Download 3.1.4 Loss of competitiveness arising from exchange rate policies

Causes, Effects And Regulatory Implications Of Financial and Economic Turbulence in Emerging Markets
3.1.4 Loss of competitiveness arising from exchange rate policies
In addition to the factors above, the exchange rate regime adopted by most of the afflicted countries was
seen by some as having played a crucial role in the emergence of the crisis in East Asia. Many countries in
the region appear to have had currencies which were either firmly pegged to or heavily managed within a
narrow band against the US dollar. It has been suggested that the reason for this could be because, despite
the fact that trade with Japan, Asia and Europe was significant, a large proportion of trading was conducted
and denominated in US dollars. Estimates show that the implicit US dollar weights in a composite basket
of East Asian effective exchange rates were extremely high (see table below).
Table 5: Implicit weights of US dollar and Japanese yen in nominal
values of selected Asian currencies
Estimate A1
Currency
South Korean won
US dollar
0.96
Japanese
yen
–0.01
Estimate B2
US dollar
0.84
Japanese
yen
0.17
Singaporean dollar
0.75
0.13
0.75
0.18
Malaysian ringgit
0.78
0.07
0.87
0.16
Indonesian rupiah
0.95
0.16
0.97
0.01
Philippine peso
1.07
–0.01
1.07
0.03
Thai baht
0.91
0.05
0.86
0.09
Source: Reproduced from theWorld Economic Outlook, International Monetary
Fund, October 1997, page 82. Original source: “The Yen and Its East Asian
Neighbors, 1980–95; Co-operation or Competition?” by Shinji Takagi, National
Bureau of Economic Research working paper no. 5720, August 1996.
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Estimate A from “Yen Bloc or Dollar bloc?: Exchange Rate Policies of East Asian
Economies” by Jeffrey A. Frankel and Shang-Jin Wei, inMacroeconomic Linkage:
Savings, Exchange Rates, and Capital Flows, ed. by Takastoshi Ito and Anne
Krueger, University of Chicago Press, 1994.
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Estimate B from “Enken no Keizaigaku” (“The Economics of the Yen Bloc”) by
C.H. Kwan, Nihon Keizai Shiunbunsha, 1995.
A depreciation in the US dollar against major currencies in the first half of the 1990s— due to the United
States’ policy of a weak dollar to reverse the cyclical slowdown in the US economy— resulted in the
depreciation of the real exchange rate of many East Asian economies and hence an increase in
competitiveness against other emerging markets.21 However, the situation started to reverse itself in 1995
when the United States stock market began to embark on its journey upwards and the strengthening of the
United States’ economy heightened expectations of domestic interest rate increases. This strengthened the
21
Declining interest rates in US coupled with tight interest rates in Europe saw interest differentials
between US and German short-term interest rates soar to 6.5 percentage points in September 1992. In
addition, the first half of the 1990s also saw a steady growth in the size of the US current account deficit
without a commensurate growth in its capital account surplus. In particular, the hesitation of Japanese
investors in purchasing dollar-denominated assets in 1995 saw the US dollar weakened substantially
against the yen. See for example 63rd Annual Report 1992/93, 14th June 1993, pages 182–183, and 66th
Annual Report 1995/96, 10th June 1996, pages 96–99, Bank for International Settlements.
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Causes, Effects And Regulatory Implications Of Financial and Economic Turbulence in Emerging Markets
US dollar and, with burgeoning inflationary pressures in East Asia, meant that the economies in the region
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experienced very significant real effective exchange rate appreciation (see charts below).
Figure 10: Evolution of real exchange rates pre- and post crisis
ASEAN-4 economies
Indonesia
80
60
100
120
Index points (Jan 1987=100)
100
120
Real appreciation
Real depreciation
260
280
Real depreciation
300
Jul-98
Jul-97
Jan-98
Jul-96
Jan-97
Jul-95
Jan-96
Jul-94
Jan-95
Jul-93
Jan-94
Jul-92
Jan-93
Jul-91
Jan-92
Jul-90
Jan-91
Jan-87
Jul-98
Jul-97
Jul-89
340
Jan-98
Jul-96
Jan-97
Jul-95
Jan-96
Jul-94
Jan-95
Jul-93
Jan-94
Jul-92
Jan-93
Jul-91
Jan-92
Jul-90
Jan-91
Jul-89
Jan-90
Jul-88
Jan-89
Jul-87
Jan-88
240
320
180
Jan-87
Real appreciation
220
Jan-90
Thailand
200
Jul-88
Philippines
Singapore
180
Jan-89
Malaysia
160
160
Jul-87
140
140
Jan-88
Index points (Jan 1987=100)
80
Sources for all charts: Datastream/ICV and Securities Commission, Malaysia
Northeast Asian economies
50
Index points (Jan 1987=100)
60
70
80
90
100
110
South Korea
120
Real appreciation
China
130
Taiwan
140
Hong Kong
Real depreciation
Jul-98
Jan-98
Jul-97
Jan-97
Jul-96
Jan-96
Jul-95
Jul-94
Jan-95
Jul-93
Jan-94
Jul-92
Jan-93
Jan-92
Jul-91
Jan-91
Jul-90
Jan-90
Jul-89
Jan-89
Jul-88
Jan-88
Jul-87
Jan-87
150
Sources for all charts: Datastream/ICV and Securities Commission, Malaysia
While the extent of the causal link is ultimately an empirical question, the loss of competitiveness arising
from the real exchange rate appreciation was also accompanied by a decline in the global demand for key
Asian exports such as semiconductors and electronics. The situation was further exacerbated by dampened
demand from a sluggish recovery in the Japanese economy— a destination for a significant portion of the
region’s exports. Finally, increasing competition from low-cost countries meant that East Asian countries
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experienced not only declining export volume but also export prices.
22
Given the high implicit weight of the US dollar in the composite basket, the nominal effective exchange
rate for East Asian countries was effectively the nominal bilateral exchange rate with the US dollar. The
real effective exchange rate is defined as the foreign price index in domestic currency per unit of domestic
price index. The strengthening of the US dollar against other major currencies and the greater inflationary
pressure in East Asia vis-à-vis the US meant that the real exchange rate appreciation was being fed from
two different channels which reinforced one another.
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See “Asian Competitive Devaluations” by Liu Ligang, Marcus Noland, Sherman Robinson and Zhi
Wang, Institute of International Economics working paper 98-2, Washington, January 1998.
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