Of all the roles central banks are asked to perform, keeping a lid on currency appreciation by directly intervening in foreign exchange market is perhaps one of the trickiest. And it’s certainly not made any easier when politicians weigh in with their two cents on how it should be done.
In Taiwan’s case, however, the Central Bank of the Republic of China may do well to listen to the pols.
In a rare display of government criticism, Taiwanese vice premier Sean Chen delivered a broadside against the CBC in the Legislature on Wednesday, demanding the bank radically change the way it manipulates the New Taiwan Dollar.
The issue isn’t over whether the huge intervention that’s been underway in recent months to curb the NTD’s unstoppable gains is in fact money well spent. This is Asia after all, and governments across the region are actively resisting pressure to appreciate. Taiwan in particular has a reputation for being one of the most — if not the most – interventionist of central banks in Asia.
Rather, it’s a question of whether they can get more bang from their buck.
The way the central bank intervenes is quite unique. It buys dollars in massive quantities from state-owned banks during the last 15 minutes of the onshore five-hour trading session. It typically makes only one or two trades, but their size is large enough to bring the value of the NTD against the U.S. dollar back down to a level somewhere very near to the previous day’s close.
So, should investors sell the U.S. dollar during trading hours? Or to wait until the onshore market closes so that they can get a better price?
The tricky part is that investors literally can’t sell the U.S. dollar at those “closing” prices. The banks that are in on the trade with the central bank don’t pass the prices through to the market because market expectations – as reflected in the offshore nondeliverable forwards market – are that the NTD will continue appreciate. The opening price for the NTD against the dollar the following day is invariably lower than it would have been had the central bank not intervened the next day, but is higher than the negotiated trading price. That dilutes the benefit to exporters – for whom the government tries to control appreciation in the first place - who have to settle their trades at less advantageous level than where the central bank intervened.
In short, the central bank’s high jinks have managed to slow the headline rate of appreciation, but the closing prices are in effect fictional.
The problem is that the Taiwanese style of intervention effectively resets the closing level each day, but fails to send a clear message to the market about where the central bank wants the currency to be. In other words, the central bank has failed to draw a line in the sand and instead the market has come to expect that the gradual appreciation of the NTD is the norm.
The contrast with Japan and Singapore – neither of whom shy from currency intervention – is instructive. They have internal moving target levels at which they intervene in the market. They don’t broadcast those levels in advance, but by being willing to trade to defend those levels they signal to the market how much movement they’re willing to accept.
And by knowing the boundaries the market can trade accordingly–a superior approach to having the central bank press reset each day.
One might argue Taiwan’s forex interventions have worked to a certain extent, given the Taiwan dollar has risen less than its rival Korean won. But it’s a case of apples and oranges: Korea’s local-currency bonds are offering more decent returns than their Taiwanese counterparts, attracting additional capital flows.
Taiwan’s forex regime is best judged on its own terms – and surely there has to be a better way.