The issues faced by central banks in Asia
By Jon Fernquest[Introduction|Vocabulary|Article]
[Reading Questions|Answers]
 |
An overview of the issues that Asian central banks, including Thailand, currently face in the global economy, is the subject of today's article.
The column was written by Dr. Sethaput Suthiwart-Narueput, chief economist at SCB Securities.
Reading Questions
Here are some questions to guide your reading (See answers at end):1. What is the kind of "volatile short-term capital flow" that analysts have been most concerned about to date?
2. What is the difference betweem Foreign Direct Investment (FDI) flows and equity portfolio investment flows into a country? (Outside research required)
3. Which of the two flows could be classified as a more volatile short-term capital flow?
4. Which is currently the greater flow of investment funds into Thailand, FDI or equity portfolio investment?
5. What are central bankers traditionally concerned about in the short-run? In the long-run?
6. What does the Thai central bank do when it sterilises capital inflows?
7. Can the Thai central bank continue indefinitely to sterilise capital inflows? Why or why not?
8. What is the impossible policy trinity?
9. How can small open economies like Thailand control the impact of problems in the external global economy? (Express your opinion)
10. Does central bank credibility mean doing what markets want?
Bangkok Post Article March 28, 2007
Tuesday November 13, 2007
Issues facing central banks in Asia
SETHAPUT SUTHIWART-NARUEPUT
If there is one clear sign that things are now different on the macroeconomic front, it is that current account balances are now persistently in surplus, unlike before. This largely reflects the fact that investment rates have not really recovered while savings have held up. It also means that flows into the economy will continue to remain strong for the foreseeable future.
Much ink has been spilled about the evils of volatile short-term capital flows, especially portfolio flows into regional equity markets.
But the fact of the matter is that these flows pale in comparison to the more fundamental flows coming into the economy.
In Thailand, for example, current account plus FDI flows have reached nearly US$15 billion for the year to date, much larger than foreign equity investment portfolio flows of less than $4 billion for the year to August. These strong fundamental flows - coupled with the inevitable, continuing weakness of the US dollar make further regional currency appreciation a no-brainer.
on the macroeconomic front - in the battle with economic forces (the "front" of a war is the place where two opposing sides meet)
current account - mainly the difference between exports and imports, but contains other things such as cross-border dividend and interest payments, payments for services, private transfers such as remittances by workers working in other countries and official transfers such as foreign development aid (See The Economist's Glossary)
balances - the amount of money in an account and whether it is in surplus or deficit
persistently - always this way, never changes
in surplus - a positive amount in an account
have held up -
for the foreseeable future - as far as we can see or predict in the future
much ink has been spilled about - much has been written about
but the fact of the matter is - but the truth is
pale in comparison to - extremely small when compared to
fundamental - important and basic
FDI - Foreign Direct Investment, Investing directly in production in another country, either by buying a company there or establishing new operations of an existing business (See The Economist's Glossary)
year to date - from the beginning of the year until now
equity investment portfolio flows -
coupled with - combined with
inevitable - will happen for sure eventually
no-brainer - very easy to understand
Balancing short-term with long-term economic management
All this makes your jobs as central bankers very tough. The region remains even more dependent on exports now than before the crisis. So what to do?
The standard and oft-repeated line is "to manage short-term inflows to smooth volatility without resisting long-term trends".
But if the short term keeps on happening, when does it eventually become the long-term? We can only intervene and sterilise for so much and so long. The costs are significant and will only increase with lower US dollar rates and a weaker dollar.
More importantly, it prevents market imbalances from adjusting. The Asian crisis starkly highlighted the risks of violating the "impossible policy trinity" of simultaneously targeting exchange rates and interest rates while still allowing capital mobility.
Intervention and sterilisation makes sense to smooth out volatility from short-term, "hot money" portfolio flows, but the bulk of the flows now are neither short-term nor hot. They reflect deeper structural issues (low investment rates) not just a cyclical phenomenon that we can try to "ride out".
A more fundamental response than just intervention and sterilisation is required. The real challenge is to get investment, real wages, and consumption to grow and help reduce the current account surpluses, which requires a coordinated response from multiple agencies, not just the central bank.
intervene - government intervention in foreign exchange markets, buying quantities of other currencies such as the US dollar to control the baht's exchange rate with other currencies
sterilise - (See Wikipedia)
market imbalances -
starkly -
highlighted -
impossible policy trinity -
capital mobility - situation where capital can freely move about from market to market, with few restrictions
smooth out - make smoother
hot money - investment money that moves around quickly, looking for quick speculative gains
the bulk of - most of
reflect - show, are evidence of
structural issues -
cyclical phenomenon -
ride out -
Impact of global events on Thai economy
Another issue that makes the job of central bankers in the region tough is that it is more and more about what goes on outside the borders of the country in international markets - and therefore outside what we can affect or regulate.
A recent example is what happened in July and August in Thailand. In July, there was a very strong run-up in the Thai baht and the SET index. The initial trigger for the flows had nothing to do with local conditions _ there were no new political or economic events or earnings releases _ but it was due to a sharp weakening of the US dollar against the euro. The run-up led to knock-on selling of dollars here which caused the Thai baht to overshoot substantially.
