Exchange Rates and Foreign Direct Investment in Emerging Asia

Ramkishen Rajan

• Publisher: Routledge
• Year: 2013
• ISBN:
  9781136590924
• Edition: 1
• Topic: Économie
• Subtopic: Théorie économique

With the rapid growth of China and India and the resurgence of Southeast Asia post-1997–8, emerging Asia has once again become one of the most dynamic regions in the world. This dynamism has in turn been fuelled largely by a carefully calibrated embracement of economic openness to international trade, investments and capital flows. While much has been written about international trade, there has been somewhat less work on the issue of capital flows, macroeconomic management and foreign direct investment (FDI) to and from the region, a gap that this book attempts to fill.

The book is divided into two parts. The first part deals with selected issues pertaining to macroeconomic management in small and open economies, with particular focus on exchange rates. The second part of the book deals with the trends and determinants of FDI in emerging Asia, its importance as a source of finance, its impact on growth and development, and the nexus between FDI and foreign portfolio flows (FPI).

Overall, the chapters in this book tackle important policy issues of contemporary relevance, but are informed by analytical frameworks, data and empirics. While each of the topic areas chosen in individual chapters is intentionally narrow, the book as a whole covers a number of areas and countries/regions within Asia (i.e. East, Southeast and South Asia). While the chapters have been written in a manner that can stand up to academic scrutiny, they are also meant to be accessible to policy makers, researchers and others who might be interested in FDI and related issues in Asia.

Part 1

Exchange rate regimes and policies

1 How can small and open economies manage capital inflows?

The cases of Singapore and Taiwan¹

Ramkishen S. Rajan and Alice Y. Ouyang

1.1 Introduction

Asian economies have embraced the globalisation of production, trade and capital flows. One dimension of contemporary globalisation has been the rapid and massive stockpiling of foreign exchange reserves in Asia (Figure 1.1). By the end of 2008, the region held US$4.3 trillion of reserves or over three-fifths of global reserves. In view of the fact that half of Asia’s reserves have been attributable to Japan and China, most attention has inevitably been focused on these two Asian giants along with South Korea and India. However, often it is not recognised that two smaller economies, namely Singapore and Taiwan, hold over US$450 billion of reserves in aggregate (Figure 1.2). Indeed, on a per capita basis, these two economies are probably the world’s two largest reserve holders.² Despite this, scant attention has been paid to the rationale for and impact of reserve accumulation in these two economies.

Figure 1.1 International reserve holdings in emerging Asia^* 1995–2008.

Source: Compiled by the authors based on data from IMF’s International Financial Statistics (IFS). Data for Taiwan compiled from Taiwan’s central bank.

Notes:

* Reserves include gold.

** 10 ASEAN refers to the member countries of ASEAN, which include Brunei Darussalam, Cambodia, Indonesia, Lao PDR, Malaysia, Myanmar, Philippines, Singapore, Thailand and Vietnam.

Figure 1.2 Reserve growth in Taiwan and Singapore 1990–2008.

Source: Compiled by the authors based on data from IMF’s International Financial Statistics (IFS). Data for Taiwan compiled from Taiwan’s central bank.

Singapore and Taiwan share many things in common. Both are small and open middle-income economies dependent on global electronics cycles. Both were impacted indirectly by the crisis in 1997 which hit Thailand, Indonesia, Malaysia and South Korea, resulting in nominal depreciations of their respective currencies against the US Dollar (US$) during 1998.³ Both economies operate managed floats. More to the point, the Monetary Authority of Singapore (MAS) officially manages its currency against a basket of currencies, with the trade-weighted exchange rate used as an intermediate target to ensure the inflation target is attained. Empirical evidence confirms the consistency between de jure and de facto classification (for instance, see Cavoli and Rajan 2009: ch. 3, and Khor et al. 2004). While Taiwan’s central bank (the Central Bank of China or CBC) claims that it operates a flexible exchange rate regime, they add the caveat that the New Taiwan dollar (NT$) exchange rate ‘has been determined by the market. However, when the market is disrupted by seasonal or irregular factors, the Bank will step in’ (cited in Cavoli and Rajan 2009: ch. 1). There is empirical evidence to suggest that Taiwan also operates a managed float de facto, with regular foreign exchange intervention (see Cavoli and Rajan 2009: ch. 1 and references cited within). The sustained build-up of reserves suggests that intervention is largely asymmetric, and that it stems largely from a desire to maintain relatively stable and/or ‘ultra-competitive’ exchange rates (see Pontines and Rajan 2011).

Persistent reserve accumulation could run the serious risk of generating increases in inflation in the intervening countries. Accordingly, central banks in Asia have consciously attempted to offset the domestic monetary effects of reserve accumulation. To what extent has this happened in Singapore and Taiwan and how successful have they been thus far in such monetary sterilisation activities? To answer these questions, this chapter examines the causes and monetary consequences of reserve accretion in Singapore and Taiwan from 1990 to 2008.

