the exchange rate” (IMF EAER, 2002, P. 933).
Characterisation of de facto Regimes in Southeast Asia As discussed earlier, the officially stated positions of many central banks about their exchange rate system sometimes differ from their actual practice. There can be several reasons for this discrepancy, e.g. countries some time switch over to a more liberal exchange rate regime only under the IMF pressure, but they do retain a longing for more stability and usually display a “fear of floating”. In order to find out the de facto policies pursued by the four Southeast Asian nation studied in this paper, the exchange rate volatility, foreign reserves volatility and interest rate volatility are calculated for the post-crisis period. Further a flexibility index is also constructed. This data is then compared with the pre-crisis and mid-crisis data and with selected benchmark countries. Australia and Denmark have been selected as benchmarks for the post-crisis period. Australia is known for its floating exchange rate regime, Denmark on the other hand had an exchange rate band to Euro till 2003. Both the countries are middle-sized economies and thus comparable to the Southeast Asian economies. Australia also has a larger share of commodity exports, like some of the Southeast Asian countries. Additionally for some other countries e.g. Germany, Japan and India are also compared to broaden the comparability of volatilities.
This paper builds primarily on Baig (2001) and Hernández/Montiel (2001) and uses their data for years 1995-20005. Comparison of Volatilities We first examine the volatility in exchange rates. Then we turn our attention to the volatilities in interest rates and foreign currency reserves, as the authorities might be targeting the exchange rate through monetary policy and/or intervention in the foreign exchange market (Baig, 2001, P.11). Exchange Rate Volatility Volatility of exchange rate shows whether the value of a currency is determined by the market forces or the monetary authorities. It is defined as the standard deviation of the percent change of the exchange rates against a reference currency (Baig, 2001, P. 6), in this paper US dollar, unless otherwise specified.
Volatility of Daily Exchange Rates (2003 only 1st Quarter)
Country Indonesia Korea Malaysia Thailand Australia Germany India Japan Euro Denmark Denmark Reference USD USD USD USD USD USD USD USD USD USD EUR 1995 0.15 0.25 0.23 0.12 0.53 0.79 0.37 0.9 n.a. n.c. n.c. 1996 0.15 0.23 0.15 0.08 0.4 0.41 0.43 0.48 n.a. n.c. n.c. 1997 1998 2.49 4.86 2.65 1.75 0.9 1.75 1.71 1.58 Benchmark Countries 0.6 0.84 0.62 0.56 0.27 0.39 0.75 1.08 n.a. n.a. n.c. n.c. n.c. n.c. 1999 1.88 0.48 0.01 0.56 0.58 0.6 0.11 0.83 n.a. n.c. n.c. 2000 1.05 0.42 0.01 0.45 0.76 0.77 0.17 0.63 n.a. n.c. n.c. 2000 1.32 0.42 0.01 0.45 0.74 0.74 0.18 0.74 0.74 0.74 0.14 2001 1.7 0.51 0.08 0.3 0.78 0.69 0.14 0.78 0.69 0.68 0.11 2002 0.73 0.53 0.01 0.34 0.55 0.57 0.07 0.55 0.57 0.56 0.06 2003 0.38 0.7 0.01 0.22 0.6 0.56 0.11 0.6 0.56 0.55 0.03
As can be seen in the Table-1, the Southeast Asian countries experienced relative stability and little volatility in the pre-crisis period, which took a dramatic turn in the crisis period of 1997/98, for example Indonesia’s volatility jumped from 0,15 in 1995 to 4,86 in 1998. In the post-crisis period (since 1999) the volatility has receded for most of the countries in the region, except Korea. The exchange rate volatility of Korea and Indonesia has continued to be high and comparable to known floaters like Australia, Japan and Germany, Thailand has become relatively stable, its exchange rate volatility is probably comparable to India’s, an another known managed floater. Malaysia is not experiencing any significant volatility, which is consistent with its declared exchange rate regime of a fixed peg. This is also comparable with Danish’s Kroner’s volatility, when referenced against Euro. Denmark has a declared and de facto exchange rate band to Euro (IMF AR, 2002, P. 118). Not surprisingly Kroner reflects the exchange rate volatilities of Euro, when referenced against US dollar. The volatilities for Germany and Euro-Area are same, since the inception of Euro. Having analysed the volatilities of daily exchange rates, it is also useful to take a glance at those of monthly exchange rates.
