Asian countries expand FX protection

Leading Asian countries have taken a further step towards cooperation and self-protection against the global economic crisis by expanding the size and scope of their foreign exchange pooling arrangements.

At a summit held on Sunday in Phuket, Thailand, finance ministers from China, Japan, South Korea and the 10 Asean states agreed to create a $120 billion foreign exchange reserve fund that can be used by the members to defend their currencies from speculative attacks, and also to provide them with emergency short-term financing.

The size of the pool is 50% larger than the $80 billion planned in May, and the scheme is also a widening of the so-called "Chiang Mai Initiative", which was launched at the beginning of the decade. The Chiang Mai Initiative allows only bilateral currency swaps.

"The measure is in stark contrast to other emerging market regions that are not blessed with Asia's surplus savings," Patrick Bennett, Asian FX and rates strategist at Societe Generale, wrote in a note to investors.  

China, Japan and South Korea will supply about 80% of the pool, while the individual contributions of the Asean countries will probably be decided at the next meeting in May, according to a statement by the finance ministers on Sunday. However, a date for the creation of the fund hasn't yet been determined.

Meanwhile, bilateral agreements will continue and are being strengthened. On February 21, Japan and Indonesia increased the size of an existing bilateral agreement to $12 billion from $6 billion.

"The initiative speaks to ongoing and improving cooperation and policy maturity here in Asia. Still, while the pool will provide a backstop to speculative attacks on currencies and help in some cases to soften the impact of a swift withdrawal of capital that has the potential to dislocate local markets, it will not in itself prevent further modest currency weakness -- as remains appropriate in the weeks and months ahead as economies face further curtailment of external demand", says Bennett.  

With the notable exceptions of the Japanese yen and Chinese renminbi, most Asian currencies have fallen in the past year as foreign portfolio investors have deserted regional stockmarkets, motivated by deleveraging and greater risk aversion, and as export revenues have slumped in response to contracting world demand. The weakest has been the Korean won, which has dived nearly 40% in the past 12 months. Capital outflows are likely to continue this year.

Speculative attacks and capital flight devastated the foreign exchange reserves of Indonesia, Korea and Thailand during the Asian financial crisis a decade ago, prompting recourse to loans by the International Monetary Fund and hence the imposition of IMF "conditionality". This was a set menu of measures that combined fiscal austerity with monetary tightening, and a reduction in state subsidies with the lifting of import barriers. Together, these measures led to social and economic hardship for households, and forced domestic companies into fire sales of their assets to foreign, especially US, buyers.

Although IMF loan conditions apply to 80% of existing bilateral swap agreements, the ministers hinted that they might not be attached to the new scheme. Perhaps it would be a little perverse if they did. After all, countries throughout the world, led by the US and Western Europe, who championed conditionality when it could be forced on others, are rather less enthusiastic to take the same medicine when they themselves are ailing.

Instead, they are planning and implementing ever larger stimulus packages as well as bank and corporate bail-out programmes; moving towards "quantitative easing" (that is, printing money); advocating covert protectionism; providing safety-nets for its most vulnerable members; and they are also busy nationalising instead of privatising key industries. The Washington Consensus seems to have been turned on its head.

The clear lesson learned by Asian governments has been to ensure they possess a strong war chest of foreign exchange reserves, sustained by the revenues from export-oriented economies. And in the past 10 years, the 13 Asian countries have built up more than $3.5 billion of foreign exchange reserves. A large chunk of that is held by the People's Bank of China, of course, but the total makes up nearly half of the world's total foreign exchange reserves.  

But, Indonesia's reserves have dropped by $10 billion since last July to $50.9 billion at the end of January, and Korea's central bank has been forced to intervene to curb the speed of the won's decline at a time when the country's banks and companies face severe external refinancing needs in the next couple of months.  

Most Asian currencies, including the won, traded slightly stronger yesterday.