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Challenges and Opportunities in Managing Foreign Exchange Reserves PowerPoint PPT Presentation


Challenges and Opportunities in Managing Foreign Exchange Reserves. S. Ghon Rhee, Ph.D. K. J. Luke Distinguished Professor of Finance Executive Director Asia-Pacific Financial Markets Research Center University of Hawai ‘ i The 5 th Seoul International Financial Forum

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Challenges and Opportunities in Managing Foreign Exchange Reserves

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Challenges and Opportunities in Managing Foreign Exchange Reserves

S. Ghon Rhee, Ph.D.

K. J. Luke Distinguished Professor of Finance

Executive Director

Asia-Pacific Financial Markets Research Center

University of Hawai‘i

The 5th Seoul International Financial Forum

April 27-28, 2004, Seoul, Korea

Asia-Pacific Financial Markets Research Center, University of Hawaii


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Capital Flows to Asia+

US$ Billion

200120022003*2004**

Current Account Balance48.2 71.9 73.4 56.9

Direct Foreign Investment51.7 55.9 55.7 59.8

Portfolio Investment12.4 2.6 27.7 25.2

Private Credits-13.1 6.3 27.9 11.7

Official Capital Flows-8.1 -15.5 -12.6 -5.4

Resident Lending/Errors &

Omissions-20.9 -9.5 15.0 -5.6

Total Inflows70.3 111.9 187.1 142.5

*Estimate

**Forecast

+China, India, Indonesia, Korea, Malaysia, Philippines, Thailand

Source: Institute of International Finance (2004)

Asia-Pacific Financial Markets Research Center, University of Hawaii


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Increasing Capital Inflowsto the Region

Not Necessarily Good News

a. Appreciate the local currency

b. Undermine the competitiveness of export industries

c. Cause inflation to rise

d. Too much liquidity encourages over-investment and overheating of the economy

Asia-Pacific Financial Markets Research Center, University of Hawaii


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Case In Point: Challenges Facing People’s Bank of China

  • Foreign Exchange Reserves: Increased by $120 billion in 2003

  • Speculative Hot Money ($25 - $40 billion): Happy Depositors in RMB Accounts

  • Reckless Lending: Major Concern Given Too Much Liquidity in the Banking Sector

  • Issuance US$-Denominated domestic bonds: Under Plan

  • PBOC issued its short-term notes in amount of 1 trillion RMB or US$121 billion so far to reduce liquidity since its introduction in 2003; Increase Discount Rate (2% to 2.5%); Increase Reserve requirements (6% to 7% in Sept 2003 and to 7.5% for weak banks in March 2004)

  • Open Market Operations: Now twice a week since Feb. 25, 2003

Asia-Pacific Financial Markets Research Center, University of Hawaii


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Dilemma for Central Banks

Tight Monetary Policy

a.Drives up short-term interest rates

b.Encourages further capital inflows

c.More Pressure on Currency Appreciation

d.Heavy burden on government debt servicing cost

Deepening conflicts between monetary policy and fiscal policy implementation

Asia-Pacific Financial Markets Research Center, University of Hawaii


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Government

Debt Mgmt

Optimal Cost/Risk Trade-off

Fiscal

Policy

Monetary

Policy

Aggregate Debt

Price Stabilization

Separation of Government Debt Management from Monetary and Fiscal Policies

Asia-Pacific Financial Markets Research Center, University of Hawaii


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Open Market Operations with Fully-Developed Government Bond Market

1.The central bank can expand or contract bank reserves and money supply and transmit its policy signaling through open market operations

2.Two Alternatives in Setting:

a. Target Amount of Bank Reserves with Short-Term Interest Rate Fluctuating

b. Target Short-Term Interest Rate with Bank Reserves Fluctuating

With well-functioning government bond markets, second alternative becomes the norm among industrialized countries

3.Open Market Operations:

Secondary Market

Government Debt Management:Primary Market

Asia-Pacific Financial Markets Research Center, University of Hawaii


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Open Market Operations with Under-Developed Government Bond Market

1.Capital Inflows are Sterilized as part of Open Market Operations

2.Central Banks prefer short-term or floating-rate domestic debt; inflation-indexed bonds; and foreign currency debt

3.Government Debt Management Officesdo not prefer these instruments due to rollover risk triggered by external shocks

4.Rollover Risk Emerges as the Main Concern while Market Risk Remains Important and Conflicts Deepen between monetary policy and government debt management

Asia-Pacific Financial Markets Research Center, University of Hawaii


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Alternative Policies to Sterilization

1.Fiscal Adjustment

2.Switch Government Deposits from Commercial Banks to Central Banks

3.Ease Restrictions on Capital Outflows

4.Flexible Exchange Rate Regime

5.Accelerate Trade Liberalization

6.Variable Reserve Requirements on Certain Categories of Foreign Borrowing

7.Develop Long-Term Government Bond Markets

But All of Them Represent Slow Processes

Except Alternative No. 2

Asia-Pacific Financial Markets Research Center, University of Hawaii


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Foreign Exchange Reserves(As of March 2004)

Japan US$826.6 billion

China 439.8

Taiwan226.5

Korea163.6

Hong Kong123.8

India110.3

Singapore102.8(Preliminary)

Germany 94.5(as of February)

United States 84.7

Russia 83.7

-------------------------------------------------------------------------------------