Then in August, equity markets world-wide corrected on sub-prime concerns which in turn led the baht to weaken. From 34.50 to the dollar at the beginning of July, all the way down to 33.20 by the middle of July, then back up again to roughly where it was by the middle of August. All this movement in the baht, but essentially nothing had happened domestically.
It is also more and more about capital markets. For example, where are the biggest risks at present? I would argue that the biggest economic and financial risks have their origin in capital markets outside the region, such as US sub-prime-related problems, and not within any of our domestic banking systems.
trigger - cause
run-up - sudden increase
equity markets - markets for the stock and ownership of companies
corrected -
loan default - failing to pay back a loan
US sub-prime - the loan default problem with low credit quality home mortgages bundled into anonymous securities with difficult to measure risk
Domestic policy to deal with problems?
How do you keep up with financial innovations that happen elsewhere - but which affect you - and understand their risk and regulatory implications? There is no ready answer, but it may be of some comfort to know that it is a huge challenge even for home country regulators! As Federal Reserve chairman Ben Bernanke recently remarked with regard to sub-prime-related paper, "I'd like to know what those damn things are worth."
Closer to home, what can be done? The usual things to deepen capital markets - broader domestic institutional investor base (e.g., through national pension scheme, especially in Thailand) and greater free float (e.g., through reduced government holdings, especially in Malaysia) - would help.
Again, this requires a coordinated policy response. But given its centrality (no pun intended) in policy making, having central bankers who have the right skills mix with a real familiarity and understanding of capital markets is absolutely critical for such a coordinated response.
implications - things likely to happen as a result of
institutional investor - a company that holds large amounts of money that needs to be invested, a company in which investment is an important part of the business, for example insurance companies, mutual funds, retirement and pension funds, endowments..
pension - money saved for retirement
coordinated policy response -
the right skills mix - the various skills needed to get the job done
Communication and credibility
We live in the Bloomberg-Reuters era where information gets disseminated virtually instantly to market participants. Unfortunately, as someone once noted, understanding is often delayed. This places a huge premium on communicating effectively with markets to minimise "disconnect" and avoid misunderstanding.
Listening to markets and participants could help. This does not mean doing what markets want: regulators are not in the business of winning popularity contests! But they are in the credibility business. Showing a deep understanding and appreciation of market reactions - including the operational implications of proposed measures - could go a long way towards enhancing this credibility and reducing policy-induced uncertainty. Ultimately, the challenge is a broader and difficult cultural one of maintaining independence and even-handedness while at the same time avoiding insularity.
Bloomberg-Reuters - two major global news agencies that carry financial news
disseminated - make information available for consumption
places a huge premium on... - makes very valuable...
credibility - believability
operational - regarding the day to day operations (not the large scale effect of all these operations over long periods of time, that is studied in macroeconomics, for instance)
enhancing - making stronger
induced - caused
independence - acts without excessive influence from outside
even-handedness - fair, without being extreme
insularity - completely shut off from outside world (like an island)
Dr Sethaput Suthiwart-Narueput is chief economist at SCB Securities. The preceding article is an abridged version of a talk given by the author at the Bank Negara Malaysia on Oct 23. The views expressed are those of the author and do not represent those of SCB Securities.
Answer Key:
1. What is the kind of "volatile short-term capital flow" that analysts have been most concerned about to date?
Portfolio flows into regional equity markets.
2. What is the difference betweem Foreign Direct Investment (FDI) flows and equity portfolio investment flows into a country? (Outside research required)
Equity portfolio investment is investment in the stock market. A portfolio is a mixture of different shares of stocks in different quantities.
Foreign Direct Investment is investing directly in the production of another country, either by buying a company there or establishing new operations of an existing business (See The Economist's Glossary).
3. Which of the two flows could be classified as a more volatile short-term capital flow?
Equity portfolio investment.
4. Which is currently the greater flow of investment funds into Thailand, FDI or equity portfolio investment?
FDI is greater than equity portfolio investment.
5. What are central bankers traditionally concerned about in the short-run? In the long-run?
a. Short-run: Manage inflows to smooth volatility.
b. Long-run: Allow long-term trends to have their inevitable influence.
6. What does the Thai central bank do when it sterilises capital inflows?
When the central bank intervenes in foreign exchange markets, it buys foreign currencies, which increases its foreign reserves. Baht is used to buy this foreign currency which increases the money supply of Thailand, that is unless the new baht is taken out of the economy by exchanging it for government bonds and debt. This "mopping up" or "sponging up" of excess liquidity and money with governments bonds and debt is called "sterilisation" or a "sterilised intervention." (See The Economist Glossary)
7. Can the Thai central bank continue indefinitely to sterilise capital inflows? Why or why not?
Probably not, because the costs are too great and will get greater with likely dollar depreciation and baht appreciation in the future.
8. What is the impossible policy trinity?
Three policies cannot be pursued simultaneously:
a. Controlling exchange rates.
b. Controlling interest rates
c. Allowing capital mobility.
9. How can small open economies like Thailand control the impact of problems in the external global economy? (Express your opinion)
10. Does central bank credibility mean doing what markets want?
No, it means:
a. Understanding market reactions.
b. Understanding operational implications of policy measures.
c. Reducing policy induced uncertainty.
d. Maintaining indepedence.
e. Maintaining even-handedness.
d. Avoiding insularity (cutting oneself off from the public).
