Foreign exchange reserves of eight Asian countries have depleted by a record $36 billion in August alone, as foreign investors pulled out money and central banks were seen using the reserves to prop up falling local currencies.
Though the reserves of these Asian countries have dropped in the last four months, economists say a repeat of currency crisis that hit South East Asian countries a decade back is unlikely because of improved external reserves.
"A full-blown crisis that would overwhelm currency intervention, resulting in central banks being forced to jack up interest rates to regain control of the currency, is unlikely given Asia's much-improved external position," wrote Citigroup Global markets analyst Moh Siong Sim.
The eight Asian countries, including India, South Korea, Taiwan, Indonesia, Malaysia, Singapore, the Philippines and Thailand but not China, have seen their reserves dip by $36 billion in August 2008 alone. Three countries -- South Korea, the Philippines and Thailand -- registered a sharp decline of $32.1 billion in the three months ended June 2008, according to the latest data available from a Citigroup research report and the Reserve Bank of India.
The decline in foreign exchange reserves is mainly because of foreign investors taking money from local stock markets and central banks intervening by selling dollars in the market to prevent local currency depreciation.
In India, the foreign currency reserves dipped by nearly $10 billion to reach $289.46 billion in August, as the RBI was seen propping up the Indian rupee that fell by Rs 1.3 to a dollar in August. Also, foreign investors have taken more than $8 billion (net outflow) from the Indian markets in the current calendar year.
"Intervention by central banks may be effective and it is a reasonable position to take," said Subir Gokarn, chief economist with Standard & Poor's, a rating and advisory firm. "The movement of currencies has swung to two extremes and far away from fundamentals because of two distortions -- oil price increase and current financial crisis," he added.
Though depreciation of local currencies accompanied by depletion of foreign exchange reserves is similar to what happened in the crisis that hit the South East Asian countries in 1997, the crucial difference now is that countries have aggressively built reserves and have reduced short-term external debt.
"Now the root problems are external and any impact on Asian countries is more in the nature of ripple effects," said Sanjaya Parth, senior resident representative of the International Monetary Fund (IMF) in India. "It is important to note in this context that interventions cannot have a lasting effect on the exchange rate," he said on the central banks selling US dollars when local currencies are depreciating.
He said the earlier crisis were due to risky investments financed by foreign capital and domestic credit expansion with a weak domestic financial institutions that could not handle currency fluctuation.
The eight Asian economies have adhered to Guidotti-Greenspan rule named after former Argentina official and former US Federal Reserve governor. The rule says that countries should have foreign exchange reserves enough to recover all their foreign debt coming due within 12 months.
Based on this rule, India would have a surplus reserve of $180 billion after accounting for the current account deficit (exports less imports) and short-term obligations.
"In the long-term view, Asia gives the best returns," said Gokarn, adding that this would bring capital back into the Asian economies.
However, a recent report by the Asian Development Bank (ADB) said that outlook for the region remained tied to the fortunes of developed countries. "Uncoupling is a myth," said Ifzal Ali, chief economist of ADB in a press statement issued earlier this month. "Our study shows that the region still depends on industrial countries to fuel its growth. If the global slowdown extends beyond 2009, the repercussions for the region could be severe."