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The Forum > General Discussion > The effects of the Asian Financial Crisis on Foreign Reserves. How much is enough?

The effects of the Asian Financial Crisis on Foreign Reserves. How much is enough?

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The Asian financial crisis started off with a speculative attack on the overvalued Thai baht in May 1997. At that time, the Thai central bank can defend the pegged currency rate either in the spot market or through intervention in the forward market. In the case of defending the value of the baht, the Thai central bank had to sell US dollars. Once, the limited reserves are depleted, the Thai central bank will have no other means of defending the value of baht and could only watch in despair as it continues to devaluate. The attack was also fuelled by structural flaws in the country’s economy. Soon, countries with similar economic structures were affected as well. The result of it, is an over-reaction and excessive outflow of investment which caused the collapse in the Asia currency and share market. In no time, Asia was described as “running out of an international lender of last resort”.

During the financial crisis, Indonesia and Thailand sort help from the International Monetary Fund to maintain their currency value whereby Malaysia and China pegged their currencies to the US dollar. Generally, countries started to build up large foreign reserve base so as to maintain their exchange rate.

From the recent share market surges and the currency appreciation in Asia, one might say that Asia have come out of the recession.
The recent financial and property market bubble might be caused by the large foreign reserve accumulation where the capital flow is not sterilized, created a massive growth of monetary base and of credit that feed of those bubbles which in turn generate inflationary pressure. The bubbles in both markets over time will eventually burst and might indeed trigger the beginning of the next financial crisis. This will inevitably happen as the sterilization cost of capital inflow is large for an ever increasing foreign reserve especially during period of capital inflow surge.

According to the outgoing chief economist of IMF, Kenneth Rogoff, “Asia is now sitting on high foreign exchange reserve and the question is how much is enough?”

Hanwei & Sylvia
Posted by han_syl, Wednesday, 16 May 2007 10:02:35 PM
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