Volatility of Monthly Exchange Rates (2003 only 1st Quarter)
Country Indonesia Korea Malaysia Thailand Australia Germany India Japan Denmark Denmark Saudi Arabia Reference USD USD USD USD USD USD USD USD USD EUR USD 1995 0.51 1.06 1.06 0.59 1.84 3.25 1.81 4.89 n.c. n.c. n.c. 1996 1997 1998 0.65 11.25 32.66 0.93 10.06 7.49 0.61 4.48 7.21 0.34 8.45 8.93 Benchmark Countries 1.84 2 3.73 2.05 2.92 2.06 1.99 2.08 1.53 2.04 3.84 6.3 n.c. n.c. n.c. n.c. n.c. n.c. n.c. n.c. n.c. 1999 10.25 2.86 0.01 3.08 2.53 2.03 0.47 2.6 n.c. n.c. n.c. 2000 3.85 2.44 0.01 2.18 3.55 3.7 0.77 3.44 n.c. n.c. n.c. 2000 4.16 2.61 0.01 2.22 3.55 3.74 0.81 3.39 3.66 0.18 0.05 2001 7.86 2.49 0.01 2.07 3.86 2.58 0.51 3.69 2.56 0.14 0.02 2002 3.11 2.17 0.01 1.25 2.2 2.59 0.39 2.13 2.57 0.07 0.04 2003 3.07 2.85 0.01 1.26 2.5 2.07 0.29 1.99 2.07 0.07 0.06
The data in Table above points in the same direction. Remarkable is that the volatility for Korea is stabilising gradually and is in the same region as Australia, Germany and Japan. Indonesia seems to be on a roller coaster ride, which points to the turbulent period in years 2000/01. Malaysia is consistent with low volatility, which shows a remarkable comparability with another known fixed peg regime of Saudi Arabia, categorised by the IMF in the same group as Malaysia (IMF AR, 2002, S.118). Thailand’s volatility has decreased. It is significantly lower than those of known floaters but is still considerably higher than India’s, another managed floater.
Country Indonesi a Malaysia Korea Thailand
Volatility of Daily Rates High High Low Medium
Volatility of Monthly Rates High/Unstable High Low Medium/Low
Interest Rates Volatility Since it is possible that two countries with similar exchange rate volatilities have two very different exchange rate regimes – one might be a stable free-float and the other a dirty float “kept in check through interest changes or foreign exchange market interventions” (Baig, 2001, P.11) – it is necessary to examine the volatility of interest rates in Southeast Asia.
Volatility of Interest Rates (2003 only 1st Quarter)
Country Indonesia Korea Malaysia Thailand Australia Denmark Germany Japan India 1995 1.28 1.16 0.13 2.53 0.16 n.a. 0.1 0.2 8.57 1996 1.17 1.3 0.34 1.84 0.2 n.a. 0.15 0.02 6.75 1997 15.6 2.27 2.45 5.54 0.16 n.a. 0.1 0.03 3 1998 1999 14.75 4.06 1.99 0.29 1.12 0.48 4.76 0.35 Benchmark Countries 0.07 0.07 n.a. n.a. 0.1 0.17 0.05 0.04 5.55 1.92 2000 0.88 0.08 0.06 0.41 0.16 n.a. 0.11 0.05 1.72 2000 0.9 n.a. 0.05 n.a. 0.18 0.2 0.07 2.77 2001 0.79 0.13 0.09 0.31 0.2 0.19 0.07 1.49 2002 1.61 0.07 0.05 0.09 0.09 0.17 0 0.54 2003 n.a. 0.04 0.06 0.14 0 0.25 0 0.1
Interest Rate Volatilities Indonesia: Korea: Malaysia: Thai India Australia: Interbank Call Money Overnight Overnight Call Rates Interbank Overnight Borrowing Rates Interbank Overnight Borrowing Rates (average) Overnight Call Money Markets Rates Overnight and Call funds
Interest rates volatility in pre-crisis Southeast Asia with the only exception of Malaysia. was substantially higher than in the floating countries of Australia, Germany or Japan but significantly lower than in managed-floating regime of India. The volatility in Southeast Asia increased dramatically during the crisis – in Indonesia it jumped from 1.28 in 1995 to 15.6 in 1997 and in Malaysia from 0.13 to 2.45 in the same period. In the post-crisis period this volatility has receded considerably with Indonesia (1.61) being the only country in Southeast Asia in year 2002 with a volatility greater than 0.10. Korea (0.07). Malaysia (0.05) and Thailand (0.09) all have a volatility that is comparable to those of the known floaters e.g. Australia (0.09). Managed-floater India had a volatility of 0.54 in year 2003 down from 8.57 in year 1995. and a with recession confronted Japan had experienced no volatility at all. So it can be said that amongst the surveyed countries only Indonesia had a relatively high volatility in interest rates. All other surveyed countries in the region had low interest