Malaysia 51.3

Thailand 42.9

Philippines 15.7

------------------------------------------------------------------------------------- Total ( 10 Asian Economies) $2,103.3

Asia-Pacific Financial Markets Research Center, University of Hawaii


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Foreign Holdings of US Securities by Selected Asian Economies (June 2002)

US$ Billion

Source: US Department of Treasury

  • Asia-Pacific Financial Markets Research Center, University of Hawaii


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Foreign Holdings of US Treasury Securities

*Rankings are of the year of 2004. Source: US Department of Treasury www.treas.gov/tic/mfh.txt

  • Asia-Pacific Financial Markets Research Center, University of Hawaii


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Utilization of Reserves for Various Purposes

a.Korea

$20 billion investment in Korea Investment Corporation

b.China

$45 billion diverted for Restructuring of State Banks

Additional $40 billion for the same purpose?

c.Thailand

Unspecified amount diverted to buy machinery or license intellectual property for local corporations

d.Taiwan

$10 billion allocated to banks to participate in major investment projects relating to overall domestic economic development

Asia-Pacific Financial Markets Research Center, University of Hawaii


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Korea Investment Corporation

a.Capital:

$20 billion from the BOK’s FX reserves; Additional capital may be drawn if reserves reach $200 billion

b.“Cashing Contract”:

KIC’s assets be cashed when necessary upon request from BOK

c.Initial Investment: Financial Assets

d.Critical Vehicle:

To Attract Global Asset Management Companies

Asia-Pacific Financial Markets Research Center, University of Hawaii


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Bank of Korea’s Current Reserve Management (I)

Source: IMF (2003)

Asia-Pacific Financial Markets Research Center, University of Hawaii


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Bank of Korea’s Current Reserve Management (II)

Investment Instruments

a.Marketable Securities:

sovereign bonds, government agency bonds, MDI-issued bonds with AA-rated or higher

b.Deposits:

Only with financial institutions with credit ratings of A or above

c.Outsourced Assets:

May include corporate bonds, ABSs, and MBSs with AA ratings or higher

Differences between KIC’s management and BOK’s management?

Asia-Pacific Financial Markets Research Center, University of Hawaii


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Major Operational Policy Issues with KIC (I)

1.Is KIC’s Operation Part of Foreign Exchange Reserve Management?

a.If yes, then the relation between MOFE and BOK vis-a-vis KIC?

b.If not, the integrity of foreign exchange reserve management may be questioned.

2.Governance System of KIC?

a.Transparency

b.Accountability and Assurances of KIC’s integrity

Asia-Pacific Financial Markets Research Center, University of Hawaii


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Major Operational Policy Issues with KIC (II):

c.Lack of Transparency and Accountability

1.Fiscal Investment and Loan Program of Japan

Assets:US$3.67 trillion

Loans:US$2.88 trillion

Extended to: (i) FILP-Dependent Enterprises*;

(ii) Municipal Governments; and (iii) Government-Owned Banks

* Transportation, Education, Utilities, Housing, Roads, Bridges, Airports, SMEs

Sources of Funds:

Postal Savings Deposits

Employees’ Insurance Deposits

75% of FILP Loans are Non-Performing & Estimated Losses = ¥75 trillion ( = US$680 billion) or 15% of GDP [Doi and Hoshi (2002, NBER)]

Asia-Pacific Financial Markets Research Center, University of Hawaii


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Major Operational Policy Issues with KIC (III):

2.Temasek Holdings Ltd. (Singapore)

Singapore’s Ministry of Finance-owned investment arm controlling more than 20% in 22 major local companies

Total investment > US$130 billion over 30 years

Its financial statement will be disclosed to the public for the first time in its 30 year history

3.Government Investment Corporation of Singapore

Total Fund under Management > US$100 billion

i.Government of Singapore Investment Corporation Pte Ltd.

ii.GIC Real Estate Pte Ltd.

iii.GIC Special Investments Pte

Very little is known about its financial status

Asia-Pacific Financial Markets Research Center, University of Hawaii


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Major Operational Policy Issues with KIC (IV):

4.Khazanah Nasional Berhad (Malaysia)

6 subsidiaries

18 associates

13 investments

No information on its performance

5.The Minister of Finance (MOF) Inc. (Malaysia)

No information on its performance

Asia-Pacific Financial Markets Research Center, University of Hawaii


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Major Operational Policy Issues with KIC (VI)

3.Reserve Adequacy

a.Money Supply-Based Approach (Ratio of Reserves to Money Supply):

Poor measure of capital flight

Poor predictor of currency crisis

b.Current Account-Based Approach (Reserves in Months of Imports):

Relevant for Small Economies?

Poor predictor of currency crisis for Open Economies

c.Capital Account-Based Approach (Ratio of Reserves to Short-term External Debt)

Better measure for Economies with significant but uncertain access to international capital market?

d.Combination of current and capital account approaches

Asia-Pacific Financial Markets Research Center, University of Hawaii


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Reserve Adequacy: Korea’s Reserves and External Debt (November 2003)

Source: Asian Development Bank

Asia-Pacific Financial Markets Research Center, University of Hawaii


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Thank You!For Further References,Please visit http://www2.hawaii.edu/~rheesg

  • Asia-Pacific Financial Markets Research Center, University of Hawaii


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Asian Stock Market Performance(Annual Return)

Asia-Pacific Financial Markets Research Center, University of Hawaii


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