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EDITORIAL: NT dollar's rise pressures central bank

With the US dollar's persistent weakness across the board because of the subprime mortgage crisis, the appreciation pressures on Asian currencies, including the New Taiwan dollar, have become a hot issue for many of the region's monetary policymakers.

So far this year, the NT dollar has gained 4.61 percent against the greenback on the back of continued foreign capital inflows and a strong sell-off in the US dollar by exporters to avert exchange losses. This was compared with a mere 0.47 percent increase for all of last year.

Across Asia, the strength of the NT dollar's appreciation this year has been second only to that of Thailand's baht, which has prompted the central bank to repeatedly send warnings to currency speculators. The bank has urged them to use the funds remitted into the country as described in their applications (for equity investment) and not for any other purpose (such as currency speculation).

While the central bank intervened in the foreign exchange market last Friday to halt the NT dollar's rise for the seventh straight trading day, there is further room for the currency to strengthen as it has long been undervalued.

The NT dollar was undervalued partly because of the monetary authorities' "weak currency" stance. But it was also the very embodiment of years of domestic bickering and weak investor confidence. Today, the situation has changed. The value of the NT dollar is not only underpinned by expectations of a more stable political scene following the March 22 presidential election, there is also a market consensus that appreciating Asian currencies will help ease the central bank's nerves in seeing a stronger NT dollar.

Also, the government has viewed inflation control as its main economic target in an election year and the central bank should be able to accept the NT dollar's strengthening in a bid to help curb inflation by making imports cheaper. Moreover, as the central bank is likely to again raise interest rates later this month -- the 15th consecutive rate hike since October 2004 -- to contain inflationary pressure, expectations are that the NT dollar will sustain its upside momentum against the US dollar, as least in the short term.

In the medium term, the NT dollar will also gain support from slower portfolio capital outflows as the increasingly narrowed interest rate differentials between the US and Taiwan will slow capital outflows and attract portfolio inflows to NT dollar-denominated deposits and assets.

The capital inflows are certainly welcome to the central bank after the latest monetary statistics showed that capital flight had caused the nation's balance of payments last year to record the first deficit in 10 years and slowed M2 money supply growth to 1.06 percent in January, which is further away from the bank's target range of 3 percent to 7 percent annual growth this year.

Central bank Governor Perng Fai-nan (彭淮南), who was reappointed last month for another five-year term, faces the challenge of trying to adopt policies that can ease concerns of imported inflation without compromising export competitiveness.

But that's just an ideal scenario. If imported inflation is caused by price pressures, the central bank needs to act in a decisive, timely and effective manner. It may have to resort to the currency tool rather than interest rates to stem inflation this time, as higher inflation poses a bigger threat to the country than slowing exports since most people have already seen their buying power eroded because of rising prices and stagnating salaries.
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