rate volatility in the post-crisis period. Reserves Volatility As discussed above, the volatility in foreign reserves is one of the instruments, which might give valuable information on the exchange rate interventions by a central bank. However one has to keep in mind that fluctuations in foreign reserves do not necessarily reflect interventions in foreign exchange markets. They might also occur on account of other factors such as debt repayments, value adjustment owing to exchange rate movements etc. (Baig, 2001, P. 12) Apart from that forward market interventions by central banks are not fully reflected by the gross reserves figures.
Volatility of Foreign Reserves (Total Reserves) (2003 only 1st Quarter)
Country Indonesia Korea Malaysia Thailand Australia Denmark India 1995 1.58 2.78 2.64 2.52 4.88 n.a. 3.11 1996 3.58 3.77 2.72 1.4 10.3 n.a. 3.49 1997 4.79 8.5 6.06 9.18 1998 1999 2000 6.45 2.39 7.58 4.97 1.9 1.6 4.55 3.36 2.82 4.17 2.1 2.12 Benchmark Countries 3.45 6.21 7.63 11.01 n.a. n.a. n.a. n.a. 4.92 3.63 1.87 4.23 2000 n.a. n.a. 2.97 2.07 10.92 3.77 4.11 2001 1.06 1.21 3.53 1.31 4.14 5.82 1.38 2002 1.5 0.88 1.47 2.3 4.89 3.79 1.4 2003 0.02 0.71 0.29 2.77 4.2 0.57 2.89
Indonesia seems to have stabilised in previous two years. If the first quarter of this year is an indicator than this trend can be expected to continue. its volatility in year 2003 reaching the pre-crisis level of 1995. Korea, on the other hand, which had quite high volatilities in pre-crisis period and during crisis (2.78 in 1995) had quite a low volatility of 0.88 in 2002. Malaysia reserves continue to be volatile in the post-crisis period. though in 2002 they were lower than usual. Thailand has also had a medium level of reserves volatility in the post-crisis period. But there emerges no clear picture on this front. Free-floater Australia also has a higher level of reserves volatility than managed-floating India or Denmark with a horizontal band.
Conclusion G Ramachandran once very appropriately remarked ‘Full convertibility is a necessity that can inject high-octane fuel into the economy. It will secure the autonomy of the RBI in the management of monetary policy and interest rates. The RBI and the Government have an onerous task ahead but it will vouchsafe India the trinity of equity, enterprise and economic growth’ Current problems 1. Managing the rupee's dirty float within a system of limited convertibility and full interest rate autonomy has become very difficult. 2. The Reserve Bank of India (RBI) has had a torrid time balancing capital inflows against the nation's policy on money supply, interest rates, inflation, price stability and growth Three tasks Implementing a dream joint combination of full convertibility and free floating system will entail the following: 1. Full convertibility will require a system of monitoring and deterrence aimed at flows related to terrorism, crime and money laundering. 2. The roadmap to convertibility will have to address how India will integrate itself into the global currency markets. They will set the spot price of the rupee after reckoning with its supply and demand. They will also set the rupee's forward price after reckoning with rupee interest rates. The road map will have
to address how the price of domestic credit will flow into the global currency markets. 3. The road map to convertibility will have to address how India will put in place a fair and free market for domestic credit. India has come a long way since July 1991 when it deregulated interest rates on corporate debentures. But there is some more distance to go in the context of other borrowers. Full convertibility is a necessity that injects high-octane fuel into the economy. It secures the autonomy of the RBI in monetary policy and interest rates but only when the rupee can float freely. It can push India into the possible trinity of equity, enterprise and economic growth.
doc_604919506.doc
This is a document describes exchange rate regimes and the road ahead of asian crisis.
