As expected, the annual IMF meeting a week ago in Washington failed to generate anything solid to deter a looming currency war. No one was surprised when the US government on Friday delayed once again a report that could have labeled China as a currency manipulator.
The issues of the global devaluation race and the allegedly undervalued Chinese yuan are now likely to dominate a preparatory meeting of G20 officials on Friday and Saturday in South Korea, before the G20 summit in Seoul on Nov. 11 and Nov. 12.
What is perhaps most disturbing about the situation is that US congressional elections are scheduled for Nov. 2 and the US Federal Reserve is likely to announce more quantitative easing measures at its Federal Open Market Committee meeting on Nov. 2 and Nov. 3, which will only keep the currency issue alive and lead to more capital flowing to emerging markets in the short term.
That explains why several emerging economies have recently moved to adopt various capital control and intervention measures to pre-empt potential negative impacts from a surge in capital inflows.
For instance, Brazil announced on Oct. 4 that it would double its financial transactions tax on foreign investment in fixed-income and equity funds; China on Monday unexpectedly ordered six of its major banks to temporarily raise reserve requirements; Thailand on Tuesday reinstated a 15 percent withholding tax on foreigners’ purchases of Thai bonds; and in a surprise move on Thursday, Singapore tightened its monetary policy by widening the trading band for the Singapore dollar.
In Taiwan, short-term “hot money,” which pushed the NT dollar to a 27-month high of NT$30.77 against the US dollar on Thursday, has driven the local currency up more than 4 percent so far this year. Market watchers are speculating that the central bank will tighten regulations on foreign holdings of fixed income instruments if the capital inflows continue.
It appears that more tightening measures on capital inflows are inevitable for Asian economies. These measures are hardly perfect, but they are what emerging markets have on hand in order to curb currency appreciation and ward off potential asset bubbles. The question is how effective the measures are and whether they can reverse the appreciation trend.
Another downside of such capital control measures is that they might adversely impact capital mobility while discouraging the flow of foreign investment in this region if the currency markets become too volatile.
In its latest report of global trends in private investment in the form of foreign direct investment (FDI) issued on Thursday, the UN Conference on Trade and Development (UNCTAD) said global FDI inflows would increase modestly to US$1.12 trillion this year from US$1.11 trillion last year. However, the figure would still be 25 percent lower than the average pre-crisis level of US$1.52 trillion from 2005 to 2007 and 40 percent less than the peak level of US$2.1 trillion in 2007.
Moreover, UNCTAD warned that potential currency wars and mounting trade protectionism would threaten a full recovery in FDI, because transnational corporations are very sensitive to the risk of currency devaluation and market uncertainty.
Emerging economies — including Taiwan — prefer to keep their currencies weak to boost export competitiveness while seeking FDI to help revive their economies. Now their monetary policymakers are facing a challenge to balance their needs for competitive currencies and FDI inflows.
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