Taiwan has come to a crossroads in terms of its interest rates and exchange rates, and the direction it chooses now will have significant consequences for its economic revival and inflation.
The US Federal Reserve Bank on Tuesday raised its benchmark interest rate by 0.25 percent, raising the federal funds target rate to 2.25 percent, the fifth increase by the Fed this year. This has put pressure on interest rates in Taiwan to follow suit. Should they continue to rise, it would have a negative impact on traditional industries, and also real estate and the stock market, offsetting the government's attempts to boost the economy. The central bank does not plan to follow suit out of concern over inflationary pressure. If commodity prices do not rise, the central bank can take a wait-and-see attitude and maintain a more laissez-faire policy.
After the legislative elections, the government has gradually eased the pressure restraining potential inflation in the face of soaring oil prices. As a result, the media have run many reports claiming that Taiwan's water and electricity rates, as well as the prices of many other products, will soon increase as inflationary pressure grows. On the other hand, the appreciation of the NT dollar against the greenback will be beneficial in regulating the prices of imported goods and relieving potential inflation. This is the central bank's "dual-rate policy," in which it uses the appreciation of the NT dollar to gain access to low interest rates.
Although both the US and the World Bank believe that the Chinese yuan has been seriously undervalued, and that it should be allowed to float freely as "hot money" pours into Asia from the rest of the world, Beijing still insists on pegging the yuan to the dollar. Under such circumstances, however, the NT dollar, yen and Korean won have already appreciated. Since the appreciation of the NT dollar is much greater than that of the yuan, Taiwan's competitiveness in the export market has also been weakened, as international orders quickly flow to China. This is disadvantageous for local enterprises who want to keep their roots in Taiwan. It will also strengthen China's "magnetic effect" for attracting Taiwanese and foreign capital as well.
China is growing into a major trading nation, but its financial and trade systems are still lagging way behind. This is especially true for the currency exchange market, which needs to be more open and flexible. Other nations want the yuan to appreciate in value, or at least be more flexible to reflect market supply and demand.
Taiwan, as a free market, cannot maintain a fixed exchange rate, as the yuan does. Nevertheless, it has risen against the yen and won, within a tolerable range. The government must keep an eye on the country's international competitiveness, for although it does not have the luxury of fixing the exchange rate, it should at the very least be cautious about the degree to which the yen and won rise, in order to maintain Taiwan's competitiveness in the international market.
The central bank's dual-rate policy has paid off until now. However, it should be prepared to fine-tune interest rates in the event of more serious forex fluctuations. By using the exchange rate and interest rates together, it is possible to avoid excessive manipulation of the exchange rate, which would only serve to cause speculation, and this would not be in the best interests of stability and development in Taiwan's financial markets.