Exchange Rate Regimes: The Road ahead of the Asian Crisis The Asian Crisis of 1997/98 forced a host of South-East and East Asian countries to move towards a flexible exchange rate regime under IMF pressure. However, there have been observations that these countries are reverting to their pre-crisis practices of maintaining soft-peg to US dollar while retaining the official tag of “Free-Floating” regimes. In this section we are attempting to crystallise the de-facto exchange rate regimes of a host of South-East Asian countries (Indonesia, South Korea, Thailand and Malaysia) by performing a battery of volatility tests and creating a “Flexibility Index” in this process by comparing the data with some benchmark countries. The Bipolar view: In recent years a new theory of “Bipolar View” has gained ground .According to this view countries increasingly face the choice between a “Hard Peg” exchange rate regime, e.g. a currency board, or a free-floating regime. The choice of a middle ground in the form of a “Soft Peg” is thought to be no more viable since it is supposed to make a country more prone to financial crises.1 A “Soft Peg” is defined as “exchange rates that are currently fixed in value (or in a narrow range of values) to some other currency or basket of currencies, with some commitment by the authorities to defend the peg, but with the value likely to change if exchange rates come under significant pressure” (Fischer, 2001, P. 3). More and more countries are abandoning their intermediate exchange rate regimes and adopting a “corner solution”, as seen in Figure-1.
The percentage of total number of IMF member countries having intermediate exchange rate regimes has gone down significantly in the previous decade. A whooping 62% of IMF members used to have a soft peg exchange rate regime in 1991, which has come down to 31% at the end of 2002. On the other hand free floating regimes registered an impressive growth In the same period almost doubling from 23% to 43%. Hard peg regimes also registered a modest growth of about 10%2. Thus an actual trend of a “vanishing middle” can be observed. The reason, as Fischer (2001, P. 9-13) argues, is that soft peg systems have proved to be nonviable in the longer run, especially for countries that are open or opening to international capital flows. If and when such a system breaks down, it causes serious economic damage to the economy, for a few years at least. Laxity and False Perception of Stability: Once a pegged arrangement has been in place for a few years, a false perception arises that the exchange rate won’t change ever, leading to reduced risk perception while borrowing in foreign currencies and "eliminating" the need to hedge. Thus when a crisis does occur, its effects are unusually severe. Though principally it is possible to put regulations in place limiting the foreign exchange positions of banks, but it is difficult to enforce such regulations in a period of stability (Fischer, 2001, P. 10). Moreover these transactions are profitable and hence attractive and it would be a loss to ban such transactions in a period of stability. Impossible Trinity The goals of having a fixed exchange rate, capital mobility and a monetary policy dedicated exclusively to domestic considerations – simultaneously – are referred to as an impossible trinity, since a domestically oriented monetary policy is not compatible with fixed exchange rates (Fischer, 2001, P. 10). Such attempts of reaching the “magic triangle” are practically doomed to fail”. The question arises: why can’t domestic monetary policy be used effectively to maintain the fixed exchange rate arrangement? Fischer (2001, P. 10-11) sees the root cause of the problem in the inconsistency of the political system – “if the option of changing the exchange rate is open to the political system, then at a time when the short-run benefits of doing so outweigh the costs, the option is likely to be chosen”. Futility of Capital Controls Imposing capital controls is sometimes suggested as a way out and to protect the exchange rate from the effects of unwanted capital flows. But this is problematic on many counts. Imposing capital controls on outflows would scare the potential investors and affect the capital inflows, drying up the foreign investment 3. Besides controls on outflows have to be very extensive to prevent loopholes. If domestic policies are “fundamentally inconsistent with the maintenance of the pegged exchange rate”, then even such controls can not prevent devaluation (Fischer, 2001, P.12). Apart from that controls generally lose their effectiveness in the longer run. Fischer suggests, instead, a tax on short-term capital inflows and shifting of “the composition of capital inflows towards longer-term investments”. Since most of the developed economies do have open capital markets, it can be reasonably assumed that this system is helpful for the growth and that most of the emerging market economies are interested in that system. Besides most of the
