The central bank's interest rate hikes last week showed its determination to balance the risk of higher inflation against the risk of weakening the local currency and encouraging continued capital outflows.
While the fears of a US economic recession amid the slump in the housing market prompted the US Federal Reserve to cut its benchmark rates earlier last week, the central bank appeared to want to go its own way because it didn't think the international financial market woes would seriously impact this country.
Taiwan still faces the risk of higher inflation because of rising oil and raw material prices worldwide as well as a possible fluctuation in food prices as a result of seasonal climate changes. Just last week, oil prices soared to new highs on international markets, approaching US$85 a barrel.
Rising commodities prices worldwide will eventually force manufacturers to pass on increased costs to consumers. The government predicts the inflation rate will increase 2.34 percent in the second half of the year from a year earlier, compared to the 0.61 percent increase in the first six months.
Inflation is clearly the central bank's concern and the bank has to address this issue by boosting the exchange value of the NT dollar, or it would heap extra pressure on consumer prices as the cost of imported goods keeps climbing.
But the central bank is also facing the challenge of continued capital outflows. This problem is so serious that since late May, the bank has used every available opportunity to induce domestic investors to keep their money onshore.
Taiwan's interest rates are the second-lowest in the region after Japan's, and many Taiwanese investors and companies have reallocated their investment portfolios to higher-yielding assets abroad.
To counter this trend, the central bank has to narrow the spread between interest rates in Taiwan and other countries, particularly the US. The latest rate adjustment narrowed the spread between the Taiwanese and US rates by 1.5 percent.
The normalization of interest rates will continue, given that central bank Governor Perng Fai-nan (
The bank has shown its determination to stem capital outflows and has continued to intervene in the currency markets to boost the NT dollar, but pressure on the currency to rise remains due to excess savings and a poor domestic investment environment -- issues outside the bank's remit.
Still, the biggest challenge facing the central bank is balancing a stable currency exchange and monetary policy independence.
Taiwan should keep its currency stable because a stronger NT dollar will hurt exports while a big fall in the currency will lead to capital outflows. People can factor a steady currency rise or fall into their business costs. But it is when the pace of appreciation or depreciation is too fast that problems arise for the economy.
In addition, the independence of the central bank is absolutely essential to ensure its credibility despite political and business pressure.
The bank's latest rate adjustment showed its monetary policy independence, yet took into account public interests and safeguarded the stability of consumer prices. The bank should maintain this spirit in December and in the future.
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