VoxEU Column Exchange Rates Macroeconomic policy

Asian exchange rate asymmetry

Why are emerging Asian economies accumulating massive foreign exchange reserve stocks? Much research has focused on precautionary or export-promoting motives. This column argues that emerging economies are pursuing exchange rate management with a strong bias towards preventing appreciation.

Following Calvo and Reinhart (2002), it has become commonplace to argue that there is a “fear of floating” among emerging economies in Asia and elsewhere. However, the sustained reserve build-up in emerging Asian economies since 2000 until 2008 (with the onset of the global financial crisis) suggests that they are more sensitive to exchange rate appreciation than depreciation. Indeed, a massive body of work has focused on trying to rationalise the causes and consequences of reserve build-up in emerging Asian economies and elsewhere especially since 1998. Apart from valuation changes due to currency composition of reserve stocks, the three main rationales often suggested for reserve accumulation are insurance (i.e. preventing a crisis), mercantilism (i.e. stimulating growth), and reducing exchange rate volatility. The last rationale (i.e. managing exchange rate volatility), while often used by central bankers, is unconvincing as it should imply that, on average, international reserves do not change much. The fact that reserves are being accumulated on a sustained basis suggests that intervention has involved more that just minimising exchange rate volatility.

While the first two rationales have very different motivations, they are similar in the sense that they involve the central bank having to intervene in the foreign exchange market by leaning against the wind. Regardless of whether one looks at commonly used benchmarks of reserve adequacy or compares reserves holdings against some benchmark like the buffer stock model, most studies conclude that Asia holds more than enough precautionary reserves. This in turn strongly implies that the sustained reserves build-up is due to a desire to keep exchange rates from appreciating significantly. Indeed, many emerging economies have begun to earmark some portion of their reserves to invest in less liquid, potential higher return but higher risk assets. As they move from liquidity management to wealth management, many countries have created (China) or are considering establishing (India) a sovereign wealth fund. Revealed preferences therefore suggest that many of the central banks view their reserve holdings as more than adequate for precaution and are yet building it up (largely as a side-effect of exchange rate interventions).

Many observers have drawn the conclusion that Asian currencies remain heavily managed and are effectively undervalued in order to sustain export-led growth. This in turn has contributed to a massive reserve accumulation in emerging Asian economies as well as to the ongoing global macroeconomic imbalances. While this is a reasonable conjecture, it ignores the concerns that small and open economies in Asia and elsewhere have a currency that is “too weak”. During the crisis period of 1997-98 and its immediate aftermath, there was a great deal of discussion on the problems associated with a weak currency, i.e. a rise in unhedged foreign currency liabilities. While some corporate and financial institutions in Asia remain vulnerable to their home currency depreciations, in aggregate, as these economies have moved from running current account deficits to surpluses and stockpiled reserves in US dollars and Euros, they may arguably be more concerned about a loss in capital values with a sharp appreciation rather than about the depreciation of their currencies.

This said, there remains a more persistent problem of currency depreciation passing through into domestic inflation, i.e. exchange rate pass-through. While there is some evidence that exchange rate pass-through into emerging economies has been declining over time, it does not seem to have fallen as rapidly as in the case of developed economies (Ghosh and Rajan, 2007). In other words, there is less evidence of pricing-to-market or local currency pricing of imports to emerging economies in Asia and elsewhere.

Fear of appreciation

We are thus left with the tentative conclusion that many emerging economies desire some sort of exchange rate management with a strong bias towards preventing appreciation. Somewhat surprisingly, there has been scant discussion of this issue of asymmetry in foreign exchange market intervention in the debate of de facto exchange rate regimes in Asia, a gap that we attempted to fill in a recent paper (Pontines and Rajan, 2008). Using a sample of five emerging Asian economies that operate a variety of managed floats (India, Korea, Philippines, Singapore, and Thailand) from 2000 to 2006, our results confirm the existence of an asymmetry in central bank foreign exchange intervention responses to currency appreciations versus depreciations. Asian central banks appear to react much more strongly to rates of appreciation than to depreciation.

In other words, Asian exchange rate policies since the 1997-98 crisis have evolved towards an apparent “fear of floating in reverse” or “fear of appreciation” a la Levy-Yeyati and Sturzenegger (2007), whereby interventions have been aimed at limiting appreciations rather than depreciations. This conclusion is particularly strong in the case of the trade-weighted exchange rate. This finding appears to be a manifestation of some sort of a managed float such as a currency-basket exchange rate arrangement being pursued in these countries. While this finding for Singapore is consistent with the fact that it officially pursues a band-basket-and-crawl regime, with a basket essentially referring to the nominal effective exchange rate, many other countries in the region like Thailand and India are also believed to operate de facto basket pegs (Cavoli and Rajan, forthcoming). The fact that Asian economies have been managing their currencies asymmetrically against a trade-weighted basket rationalises the relative exchange rate stability as well as the sustained reserve accumulation in the region that prevailed until the onset of the recent global financial crisis.


Calvo, G. and C.M. Reinhart (2002). “Fear of Floating,” Quarterly Journal of Economics, 117, pp.379-408.
Cavoli, T. and R.S. Rajan (forthcoming). Exchange Rate Regimes and Macroeconomic Management in Asia, Hong Kong: Hong Kong University Press, forthcoming.
Ghosh, A. and R.S. Rajan (2007). “A Survey of Exchange Rate Pass-through in Asia: What does the Literature Tell us?,” Asia Pacific Economic Literature, 21, pp.13-28.
Levy-Yeyati, E.L. and F. Sturzenegger (2007). “Fear of Floating in Reverse: Exchange Rate Policy in the 2000s,” mimeo.
Pontines, V. and R.S. Rajan (2008). “Fear of Appreciation” Not “Fear of Floating”? Foreign Exchange Market Intervention in Emerging Asia, mimeo, October.
Ramachandran, M. and N. Srinivasan (2007). “Asymmetric Exchange Rate Intervention and International Reserve Accumulation in India,” Economics Letters, 94, pp.259-265.

210 Reads