developed and emerging market economies are members of international accords on free trade, such as WTO (World Trade Organisation) and capital controls would be problematic to apply. Proponents of the bipolar view argue that the only way out of the trouble faced by soft peg regimes is offered by the corner solutions. The countries ought to either let the exchange rate float freely, so that the currency does not become a target of speculative attacks. Alternatively the monetary authorities could go for a very hard peg making institutional commitments that “both constrain and enable monetary policy to be devoted to the sole goal of defending the parity” (Fischer, 2001, P. 6). Classifying Official Exchange Rate Regimes in South East Asia Before beginning with the characterisation of prevailing de facto Exchange Rate Regimes in the Southeast Asian countries of Indonesia, Korea, Malaysia, and Thailand, it is useful to have a glance at the officially stated positions of these countries. Since many central banks routinely declare a position that is somewhat different from their actual practice, a de facto classification by the IMF is also provided. Indonesia Indonesia describes its exchange rate system as a “free foreign exchange system”, that it claims to be following since 1970.10 On the other hand Bank Indonesia has put certain restrictions on free movement of currency, e.g. on forward sales of foreign exchange to non-residents, in order to reduce exchange rate volatility (IMF EAER, 2002, P.444). The IMF classifies Indonesia’s exchange rate regime as “Managed floating with no pre-announced path for the exchange rate” (IMF EAER, 2002, P. 444). Korea South Korea has adopted a “free-floating exchange rate system” since December, 1997.11 Earlier it had followed several different exchange rate regimes, e.g. a fixed exchange rate system until 1980, a multiple-basket pegged exchange rate system from 1980 to 1990 and a Market Average Exchange Rate System till 1997, in which the exchange rate was allowed to move within an upper and a lower limit around each day's basic exchange rate. In December 1997 Korea shifted to a free floating regime. The foreign exchange market has been liberalised, allowing participants to buy and sell spots, forwards and foreign exchange swaps. The ceiling on foreign investment in Korean equities and money markets has been abolished. The IMF classifies Korea’s exchange rate regime as “independently floating” (IMF EAER, 2002, P. 505). Malaysia After experimenting with managed float in 1998 vis-à-vis an undisclosed basket of major trading partners’ currencies, Malaysia has adopted a fixed peg exchange rate regime since Sept. 1998 and has introduced a wide range of capital controls, removing all legal channels of transferring Ringgit abroad, or vice versa (IMF MRED, 1999, P.23) in order to insulate the monetary policy from external volatility. The IMF classifies Malaysia’s exchange rate regime as a “conventional pegged arrangement”, whereby the Ringgit is pegged against the US dollar at RM 3.8 per $1 (IMF EAER, 2002, P. 576). Thailand The Bank of Thailand declares to be following a “managed float” policy since July 1997. It claims to let the value of the Baht get
determined by market forces, on the basis of supply and demand, in both on-shore and off-shore foreign exchange markets and to let the currency move in line with “economic fundamentals”. It however reserves the right to intervene in the market, if necessary, to prevent, what it calls are, excessive volatilities and to achieve its economic policy targets of enhancing flexibility and efficiency in monetary policy implementation,15 and to improve supervision of foreign capital flows. The IMF classifies Thailand’s exchange rate regime as “Managed floating with no preannounced path for the exchange rate” (IMF EAER, 2002, P. 933).
