Download Further Reforms after the “BIG BANG”: The JGB Market

Challenges and Opportunities
in Managing Foreign Exchange
Reserves
S. Ghon Rhee, Ph.D.
K. J. Luke Distinguished Professor of Finance
Executive Director
Asia-Pacific Financial Markets Research Center
University of Hawai‘i
The 5th Seoul International Financial Forum
April 27-28, 2004, Seoul, Korea
Asia-Pacific Financial Markets Research Center, University of Hawaii
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Capital Flows to Asia+
US$ Billion
Current Account Balance
Direct Foreign Investment
Portfolio Investment
Private Credits
Official Capital Flows
Resident Lending/Errors &
Omissions
Total Inflows
*
**
+
2001
2002
2003*
2004**
48.2
51.7
12.4
-13.1
-8.1
71.9
55.9
2.6
6.3
-15.5
73.4
55.7
27.7
27.9
-12.6
56.9
59.8
25.2
11.7
-5.4
-20.9
70.3
-9.5
111.9
15.0
187.1
-5.6
142.5
Estimate
Forecast
China, India, Indonesia, Korea, Malaysia, Philippines, Thailand
Source: Institute of International Finance (2004)
Asia-Pacific Financial Markets Research Center, University of Hawaii
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Increasing Capital Inflows
to the Region
Not Necessarily Good News
a. Appreciate the local currency
b. Undermine the competitiveness of
export industries
c. Cause inflation to rise
d. Too much liquidity encourages
over-investment and overheating
of the economy
Asia-Pacific Financial Markets Research Center, University of Hawaii
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Case In Point: Challenges
Facing People’s Bank of China






Foreign Exchange Reserves: Increased by $120 billion in 2003
Speculative Hot Money ($25 - $40 billion): Happy Depositors in
RMB Accounts
Reckless Lending: Major Concern Given Too Much Liquidity in
the Banking Sector
Issuance US$-Denominated domestic bonds: Under Plan
PBOC issued its short-term notes in amount of 1 trillion RMB or
US$121 billion so far to reduce liquidity since its introduction in
2003; Increase Discount Rate (2% to 2.5%); Increase Reserve
requirements (6% to 7% in Sept 2003 and to 7.5% for weak banks
in March 2004)
Open Market Operations: Now twice a week since Feb. 25, 2003
Asia-Pacific Financial Markets Research Center, University of Hawaii
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Dilemma for Central Banks
Tight Monetary Policy
a.
b.
c.
d.
Drives up short-term interest rates
Encourages further capital inflows
More Pressure on Currency Appreciation
Heavy burden on government debt
servicing cost
Deepening conflicts between monetary
policy and fiscal policy implementation
Asia-Pacific Financial Markets Research Center, University of Hawaii
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Separation of Government Debt
Management from Monetary and
Fiscal Policies
Government
Debt Mgmt
Optimal
Cost/Risk Tradeoff
Fiscal
Policy
Aggregate Debt
Asia-Pacific Financial Markets Research Center, University of Hawaii
Monetary
Policy
Price Stabilization
6
Open Market Operations with FullyDeveloped Government Bond Market
1.
2.
The central bank can expand or contract bank
reserves and money supply and transmit its policy
signaling through open market operations
Two Alternatives in Setting:
a. Target Amount of Bank Reserves with Short-Term Interest
Rate Fluctuating
b. Target Short-Term Interest Rate with Bank Reserves
Fluctuating
With well-functioning government bond markets, second
alternative becomes the norm among industrialized countries
3.
Open Market Operations:
Secondary Market
Government Debt Management:
Primary Market
Asia-Pacific Financial Markets Research Center, University of Hawaii
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Open Market Operations
with Under-Developed
Government Bond Market
1.
2.
3.
4.
Capital Inflows are Sterilized as part of Open Market
Operations
Central Banks prefer short-term or floating-rate
domestic debt; inflation-indexed bonds; and foreign
currency debt
Government Debt Management Offices do not prefer
these instruments due to rollover risk triggered by
external shocks
Rollover Risk Emerges as the Main Concern while
Market Risk Remains Important and Conflicts Deepen
between monetary policy and government debt
management
Asia-Pacific Financial Markets Research Center, University of Hawaii
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Alternative Policies to Sterilization
1.
2.
3.
4.
5.
6.
7.
