To discourage volatile short-term capital flows, the Bank of Indonesia will extend the minimum holding period of its bank certificates, SBIs, from one month to six months, effective May 13. This means traders holding the notes will not be able to sell them in the secondary market until they have held them for six months.
The unexpected news builds upon previous measures aimed at slowing down investment in very short-term debt. For example, the Bank of Indonesia has already all but stopped issuing 3- and 6-month SBIs. A key risk for countries receiving increased capital inflows is that they might reverse, which could have sudden and unpredictable consequences, as the Bank of Japan has pointed out. The Bank of Israel’s Stanley Fischer has made the same argument.
The International Monetary Fund has proposed its first ever guidelines for using controls on flows of speculative capital, legitimising a controversial tool that it once campaigned against.
The guidelines – which are not yet official Fund policy – say that countries can control capital inflows when their currency is not undervalued, when they already have enough foreign exchange reserves, and when they are unable to use monetary or fiscal policy instead.
There are international rules to govern global trade, but none to oversee foreign exchange markets or capital movements, Israel’s central bank governor has observed.
Stanley Fischer said standards for capital movements were needed, even though it was not possible to govern how much central banks could intervene in markets. Reuters news wire reports: “It is important that the IMF is now trying to develop such rules, to figure out what works and what doesn’t work when the exchange rate starts to appreciate and … what measures they can take that are acceptable from the viewpoint of managing the international economy,” he told a conference. “Those are rules we have to develop just as we developed rules gradually in the years since the 1950s that produced a global trading system,” he added.
Many countries grappling with “hot money” blame the US openly and directly, but Professor Fischer did not join them. “I believe the US is doing what needs to be done for growth.
Israeli foreign currency reserves rose to $73.4bn by the end of January as the country’s central bank bought foreign currency to dampen the shekel. The Bank bought $2.09bn and benefitted from an upward revaluation of its reserves by $628m, reports Bloomberg news wire.
Since the start of the year, the shekel weakened against the dollar, from 3.51421 to 3.712 per dollar, which explains the upward revision. Last time there was a net weakening in the currency over the month, it was followed by a net reserve reduction the month after (October-November last year). By that logic we could expect Israel’s foreign exchange purchases to fall during February.
Interest rates will be a quarter of a point higher from tomorrow in Poland, after the MPC voted to increase them. The key refi rate will be 3.75 per cent. The move was expected, after bullish signals in December followed by strong hints from council members in the new year. Those comments suggested this would be the start of a rate normalisation policy, rather than a one-off reactive decision. All else equal, expect further rate rises ahead.
Headline inflation rose to 3.1 per cent in December, driven by higher energy prices. Initial estimates suggest core inflation rose, too. “The inflation rise,” said the Bank, “was accompanied by a rise in inflation expectations.” This was given as the main reason for the rate rise in today’s news conference.
Governor Marek Belka has also said in recent months that he saw a decreased risk of strong capital inflows into Poland. Inflationary “hot money” inflows are encouraged by rate rises, which increase the return to investors. If those inflows are subsiding, Poland would be liberated to raise interest rates without fear of undue inflation.
Effective tomorrow, the 25bp rate rise will be the first
Research from the Bank of Japan argues that we are seeing a multiplier effect in capital flows between emerging markets and the US, and its reversal could cause a very sudden upward correction in US government bond prices.
The argument runs along these lines: investors seeking high returns have caused large capital inflows into emerging markets, causing forex intervention and leaving governments with stockpiles of US dollars. Those dollars are then invested in US treasuries, reducing the yield and making it cheaper for US investors to borrow – and to seek high returns in emerging markets. Repeat.
While no direct mention is made of the Fed’s recent $600bn stimulus,
Chile has held rates at 3.25 per cent, following its pledge to buy $12bn in the forex market to weaken the peso. Pundits had been split roughly equally between a rate hold and a small rate rise. The central bank has typically been raising rates regularly but by small increments of late (see chart, right).
Inflation in Chile is running at 3 per cent, exactly on target (which allows for one per cent either side of this) – but it is rising quickly. Chile recently pointed to the effect of the Fed’s $600bn stimulus programme on its currency – i.e. causing appreciation – and in doing so, joined a chorus of opposition from emerging markets trying to cope with an influx of “hot money”.
As expected, Turkey’s central bank has cut its key rate as part of a two-pronged strategy to address hot money and inflation. The following information is from the Bank, courtesy of Google translate:
“The bank said the measures, taken in tandem with hikes to the lira required reserve ratio due to be announced on Friday, would not have an expansionary effect on monetary conditions,” reports Reuters.
Officials from Taiwan’s central bank have rejected the implication of currency undervaluation in a chart used by Ben Bernanke. The offending graph – to the right – shows changes in the real effective exchange rate on its vertical (y) axis. Taiwan’s currency weakened by 2.8 per cent in real terms between September 2009 and 2010, according to this Fed chart. Taiwan says it fell by just 0.2 per cent, and argues that REER is not a good measure of undervaluation anyway.
At stake is responsibility for volatile capital flows that add to inflation in emerging markets and threaten to destabilise recovery. Emerging markets point to the Fed’s stimulus programme. But Mr Bernanke argued in his speech that the Fed’s $600bn stimulus programme was good for the world economy, refusing to accept responsibility for the extra inflationary pressure flowing through to emerging markets. In spite of former chair Alan Greenspan’s comments to the contrary, the Fed also continues to deny any attempt deliberately to weaken the dollar.
Indeed, Mr Bernanke accused emerging market economies of spending their reserves to slow the appreciation of their currencies. Hot money, he argued, was flowing into emerging markets regardless of Fed actions, because investors expected currencies they were buying to strengthen further. Since – by this chart – Taiwan’s currency has strengthened the least (indeed, has weakened), the implication is that Taiwan is one of the worst ‘offenders’.
Former Fed chair Alan Greenspan has an article in today’s FT. It’s quite blunt about China and the US. “Both may be right about each other,” he says. “America is pursuing a policy of currency weakening,” while China’s reserve accumulation has caused exchange rate suppression for “competitive export advantage”. China and the US aren’t just hurting each other: the joint effect of their policies is to strengthen other currencies, placing those countries at a disadvantage.
Unlike most pundits hand-wringing over the current state of play, Mr Greenspan proposes a solution. It is quite radical. The G20, he says, can propose a new rule through the IMF that “limits the accumulation of reserve assets and sterilisation of capital flows”. “It would be easier to maintain and control than a stability and growth pact,” he says, referring to the “failed” eurozone agreement.
Well, yes, it would be easier. But the fact he has considered a stability and growth pact for sovereign states with separate currencies is staggering. The monetary proposal is also radical.