Characterisation of de facto Regimes in Southeast Asia As discussed earlier, the officially stated positions of many central banks about their exchange rate system sometimes differ from their actual practice. There can be several reasons for this discrepancy, e.g. countries some time switch over to a more liberal exchange rate regime only under the IMF pressure, but they do retain a longing for more stability and usually display a “fear of floating”. In order to find out the de facto policies pursued by the four Southeast Asian nation studied in this paper, the exchange rate volatility, foreign reserves volatility and interest rate volatility are calculated for the post-crisis period. Further a flexibility index is also constructed. This data is then compared with the pre-crisis and mid-crisis data and with selected benchmark countries. Australia and Denmark have been selected as benchmarks for the post-crisis period. Australia is known for its floating exchange rate regime, Denmark on the other hand had an exchange rate band to Euro till 2003. Both the countries are middle-sized economies and thus comparable to the Southeast Asian economies. Australia also has a larger share of commodity exports, like some of the Southeast Asian countries. Additionally for some other countries e.g. Germany, Japan and India are also compared to broaden the comparability of volatilities.
This paper builds primarily on Baig (2001) and Hernández/Montiel (2001) and uses their data for years 1995-20005. Comparison of Volatilities We first examine the volatility in exchange rates. Then we turn our attention to the volatilities in interest rates and foreign currency reserves, as the authorities might be targeting the exchange rate through monetary policy and/or intervention in the foreign exchange market (Baig, 2001, P.11). Exchange Rate Volatility Volatility of exchange rate shows whether the value of a currency is determined by the market forces or the monetary authorities. It is defined as the standard deviation of the percent change of the exchange rates against a reference currency (Baig, 2001, P. 6), in this paper US dollar, unless otherwise specified.
Volatility of Daily Exchange Rates (2003 only 1st Quarter)
Country Indonesia Korea Malaysia Thailand Australia Germany India Japan Euro Denmark Denmark Reference USD USD USD USD USD USD USD USD USD USD EUR 1995 0.15 0.25 0.23 0.12 0.53 0.79 0.37 0.9 n.a. n.c. n.c. 1996 0.15 0.23 0.15 0.08 0.4 0.41 0.43 0.48 n.a. n.c. n.c. 1997 1998 2.49 4.86 2.65 1.75 0.9 1.75 1.71 1.58 Benchmark Countries 0.6 0.84 0.62 0.56 0.27 0.39 0.75 1.08 n.a. n.a. n.c. n.c. n.c. n.c. 1999 1.88 0.48 0.01 0.56 0.58 0.6 0.11 0.83 n.a. n.c. n.c. 2000 1.05 0.42 0.01 0.45 0.76 0.77 0.17 0.63 n.a. n.c. n.c. 2000 1.32 0.42 0.01 0.45 0.74 0.74 0.18 0.74 0.74 0.74 0.14 2001 1.7 0.51 0.08 0.3 0.78 0.69 0.14 0.78 0.69 0.68 0.11 2002 0.73 0.53 0.01 0.34 0.55 0.57 0.07 0.55 0.57 0.56 0.06 2003 0.38 0.7 0.01 0.22 0.6 0.56 0.11 0.6 0.56 0.55 0.03
As can be seen in the Table-1, the Southeast Asian countries experienced relative stability and little volatility in the pre-crisis period, which took a dramatic turn in the crisis period of 1997/98, for example Indonesia’s volatility jumped from 0,15 in 1995 to 4,86 in 1998. In the post-crisis period (since 1999) the volatility has receded for most of the countries in the region, except Korea. The exchange rate volatility of Korea and Indonesia has continued to be high and comparable to known floaters like Australia, Japan and Germany, Thailand has become relatively stable, its exchange rate volatility is probably comparable to India’s, an another known managed floater. Malaysia is not experiencing any significant volatility, which is consistent with its declared exchange rate regime of a fixed peg. This is also comparable with Danish’s Kroner’s volatility, when referenced against Euro. Denmark has a declared and de facto exchange rate band to Euro (IMF AR, 2002, P. 118). Not surprisingly Kroner reflects the exchange rate volatilities of Euro, when referenced against US dollar. The volatilities for Germany and Euro-Area are same, since the inception of Euro. Having analysed the volatilities of daily exchange rates, it is also useful to take a glance at those of monthly exchange rates.
