On October 17, the New Taiwan Dol-lar (NTD) fell by nearly NT$1 to the US dollar, hitting 29.5:1, its lowest level in 10 years. Under pressure from expectations that it would depreciate still further, in the next few days the exchange rate fell to nearly 31:1. After the currency's earth-shattering one-day dive, there were aftershocks in the market and investors are pointing the finger of blame at the Central Bank of China (CBC). What is the CBC's current policy on the exchange rate? And if market mechanisms are allowed to determine it, what is a reasonable exchange rate for the NT dollar?
For the last six months, the currencies of SE Asia have been depreciating and financial markets have been in turmoil. Many in Taiwan worried that Taiwan would become the next target for speculators. Given, too, the continued strengthening of the US dollar on international markets, there was intense pressure on the NTD to depreciate. After defending the currency for the last three months, the CBC finally threw in the towel, causing the NTD:USD exchange rate to plummet to nearly 31:1.
The recent fluctuations in the foreign exchange rate are the visible manifestations of a war between the CBC and speculators who have been holding US dollars in anticipation of depreciation in the local currency. As early as the end of July, there was a scent of smoke in the air over the forex market as the NTD fell to 28:1. In order to stop speculators from profiting from a devaluation, the CBC spent over US$5 billion supporting the currency in the forex market, hoping to force foreign banks and exporters short of NT dollars to sell some of their US dollar holdings. But the market's expectations of a devaluation were too strong and so not only were speculators buying US dollars, but even exporters were refusing to exchange their US dollar earnings for NT dollars. The CBC was therefore forced to raise the stakes in its US dollar sales to the point that on October 13th, the forex market's single-day trading volume was an unbelievable US$1.5 billion.
The CBC was using its foreign reserves to buy NTDs on the capital market to support the currency, an action which tightened supplies of NT dollars. This, in turn, caused interbank lending rates to shoot up to 19%. Short-term interest rates also headed skyward causing dismay among industry figures. With the tightening of capital, foreign investors anticipated a fall in the stock market. They began selling their holdings and buying US dollars, adding fuel to the fire. Although the CBC had lowered the deposit reserves ratio at the end of September in an effort to free up money in the banking system and bring down interest rates, it turned out to be difficult to stabilize the financial markets.
After trying to protect both the exchange rate and the stock market, on October 17th, the CBC finally once again lowered the deposit reserves ratio and gave up its fight to protect the currency. This action caused the NTD to drop NT$0.981 in one day to 29.5:1. Trading volume was US$760 million. Now, personnel at the foreign exchange banks feel that the currency has fallen enough and that in the short term, it should fluctuate around the 30:1 level.
After the close of trading, Patrick C.J. Liang, deputy governor of the CBC, announced that the CBC's period of intervention in the forex market had come to an end. He went on to say that unless abnormal speculation began again, the CBC would not intervene in the market. Y.D. Sheu, governor of the CBC, also stressed repeatedly that the CBC's policy was not mistaken. But many outside the bank wonder. Wu Hui-lin, a researcher with the Chung-hua Institution for Economic Research (CHIER), is critical of the CBC saying that the CBC's policy of saving the stock market at the expense of the currency hurt those people who believed the government.
In fact, since this wave of currency devaluation which has engulfed SE Asia began in July, the NTD has only dropped about 10%, which is about as much as the Singapore dollar has fallen. Moreover, even The Economist has remarked that Taiwan's economic fundamentals are healthy and that SE Asia's currency crisis shouldn't affect the island. On the other hand, officials at the Industrial Development Bureau of the Ministry of Economic Affairs, think that an appropriate level of depreciation ends the anticipation of a devaluation and increases the competitiveness of exports, stimulating the domestic economy.
The CBC bears the dual responsibility of stabilizing demand for the currency and maintaining confidence in the NTD. But financial markets are controlled by natural market mechanisms which operate between investors as they balance the supply of financial products available with demand for those products. Liu Yi-ju, a professor in National Taiwan University's Department of Finance, says that the so-called "market" is just "a conglomeration of everybody's opinions" and intervention is likely to cause an even stronger rebound. Wu Hui-lin feels the CBC ought to enact the financial market liberalization it has talked about. But scholars are divided on the question of how much freedom the CBC should give to financial markets, and there is still much room for debate.
Now that the CBC has ended its forex intervention, the NTD will gradually stabilize. But Ma Kai, a researcher with the CHIER, reminds the CBC that with a devalued NTD, the cost of imported raw materials increases. And after action is taken to ease the money supply, how do you tighten the money supply again in the future to avoid inflation? These are the next problems the CBC must face.
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After the CBC gave up its defense of the NTD, the exchange rate fell to a ten-year low. In the days following, the NTD:USD exchange rate hovered around the 30:1 level, a level which many people involved in forex trading feel to be reasonable. (photo by Pu Hua-chih)