The remainder of the chapter is organised as follows. Section 1.2 provides an overview of the sources of reserve accumulation in the two economies, focussing on the balance of payments dynamics between 1990 and 2008. The section also offers evidence of the monetary effects of the reserve accretion in the two economies. Section 1.3 outlines a set of simultaneous equations to examine the feedback effects between net domestic assets (NDAs) and net foreign assets (NFAs) as a means of estimating the extent of de facto sterilisation (sterilisation coefficient) and capital mobility (offset coefficient) concurrently. The theoretical foundations of the equations to be estimated are based on a modified version of a model originally outlined by Brissimis–Gibson–Tsakalotos (BGT) (2002). Section 1.4 details the data and definitions of variables to be used in the empirics. Particular attention is paid to the estimation of NFA and NDA. Section 1.5 discusses the empirical results of the sterilisation and offset coefficients based on quarterly data for the period 1990:q1 to 2008:q4 in both cases of Singapore and Taiwan. We also consider recursive estimates to capture any changes in the magnitude of sterilisation over time. Section 1.6 concludes the chapter. Annex 1.1 offers a brief derivation of the BGT model used in Section 1.3.

1.2 Reserve build-up and monetary policy operations in Singapore and Taiwan

1.2.1 Evolution of balance of payments in Singapore

Figure 1.3 summarises the dynamics of Singapore’s balance of payments between 1990 and 2008. The Singapore dollar has fluctuated somewhat vis-à-vis the US$, with a persistent appreciation pre-1997 followed by a one-time depreciation in 1997–8 and relative stability after that. Reserves grew persistently throughout the entire 15 years with the exception of the recession years of 2001–2, and have been particularly marked between 2002 and 2008.⁴ Singapore’s foreign exchange reserves reached a high of US$175 billion by the end of 2008. Figures 1.3 and 1.4 reveal that Singapore’s balance of payments surplus during this period has been due to the large and increasing current account surplus as well as rising Foreign Direct Investment (FDI) inflows. This surplus in the so-called basic balance (i.e. current account plus FDI) has been offset partly by large outflows of portfolio investment and other investments (this category includes the flows between the banking sectors as well as other non-bank sectors and their foreign counterparts, including the Asian dollar market).

Figure 1.3 Trends in Singapore’s balance of payments transactions 1990–2008.

Source: Compiled by the authors based on data from IMF’s International Financial Statistics (IFS). Data for 2008 compiled from Ministry of Trade and Industry in Singapore.

Figure 1.4 Capital account components in Singapore 1990–2008.

Source: Compiled by the authors based on data from IMF’s International Financial Statistics (IFS). Data for 2008 compiled from Ministry of Trade and Industry in Singapore.

Figure 1.5 makes apparent that reserve accumulation and net domestic credit growth are negatively correlated such that the monetary base has remained fairly stable. Inflation has been well-controlled below 3 per cent until mid-2007 but spiked temporarily due to the global commodity price shock (Figure 1.6).

Figure 1.5 Quarterly annual change in NFAs, NDAs, and reserve money in Singapore 1990:q1–2008:q4.

Source: Compiled by the authors based on data from IMF’s International Financial Statistics (IFS).

Figure 1.6 Inflation (CPI % quarterly annual change) in Singapore 1990:q1–2008:q4.

Source: Compiled by the authors based on data from IMF’s International Financial Statistics (IFS).

1.2.2 Evolution of Taiwan’s balance of payments

Figure 1.7 summarises the dynamics of Taiwan’s balance of payments between 1990 and 2008. For the decade between 1987 and 1997, both the NT$ and Taiwan’s international reserves remained quite stable. However, since then, Taiwan’s reserves have been rising, especially since 2001. The overall surpluses on the balance of payments were largely due to the current account, though the economy ran capital account surpluses in a few interim years. Taiwan’s balance of payments began to decline after 2004 because of the worsening of the economy’s capital account, driven largely by continued investment bank outflows and a surge in portfolio outflows during 2006–8 (Figure 1.8). Capital mainly flowed from Taiwan to China in response to an expectation of an appreciation of the Renminbi and the boom in China’s asset markets.⁵ Interestingly, the errors and omissions balance has been large and positive during this period. By the end of 2008, Taiwan’s reserves surpassed US$290 billion.

Figure 1.7 Trends in Taiwan’s bal...

Table of contents

• Cover Page
• Half Title page
• Series Page
• Title Page
• Copyright Page
• Dedication
• Contents
• Figures
• Tables
• Preface
• Acknowledgements
• Part 1 Exchange rate regimes and policies
• Part 2 Foreign direct investment in emerging Asia
• Index