Devaluation idea loaded with pitfalls

Suggestions abound over how the government should help pull the economy out of the current doldrums. But the latest one, a textbook solution from the Taiwan Research Institute (台綜院), a think tank headed by former president Lee Teng-hui (李登輝), to devalue the NT dollar by as much as one fourth of its current value against the US dollar has definitely raised eyebrows.

The think tank has concluded, following a research conducted at the behest of President Chen Shui-bian (陳水扁), that the local currency should be devalued to NT$40 against the US dollar.

The central bank said the suggestion was overly simplistic, because such a radical drop of the local currency would trigger inflationary pressure.

Meanwhile, economists have said that such a sharp depreciation of the currency could unleash a new wave of "beggar-thy-neighbor devaluation" in Southeast Asia, which would do no good to Taiwan's regional reputation.

Although the local unit has remained relatively resilient compared with others in the region, the currency is unlikely to drop sharply considering that the cool heads prevail as usual at the central bank.

Despite the difficulties, the local currency has depreciated by seven percent over the past year -- slightly better compared than other regional currencies such as the Japanese yen and Korean won.

But Taiwan has always played the currency game very cautiously. Even at the height of the East Asian currency crisis in 1997 the central bank let the NT dollar depreciate by only 15 percent, far less than South Korea's 48 percent and Indonesia's 52 percent.

Despite its status as a diplomatic pariah, Taiwan is increasingly promoting itself as a model of monetary management in the region. Such motivation is implicit in the central bank governor Perng Fai-nan's (彭淮南) strong endorsement of a regional currency swap agreement signed at the Asian Development Bank meeting in Honolulu last week.

The agreement is designed to help avert future foreign exchange crises in the region and dispel, thanks to the existence of such a mechanism, speculative attacks on the currencies.

It is generally accepted in economic circles that currency depreciation -- which often makes exports cheaper -- is not likely to help boost outbound shipments at a time when demand weak. Depreciation will also boost the cost of raw materials and components.

In fact, the local currency income at exporters -- according to a much quoted theory called the J-curve effect -- drops in the near term as they get less local currency.

Analysts have said that fuelling speculation that the NT dollar could drop sharply could also weigh heavily on market confidence, triggering a new wave of capital flight.

Most importantly, the currency depreciation is the last thing that foreign institutional investors, hitherto a pillar of optimism in the otherwise battered local stock market, want to see. The latest figures show that the foreign portfolio investors have brought in a total of as much as US$3 billion into Taiwan, contributing, in no small measure, to the first quarter balance of payment surplus of US$5.7 billion -- a 13 year-high.

The central bank therefore is nowhere close to panic. Chou A-ting (周阿定), head of the bank's foreign exchange department, said last week that the Taiwan Research Institute, like innumerable market participants, is free to "entertain its own ideas."