Fiscal Adjustment
Switch Government Deposits from Commercial Banks
to Central Banks
Ease Restrictions on Capital Outflows
Flexible Exchange Rate Regime
Accelerate Trade Liberalization
Variable Reserve Requirements on Certain Categories
of Foreign Borrowing
Develop Long-Term Government Bond Markets
But All of Them Represent Slow Processes
Except Alternative No. 2
Asia-Pacific Financial Markets Research Center, University of Hawaii
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Foreign Exchange Reserves
(As of March 2004)
Japan
US$826.6 billion
China
439.8
Taiwan
226.5
Korea
163.6
Hong Kong
123.8
India
110.3
Singapore
102.8 (Preliminary)
Germany
94.5 (as of February)
United States
84.7
Russia
83.7
------------------------------------------------------------------------------------Malaysia
51.3
Thailand
42.9
Philippines
15.7
------------------------------------------------------------------------------------Total ( 10 Asian Economies)
$2,103.3
Asia-Pacific Financial Markets Research Center, University of Hawaii
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Foreign Holdings of US Securities
by Selected Asian Economies (June 2002)
US$ Billion
Total
Common
Stocks
Treasury
Bonds
Gov't
Agency
Bonds
Corp. &
Muni
Bonds
Treasury
Bills
181.48
4.03
95.20
58.61
10.90
12.74
84.16
15.33
37.45
12.38
4.75
14.26
Japan
636.94
118.59
259.89
88.08
62.82
107.56
Korea
43.94
0.48
30.59
7.63
1.10
4.14
9.65
0.37
6.10
2.61
0.23
0.33
Taiwan
70.04
4.75
34.49
25.30
2.95
2.55
Thailand
18.08
0.22
12.78
0.03
0.11
4.94
1044.28
143.78
476.48
194.64
82.85
146.53
China
Hong Kong
Malaysia
Total
Source: US Department of Treasury
Asia-Pacific Financial Markets Research Center, University of Hawaii
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Foreign Holdings of US Treasury Securities
#*
1
2
3
4
5
6
7
8
9
10
14
18
US$ Billions
Economy
Japan
China
United Kingdom
Caribbean Econs.
Hong Kong
Taiwan
Germany
OPEC
Switzerland
Korea
Singapore
Thailand
Total 7 East Asian
countries
Grand Totals
-Of which official
2004
Feb
2003
Dec
2002
Dec
2001
Dec
2000
Dec
607.90
145.00
137.30
74.10
61.00
50.60
45.70
43.40
41.50
37.10
22.10
14.70
545.20
149.20
113.30
69.10
57.50
46.30
44.80
44.50
39.60
43.40
17.70
11.00
378.10
118.40
80.80
49.50
47.50
37.40
37.30
50.30
34.00
38.00
17.80
17.20
317.90
78.60
45.00
33.60
47.70
35.30
47.80
46.80
18.70
32.80
20.00
15.70
317.70
60.30
50.20
37.40
38.60
33.40
49.00
47.70
16.40
29.60
27.90
13.80
938.40
870.30
654.40
548.00
521.30
1629.60
947.80
1531.10
893.90
1238.60
763.10
1040.10
619.40
1015.20
609.20
*Rankings are of the year of 2004.
Source: US Department of Treasury www.treas.gov/tic/mfh.txt
Asia-Pacific Financial Markets Research Center, University of Hawaii
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Utilization of Reserves for
Various Purposes
a.
Korea
$20 billion investment in Korea Investment Corporation
b. China
$45 billion diverted for Restructuring of State Banks
Additional $40 billion for the same purpose?
c.
Thailand
Unspecified amount diverted to buy machinery or license
intellectual property for local corporations
d. Taiwan
$10 billion allocated to banks to participate in major investment
projects relating to overall domestic economic development
Asia-Pacific Financial Markets Research Center, University of Hawaii
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Korea Investment Corporation
a.
Capital:
$20 billion from the BOK’s FX reserves;
Additional capital may be drawn if
reserves reach $200 billion
b. “Cashing Contract”:
KIC’s assets be cashed when necessary
upon request from BOK
c. Initial Investment: Financial Assets
d. Critical Vehicle:
To Attract Global Asset Management
Companies
Asia-Pacific Financial Markets Research Center, University of Hawaii
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Bank of Korea’s Current
Reserve Management (I)
Three-Tranche Approach
Purpose
Liquidity Tranche
Liquidity Demand
Investment Tranche
Higher Returns
Trust Tranche
Outsourcing
Benchmark
Deposits and US
Treasury Securities
(Short-term)
JP Morgan Government
Bond Index Adapted
Lehman Brothers
Global Aggregate Index
and US Intermediate
Government and
Corporate Index
Source: IMF (2003)
Asia-Pacific Financial Markets Research Center, University of Hawaii
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Bank of Korea’s Current
Reserve Management (II)
Investment Instruments
a.
