Monday, May 29, 2006

Asian Currencies On Tenterhooks

The dollar's slide against Asian currencies could provide a catalyst for greater regional economic cooperation in an effort to avoid another financial crisis. So far this year the US unit has fallen by between five and eight percent against the Thai baht, Malaysian ringgit, South Korean won and Indonesian rupiah amid worries about global economic imbalances and upward pressure on the Chinese yuan. This is putting pressure on Asian economies by making their exports less competitive and cutting into companies' repatriated profits and leaders in the region are worried that the dollar will continue to decline.

Somehow, the smaller Asian nations' central banks are willing to let their currency appreciate vis-a-vis the dollar because they see real competition coming more from the Chinese yuan rather than pricing in US dollars. In the global export paradigm, the blackboard is denominated in yuan and not US dollars. Current and future competition among global exporters will have to deal in yuan terms - if yuan is allowed to appreciate, it is ok to appreciate in tandem. Having said that, the quantum of the increase have been greater for the smaller Asian countries' currencies when compared to the yuan.

The appreciation in Asian currencies is a controlled thing, as long as everyone moves up together, their exporting ability is not diminished badly. Asian central banks have to allow the appreciation to cope with imported inflationary pressures also. What we don't want is a period of volatility, a period of gradual appreciation is not volatility - just a measure to get up to the new competitive landscape. All economies are basically adjusting to help the US economy compete better and to stave off a derailment of the American economy. The overall economic strategy needs to price the US dollar cheaper (as it has been printing too much money), allow for better wealth redistribution / creation in developing countries owing to the enormous deficit registered by the US economy, and doing all that without very high inflation or interest rates. Its a tricky and delicate balancing act.

Asia does not want to see another financial crisis like 1997 which was triggered by currency speculation and volatility. If your economy is big enough like China and Japan, your currency is safer. However the other Asian nations' are at the mercy of market forces especially during periods of excessive speculation. Hence the idea of an Asian Currency Unit (ACU). To be fair, an ACU is likely to be successful as a viable bond market for companies and government to tap the capital markets, and have exposure in a currency which is stable. To think that the ACU would ever become like the Euro in the EU - forget about it, its not going to happen in our lifetime.

To try and develop a deep Asian bond market in ACU will reduce volatility of the Asian currencies as much as possible and allow for more cooperation and reliance on one another. There will be a lot more cooperation and joint manouveres with respect to sharing monetary and fiscal policies in Asia. A meeting was held of the ASEAN members long with China, Japan and South Korea agreed in Hyderabad, India, earlier this month to study the possibility of a single Asian currency similar to the euro. The Asian Development Bank (ADB) has been spearheading a proposal for the creation of an Asian currency unit or ACU, which is an index of currencies, as part of a bid to bolster monetary stability and spur regional economic growth. The ADB is also supporting the Asian Bond Market Initiative to develop an efficient bond market for the region. Finance ministers of ASEAN Plus Three -- which includes Japan, China and South Korea -- have already made progress in boosting financial and monetary policy coordination. But substantive coordination could be prompted by a sudden US dollar crunch which is possible. This may take place (because of speculative) capital inflows into China, and when China suddenly has to intervene in a massive way maybe that could be an opportune time for the finance ministers to really discuss this issue. Hopefully the region does not have to wait for another crisis. Asian nations still have painful memories of the 1997 Asian Financial Crisis which began with speculative attacks on the Thai baht and spread rapidly to other regional economies, causing sharp falls in stock markets and currencies. Although Japan and China are considered less vulnerable given the size of their economies and foreign exchange reserves, they are also involved in moves towards closer economic ties. Strained relations between Japan and both China and South Korea over war-time history have raised concerns that efforts to form an "East Asian Community" are losing momentum.

Probably now the bigger Asian nations are arguing over how the currency index should be constructed as everybody wants a higher profile. When it comes to egos and pride, I fear for Asia. Its time to discard that and work for the common good of the region - failure to cooperate will result in the entire region being vulnerable and lose out in potential growth synergies.

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