Volatility of Monthly Exchange Rates (2003 only 1st Quarter)
Country Indonesia Korea Malaysia Thailand Australia Germany India Japan Denmark Denmark Saudi Arabia Reference USD USD USD USD USD USD USD USD USD EUR USD 1995 0.51 1.06 1.06 0.59 1.84 3.25 1.81 4.89 n.c. n.c. n.c. 1996 1997 1998 0.65 11.25 32.66 0.93 10.06 7.49 0.61 4.48 7.21 0.34 8.45 8.93 Benchmark Countries 1.84 2 3.73 2.05 2.92 2.06 1.99 2.08 1.53 2.04 3.84 6.3 n.c. n.c. n.c. n.c. n.c. n.c. n.c. n.c. n.c. 1999 10.25 2.86 0.01 3.08 2.53 2.03 0.47 2.6 n.c. n.c. n.c. 2000 3.85 2.44 0.01 2.18 3.55 3.7 0.77 3.44 n.c. n.c. n.c. 2000 4.16 2.61 0.01 2.22 3.55 3.74 0.81 3.39 3.66 0.18 0.05 2001 7.86 2.49 0.01 2.07 3.86 2.58 0.51 3.69 2.56 0.14 0.02 2002 3.11 2.17 0.01 1.25 2.2 2.59 0.39 2.13 2.57 0.07 0.04 2003 3.07 2.85 0.01 1.26 2.5 2.07 0.29 1.99 2.07 0.07 0.06
The data in Table above points in the same direction. Remarkable is that the volatility for Korea is stabilising gradually and is in the same region as Australia, Germany and Japan. Indonesia seems to be on a roller coaster ride, which points to the turbulent period in years 2000/01. Malaysia is consistent with low volatility, which shows a remarkable comparability with another known fixed peg regime of Saudi Arabia, categorised by the IMF in the same group as Malaysia (IMF AR, 2002, S.118). Thailand’s volatility has decreased. It is significantly lower than those of known floaters but is still considerably higher than India’s, another managed floater.
Country Indonesi a Malaysia Korea Thailand
Volatility of Daily Rates High High Low Medium
Volatility of Monthly Rates High/Unstable High Low Medium/Low
Interest Rates Volatility Since it is possible that two countries with similar exchange rate volatilities have two very different exchange rate regimes – one might be a stable free-float and the other a dirty float “kept in check through interest changes or foreign exchange market interventions” (Baig, 2001, P.11) – it is necessary to examine the volatility of interest rates in Southeast Asia.
Volatility of Interest Rates (2003 only 1st Quarter)
Country Indonesia Korea Malaysia Thailand Australia Denmark Germany Japan India 1995 1.28 1.16 0.13 2.53 0.16 n.a. 0.1 0.2 8.57 1996 1.17 1.3 0.34 1.84 0.2 n.a. 0.15 0.02 6.75 1997 15.6 2.27 2.45 5.54 0.16 n.a. 0.1 0.03 3 1998 1999 14.75 4.06 1.99 0.29 1.12 0.48 4.76 0.35 Benchmark Countries 0.07 0.07 n.a. n.a. 0.1 0.17 0.05 0.04 5.55 1.92 2000 0.88 0.08 0.06 0.41 0.16 n.a. 0.11 0.05 1.72 2000 0.9 n.a. 0.05 n.a. 0.18 0.2 0.07 2.77 2001 0.79 0.13 0.09 0.31 0.2 0.19 0.07 1.49 2002 1.61 0.07 0.05 0.09 0.09 0.17 0 0.54 2003 n.a. 0.04 0.06 0.14 0 0.25 0 0.1
Interest Rate Volatilities Indonesia: Korea: Malaysia: Thai India Australia: Interbank Call Money Overnight Overnight Call Rates Interbank Overnight Borrowing Rates Interbank Overnight Borrowing Rates (average) Overnight Call Money Markets Rates Overnight and Call funds
Interest rates volatility in pre-crisis Southeast Asia with the only exception of Malaysia. was substantially higher than in the floating countries of Australia, Germany or Japan but significantly lower than in managed-floating regime of India. The volatility in Southeast Asia increased dramatically during the crisis – in Indonesia it jumped from 1.28 in 1995 to 15.6 in 1997 and in Malaysia from 0.13 to 2.45 in the same period. In the post-crisis period this volatility has receded considerably with Indonesia (1.61) being the only country in Southeast Asia in year 2002 with a volatility greater than 0.10. Korea (0.07). Malaysia (0.05) and Thailand (0.09) all have a volatility that is comparable to those of the known floaters e.g. Australia (0.09). Managed-floater India had a volatility of 0.54 in year 2003 down from 8.57 in year 1995. and a with recession confronted Japan had experienced no volatility at all. So it can be said that amongst the surveyed countries only Indonesia had a relatively high volatility in interest rates. All other surveyed countries in the region had low interest rate volatility in the post-crisis period. Reserves Volatility As discussed above, the volatility in foreign reserves is one of the instruments, which might give valuable information on the exchange rate interventions by a central bank. However one has to keep in mind that fluctuations in foreign reserves do not necessarily reflect interventions in foreign exchange markets. They might also occur on account of other factors such as debt repayments, value adjustment owing to exchange rate movements etc. (Baig, 2001, P. 12) Apart from that forward market interventions by central banks are not fully reflected by the gross reserves figures.