Marketable Securities:
sovereign bonds, government agency bonds, MDI-issued
bonds with AA-rated or higher
b.
Deposits:
Only with financial institutions with credit ratings of A or
above
c.
Outsourced Assets:
May include corporate bonds, ABSs, and MBSs with AA
ratings or higher
Differences between KIC’s management and
BOK’s management?
Asia-Pacific Financial Markets Research Center, University of Hawaii
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Major Operational Policy
Issues with KIC (I)
1.
Is KIC’s Operation Part of Foreign Exchange
Reserve Management?
a.
b.
2.
If yes, then the relation between MOFE and
BOK vis-a-vis KIC?
If not, the integrity of foreign exchange
reserve management may be questioned.
Governance System of KIC?
a.
b.
Transparency
Accountability and Assurances of KIC’s
integrity
Asia-Pacific Financial Markets Research Center, University of Hawaii
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Major Operational Policy Issues
with KIC (II):
c. Lack of Transparency and Accountability
1. Fiscal Investment and Loan Program of Japan
Assets: US$3.67 trillion
Loans: US$2.88 trillion
Extended to: (i) FILP-Dependent Enterprises*;
(ii) Municipal Governments; and
(iii) Government-Owned Banks
* Transportation, Education, Utilities, Housing, Roads,
Bridges, Airports, SMEs
Sources of Funds:
Postal Savings Deposits
Employees’ Insurance Deposits
75% of FILP Loans are Non-Performing & Estimated Losses = ¥75
trillion ( = US$680 billion) or 15% of GDP [Doi and Hoshi (2002,
NBER)]
Asia-Pacific Financial Markets Research Center, University of Hawaii
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Major Operational Policy Issues
with KIC (III):
2.
Temasek Holdings Ltd. (Singapore)
Singapore’s Ministry of Finance-owned investment arm
controlling more than 20% in 22 major local companies
Total investment > US$130 billion over 30 years
Its financial statement will be disclosed to the public for
the first time in its 30 year history
3.
Government Investment Corporation of
Singapore
Total Fund under Management > US$100 billion
i.
Government of Singapore Investment
Corporation Pte Ltd.
ii.
GIC Real Estate Pte Ltd.
iii.
GIC Special Investments Pte
Very little is known about its financial status
Asia-Pacific Financial Markets Research Center, University of Hawaii
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Major Operational Policy Issues
with KIC (IV):
4. Khazanah Nasional Berhad (Malaysia)
6 subsidiaries
18 associates
13 investments
No information on its performance
5. The Minister of Finance (MOF) Inc.
(Malaysia)
No information on its performance
Asia-Pacific Financial Markets Research Center, University of Hawaii
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Major Operational Policy
Issues with KIC (VI)
3.
Reserve Adequacy
a.
Money Supply-Based Approach (Ratio of Reserves to Money Supply):
Poor measure of capital flight
Poor predictor of currency crisis
Current Account-Based Approach (Reserves in Months of Imports):
Relevant for Small Economies?
Poor predictor of currency crisis for Open Economies
Capital Account-Based Approach (Ratio of Reserves to Short-term
External Debt)
Better measure for Economies with significant but
uncertain access to international capital market?
Combination of current and capital account approaches
b.
c.
d.
Asia-Pacific Financial Markets Research Center, University of Hawaii
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Reserve Adequacy:
Korea’s Reserves and External Debt
(November 2003)
Source: Asian Development Bank
Asia-Pacific Financial Markets Research Center, University of Hawaii
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Thank You!
For Further References,
Please visit
http://www2.hawaii.edu/~rheesg
Asia-Pacific Financial Markets Research Center, University of Hawaii
Asian Stock Market Performance
(Annual Return)
1995-2000
China
Hong Kong
Indonesia
Japan
Korea
Malaysia
Philippines
Singapore
Taiwan
Thailand
USA(DJIA)
2001
2002
2003 2004:1stQ
27.61%
13.01
-2.38
-7.05
-13.25
-6.89
-11.71
-2.96
-7.81
-27.67
-21.89%
-24.50
-5.83
-23.52
37.47
2.42
-21.84
-15.74
17.02
12.88
-17.13%
-18.21
8.39
-18.63
-9.54
-7.15
-12.81
-17.40
-19.79
17.32
10.57%
34.92
62.82
24.45
29.19
22.84
41.63
31.58
32.30
116.60
16.4%
0.84
6.33
9.73
8.61
13.59
-1.25
5.35
10.72
-16.17
16.08
-7.10
-16.76
25.32
-0.92
Asia-Pacific Financial Markets Research Center, University of Hawaii
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