Page 188 - DCOM106_COMPANY_LAW

Unit 11: Corporate Governance

Notes

Case Study Why Intervention is effective in Emerging Markets

nd
n 2 and 3 December 2004, the BIS hosted a meeting of Deputy Governors of
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central banks from major emerging market economies to discuss foreign exchange
Omarket intervention. While few developed countries have actively intervened
within the last decade, the outstanding exception being Japan, intervention has been
commonplace in the emerging market community.
There are several reasons why developed countries no longer actively intervene. One is
that research and experience suggest that the instrument is only effective (at least beyond
the very short term) if seen as foreshadowing interest rate or other policy adjustments.
Without a durable and independent impact on the nominal exchange rate, intervention is
seen as having no lasting power to influence the real exchange rate and thus. competitive
conditions for the tradable sector. A second reason is that large-scale intervention can
undermine the stance of monetary policy. A third reason is that private financial markets
have enough capacity to absorb and manage shocks - so that there is no need to “guide”
the exchange rate.

Yet emerging market countries do intervene - presumably because they believe the
instrument to be an effective tool in the circumstances and for the situations they face. The
difference in view is brought home by the unprecedented scale of foreign exchange reserve
accumulation by the emerging market group in recent years. Between the end of 2001 and
the end of 2004, global foreign exchange reserves grew by over US$ 1600 billion, reflecting
reserve accumulation by emerging market economies in Asia. Many observers from
developed economies have publicly attributed the comparatively weak appreciation of
Asian currencies against a rapidly depreciating US dollar to such intervention. Hence
there does seem to be a common belief that intervention by emerging market economies
has significantly altered the path of the real exchange rate for long enough to matter –
even if such a view runs counter to received wisdom about intervention in the markets for
major currencies.
This meeting threw some new light on these issues. Some flavour of the discussion can be
gleaned from the central bank papers reproduced in this volume, along with overview
papers prepared by BIS staff. Four central questions are outlined below; it will be clear
that many important issues remain to be resolved.
Is intervention more effective in emerging markets?
The wide range of different objectives behind intervention in practice makes assessment
difficult - especially empirical assessment that uses data from different episodes and
different countries where policy objectives may vary. In flexible exchange rate cases, the
objectives of intervention are particularly varied, a point which emerges clearly from the
Moreno paper and the individual country papers in this volume. Reasons for intervention
cited by central banks that do not target the exchange rate include: to slow the rate of
change of the exchange rate; to dampen exchange rate volatility (in some cases to satisfy
an inflation target); to supply liquidity to the forex market; or to influence the level of
foreign reserves. The paper from South Africa provides an example of objectives that are
both subsidiary to the main objective and conditional on prevailing circumstances (in this
case, the process of reserve accumulation being used to help dampen volatility when that
is convenient). Other country papers show that varying mixtures of objectives are quite
commonplace.
Contd...

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