Difficulties and Opportunities in Overseeing Remote Trade Holds

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Difficulties and Opportunities in Managing Foreign Exchange Reserves S. Ghon Rhee, Ph.D. K. J. Luke Distinguished Professor of Finance Executive Director Asia-Pacific Financial Markets Research Center University of Hawai " i The 5 th Seoul International Financial Forum April 27-28, 2004, Seoul, Korea Asia-Pacific Financial Markets Research Center, University of Hawaii

Capital Flows to Asia+ US$ Billion 2001 2002 2003* 2004** Current Account Balance 48.2 71.9 73.4 56.9 Direct Foreign Investment 51.7 55.9 55.7 59.8 Portfolio Investment 12.4 2.6 27.7 25.2 Private Credits - 13.1 6.3 27.9 11.7 Official Capital Flows - 8.1 - 15.5 - 12.6 - 5.4 Resident Lending/Errors & Omissions - 20.9 - 9.5 15.0 - 5.6 Total Inflows 70.3 111.9 187.1 142.5 * Estimate ** Forecast + China, India, Indonesia, Korea, Malaysia, Philippines, Thailand Source: Institute of International Finance (2004) Asia-Pacific Financial Markets Research Center, University of Hawaii

Increasing Capital Inflows to the Region Not Necessarily Good News a. Welcome the nearby money b. Undermine the intensity of fare industries c. Make swelling rise d. A lot of liquidity empowers over-venture and overheating of the economy Asia-Pacific Financial Markets Research Center, University of Hawaii

Case In Point: Challenges Facing People's Bank of China Foreign Exchange Reserves: Increased by $120 billion in 2003 Speculative Hot Money ($25 - $40 billion): Happy Depositors in RMB Accounts Reckless Lending: Major Concern Given Too Much Liquidity in the Banking Sector Issuance US$-Denominated household securities: Under Plan PBOC issued its fleeting notes in measure of 1 trillion RMB or US$121 billion so far to lessen liquidity since its presentation in 2003; Increase Discount Rate (2% to 2.5%); Increase Reserve prerequisites (6% to 7% in Sept 2003 and to 7.5% for powerless banks in March 2004) Open Market Operations: Now twice every week since Feb. 25, 2003 Asia-Pacific Financial Markets Research Center, University of Hawaii

Dilemma for Central Banks Tight Monetary Policy a. Drives up fleeting loan fees b. Encourages assist capital inflows c. More Pressure on Currency Appreciation d. Heavy load on government obligation adjusting cost Deepening clashes between money related strategy and monetary approach usage Asia-Pacific Financial Markets Research Center, University of Hawaii

Government Debt Mgmt Optimal Cost/Risk Trade-off Fiscal Policy Monetary Policy Aggregate Debt Price Stabilization Separation of Government Debt Management from Monetary and Fiscal Policies Asia-Pacific Financial Markets Research Center, University of Hawaii

Open Market Operations with Fully-Developed Government Bond Market 1. The national bank can grow or contract bank stores and cash supply and transmit its arrangement motioning through open market operations 2. Two Alternatives in Setting: a. Target Amount of Bank Reserves with Short-Term Interest Rate Fluctuating b. Target Short-Term Interest Rate with Bank Reserves Fluctuating With well-working government security markets, second option turns into the standard among industrialized nations 3. Open Market Operations: Secondary Market Government Debt Management: Primary Market Asia-Pacific Financial Markets Research Center, University of Hawaii

Open Market Operations with Under-Developed Government Bond Market 1. Capital Inflows are Sterilized as a major aspect of Open Market Operations 2. National Banks lean toward s hort-term or coasting rate residential obligation; swelling listed securities; and remote coin obligation 3. Government Debt Management Offices don't lean toward these instruments because of rollover hazard activated by outer stuns 4. Rollover Risk Emerges as the Main Concern while Market Risk Remains Important and Conflicts Deepen between fiscal arrangement and government obligation administration Asia-Pacific Financial Markets Research Center, University of Hawaii

Alternative Policies to Sterilization 1. Fiscal Adjustment 2. Switch Government Deposits from Commercial Banks to Central Banks 3. Ease Restrictions on Capital Outflows 4. Flexible Exchange Rate Regime 5. Accelerate Trade Liberalization 6. Variable Reserve Requirements on Certain Categories of Foreign Borrowing 7. Develop Long-Term Government Bond Markets But All of Them Represent Slow Processes Except Alternative No. 2 Asia-Pacific Financial Markets Research Center, University of Hawaii

