Monitoring currency vulnerability: more turbulence on financial market in 2007 "not ruled out" says UNESCAP

Bangkok – A sharp fall in the United States dollar due to imbalances in the United States economy, fresh oil price hikes could lead to sharply slower growth in Asia-Pacific economies, the United Nations Economic and Social Commission for Asia and the Pacific (UNESCAP) reported in its 2007 economic Survey.

The Economic and Social Survey for Asia and the Pacific 2007 warned that a repeat of the sharp fall in equity markets that occurred in February 2007 and more turbulence on financial markets "cannot be ruled out" over the year.

"Today's uncertainty in financial markets warrants careful monitoring of economic vulnerability to recognize danger signals as early as possible," the Survey said.

The Survey pointed to possible hikes in developed country interest rates, especially in the United States, the Euro Zone or Japan – if inflation shows signs of re-emerging, as a result of renewed rises in oil prices.

The major concern is the "abrupt unwinding of global imbalances leading to a deep depreciation of the United States dollar", that would also lead to a slowing Asia-Pacific economic growth due to lower demand for exports from Asia's economies.

"(In 2006) global imbalances steadily widened, with the current account balance of the United States deteriorating by a further $100 billion, increasing the possibility of an abrupt depreciation of the United States dollar," the Survey said.

A sharp appreciation of major currencies in the Asia-Pacific against the United States dollar would undermine their ability to remain price competitive while addressing inflationary pressures that may see central banks raising interest rates.

In 2006, Asian currencies were strong due to larger-than-expected current account surpluses and capital inflows, including those for speculative purposes.

Major currencies in the Asia-Pacific appreciated sharply in 2006. At year's end the Thai baht had appreciated by 13% against the United States dollar, the Korean won reached a nine high against the United States dollar and Japanese yen.

Thailand, "in a dramatic move", imposed capital controls that startled financial markets resulting in the Thai stock market falling almost 15% in a single day.

The Survey says policy markers, as a result, face a dilemma between inflationary concerns and preventing exchange rate appreciation.

"It is impossible to juggle all three policy objectives – free movement of capital, control over exchange rates and independent monetary policy to manage inflation," the Survey says.

But many Asia-Pacific countries did try to stem inflation by rate increases leading to the accumulation of foreign exchange reserves that reached "an unprecedented $2.5 trillion at the end of 2006".

The Survey warns that several countries affected by the 1997 financial crisis are again showing signs of vulnerability. Based on UNESCAP research of four crisis affected countries – Indonesia, the Republic of Korea, the Philippines, and Thailand – were "displaying renewed vulnerability".

The vulnerability stems from the appreciation of their nominal exchange rates due to short-term capital inflows. The Survey adds that Thailand's increased vulnerability "also stems from a decline in the ratio of foreign exchange reserves to short term debt".

The Survey says there were fewer concerns for Malaysia as the real appreciation was "rather limited" and the foreign reserve adequacy ratio improved". Also, Malaysia's financial sector had been robust due to on-going financial reforms and where private domestic credit had remained at manageable levels.

As the region's oldest and most comprehensive annual review of economic and social developments, UNESCAP's Economic and Social Survey of Asia and the Pacific provides the only independent source of analysis covering all countries in this vast and diverse region, and considers both the social and economic spheres of development. The 2007 Survey, entitled "Surging Ahead in Uncertain Times," looks at the most critical issues, challenges and risks our region faces in the months ahead.

Headquartered in Bangkok, Thailand, UNESCAP is the largest of the UN's five Regional Commissions in terms of membership, population served and area covered. The only inter-governmental forum covering the entire Asia-Pacific region, it aims to promote economic and social progress.

 

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