Volatility of Foreign Reserves (Total Reserves) (2003 only 1st Quarter)
Country Indonesia Korea Malaysia Thailand Australia Denmark India 1995 1.58 2.78 2.64 2.52 4.88 n.a. 3.11 1996 3.58 3.77 2.72 1.4 10.3 n.a. 3.49 1997 4.79 8.5 6.06 9.18 1998 1999 2000 6.45 2.39 7.58 4.97 1.9 1.6 4.55 3.36 2.82 4.17 2.1 2.12 Benchmark Countries 3.45 6.21 7.63 11.01 n.a. n.a. n.a. n.a. 4.92 3.63 1.87 4.23 2000 n.a. n.a. 2.97 2.07 10.92 3.77 4.11 2001 1.06 1.21 3.53 1.31 4.14 5.82 1.38 2002 1.5 0.88 1.47 2.3 4.89 3.79 1.4 2003 0.02 0.71 0.29 2.77 4.2 0.57 2.89
Indonesia seems to have stabilised in previous two years. If the first quarter of this year is an indicator than this trend can be expected to continue. its volatility in year 2003 reaching the pre-crisis level of 1995. Korea, on the other hand, which had quite high volatilities in pre-crisis period and during crisis (2.78 in 1995) had quite a low volatility of 0.88 in 2002. Malaysia reserves continue to be volatile in the post-crisis period. though in 2002 they were lower than usual. Thailand has also had a medium level of reserves volatility in the post-crisis period. But there emerges no clear picture on this front. Free-floater Australia also has a higher level of reserves volatility than managed-floating India or Denmark with a horizontal band.
Conclusion G Ramachandran once very appropriately remarked ‘Full convertibility is a necessity that can inject high-octane fuel into the economy. It will secure the autonomy of the RBI in the management of monetary policy and interest rates. The RBI and the Government have an onerous task ahead but it will vouchsafe India the trinity of equity, enterprise and economic growth’ Current problems 1. Managing the rupee's dirty float within a system of limited convertibility and full interest rate autonomy has become very difficult. 2. The Reserve Bank of India (RBI) has had a torrid time balancing capital inflows against the nation's policy on money supply, interest rates, inflation, price stability and growth Three tasks Implementing a dream joint combination of full convertibility and free floating system will entail the following: 1. Full convertibility will require a system of monitoring and deterrence aimed at flows related to terrorism, crime and money laundering. 2. The roadmap to convertibility will have to address how India will integrate itself into the global currency markets. They will set the spot price of the rupee after reckoning with its supply and demand. They will also set the rupee's forward price after reckoning with rupee interest rates. The road map will have
to address how the price of domestic credit will flow into the global currency markets. 3. The road map to convertibility will have to address how India will put in place a fair and free market for domestic credit. India has come a long way since July 1991 when it deregulated interest rates on corporate debentures. But there is some more distance to go in the context of other borrowers. Full convertibility is a necessity that injects high-octane fuel into the economy. It secures the autonomy of the RBI in monetary policy and interest rates but only when the rupee can float freely. It can push India into the possible trinity of equity, enterprise and economic growth.
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