Foreign Exchange Reserves (As of March 2004) Japan US$826.6 billion China 439.8 Taiwan 226.5 Korea 163.6 Hong Kong 123.8 India 110.3 Singapore 102.8 (Preliminary) Germany 94.5 (as of February) United States 84.7 Russia 83.7 - - - - - - Malaysia 51.3 Thailand 42.9 Philippines 15.7 - - - - - - Total ( 10 Asian Economies) $2,103.3 Asia-Pacific Financial Markets Research Center, University of Hawaii

Foreign Holdings of US Securities by Selected Asian Economies (June 2002) US$ Billion Source: US Department of Treasury Asia-Pacific Financial Markets Research Center, University of Hawaii

Foreign Holdings of US Treasury Securities *Rankings are of the year of 2004. Source: US Department of Treasury ww w.treas.gov/tic/mfh.txt Asia-Pacific Financial Markets Research Center, University of Hawaii

Utilization of Reserves for Various Purposes a. Korea $20 billion interest in Korea Investment Corporation b. China $45 billion redirected for Restructuring of State Banks Additional $40 billion for a similar reason? c. Thailand Unspecified sum occupied to purchase apparatus or permit protected innovation for neighborhood partnerships d. Taiwan $10 billion distributed to banks to partake in real venture ventures identifying with general local monetary advancement Asia-Pacific Financial Markets Research Center, University of Hawaii

Korea Investment Corporation a. Capital: $20 billion from the BOK's FX holds; Additional capital might be drawn if saves reach $200 billion b. "Cashing Contract": KIC's benefits be gotten the money for when essential upon demand from BOK c. Initial Investment: Financial Assets d. Critical Vehicle: To Attract Global Asset Management Companies Asia-Pacific Financial Markets Research Center, University of Hawaii

Bank of Korea's Current Reserve Management (I) Source: IMF (2003) Asia-Pacific Financial Markets Research Center, University of Hawaii

Bank of Korea's Current Reserve Management (II) Investment Instruments a. Marketable Securities: sovereign securities, government organization securities, MDI-issued securities with AA-evaluated or higher b. Deposits: Only with budgetary foundations with FICO scores of An or above c. Outsourced Assets: May incorporate corporate securities, ABSs, and MBSs with AA appraisals or higher Differences between KIC's administration and BOK's administration? Asia-Pacific Financial Markets Research Center, University of Hawaii

Major Operational Policy Issues with KIC (I) 1. Is KIC's Operation Part of Foreign Exchange Reserve Management? a. If yes, then the connection amongst MOFE and BOK opposite KIC? b. If not, the uprightness of outside trade reserve administration might be addressed. 2. Governance System of KIC? a. Transparency b. Accountability and Assurances of KIC's integrity Asia-Pacific Financial Markets Research Center, University of Hawaii

Major Operational Policy Issues with KIC (II): c. Lack of Transparency and Accountability 1. Fiscal Investment and Loan Program of Japan Assets: US$3.67 trillion Loans: US$2.88 trillion Extended to: (i) FILP-Dependent Enterprises*; (ii) Municipal Governments; and (iii) Government-Owned Banks * Transportation, Education, Utilities, Housing, Roads, Bridges, Airports, SMEs Sources of Funds: Postal Savings Deposits Employees' Insurance Deposits 75% of FILP Loans are Non-Performing & Estimated Losses = ¥75 trillion ( = US$680 billion) or 15% of GDP [Doi and Hoshi (2002, NBER)] Asia-Pacific Financial Markets Research Center, University of Hawaii

Major Operational Policy Issues with KIC (III): 2. Temasek Holdings Ltd. (Singapore) Singapore's Ministry of Finance-claimed speculation arm controlling more than 20% in 22 noteworthy neighborhood organizations Total venture > US$130 billion more than 30 years Its money related proclamation will be unveiled to the general population without precedent for its 30 year history 3. Government Investment Corporation of Singapore Total Fund under Management > US$100 billion i. Government of Singapore Investment Corporation Pte Ltd. ii. GIC Real Estate Pte Ltd. iii. GIC Special Investments Pte Very little is thought about its money related status Asia-Pacific Financial Markets Research Center, University of Hawaii

Major Operational Policy Issues with KIC (IV): 4. Khazanah Nasional Berhad (Malaysia) 6 backups 18 partners 13 ventures No data on its execution 5. The Minister of Finance (MOF) Inc. (Malaysia) No data on its execution Asia-Pacific Financial Markets Research Center, University of Hawaii

Major Operational Policy Issues with KIC (VI) 3. Reserve Adequacy a. Money Supply-Based Approach (Ratio of Reserves to Money Supply): Poor measure of capital flight Poor indicator of coin emergency b. Current Account-Based Approach (Reserves in Months of Imports): Relevant for Small Ec