Asia not yet ready for free floating currencies — ADB

Most Asian nations fear adopting a fully-floating currency exchange rate regime even though Argentina’s economic debacle has shown it may be the only option left for them, the Asian Development Bank (ADB) said yesterday.

Argentina plunged into economic and political turmoil late last year after its currency which was pegged to the US dollar under a so-called currency board fixed exchange rate system collapsed following 44 months of recession.

Mired in a $141-billion public debt, the Latin American nation has adopted a floating exchange rate system, causing much devaluation of its currency.

A key lesson from the Argentine crisis is "strikingly similar" to that from the Asian financial turmoil in 1997: it is difficult for developing nations to sustain pegged exchange rates and at the same time maintain relatively open capital accounts, said the new ADB report.

Whereas the Asian crisis highlighted the weaknesses of de facto fixed exchange rate regimes in the region, the Argentine crisis has shown that a "hard peg" or a "super-fix" anchored on a currency board system is also difficult to sustain, it said.

The report was prepared by the Manila-based bank’s Regional Economic Monitoring Unit (REMU), which is closely tracking the economic recovery from the region’s worst financial crisis.

REMU Director Pradumna Rana told AFP that though unfettered currency trading seemed to be the only option left for Asian nations, "this theory may be good mainly on paper as we need to consider the practical problems and fear of floating encountered by developing countries.

"Since the 1997 crisis, Asian nations had been facing a volatile and turbulent period, partly due to global integration of financial markets, which can disrupt international trade and investments," he said.

"The key question now is how do we manage global financial integration and the ADB has embarked on various efforts to tackle this issue through both domestic and regional monetary cooperation," Rana said.

A popular view among economists and policymakers after the Asian crisis has been that developing countries with open capital accounts have only two options with regard to their exchange rate regimes: either fix it hard based on a currency board or float it freely.

All exchange rate regimes falling between these two extremely opposite cases such as crawling pegs, basket pegs, and a whole set of managed floats were considered to be unsustainable.

Following the Argentine crisis, many supporters of this theory concluded that a fully floating exchange rate regime is the only option left for developing countries.

But the ADB report, in cautioning that such theory could be true more in theory than in practice, said a free float was difficult for developing nations with thin capital markets and significant foreign currency liabilities.

Exchange rates could become volatile, causing significant "real sector disruptions," it warned.

It is possible to minimize such disruptions by hedging against foreign exchange risk but "perfect hedges are not only difficult to create technically but are also costly," the report said.

Rana said Asia faced only limited contagion from the Argentine crisis because it was a "slow-burning crisis."

Asia also had limited exposure to the Latin American nation in terms of trade and capital flows, he added.

Imports from Asia constitute only about 10 percent of Argentina’s total imports.

In terms of capital flows, only Japan and South Korea have limited exposure to Argentina.