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Central Bank of the Republic of China


Reflections on the Foreign Exchange Market

PRESS RELEASE Jun 15th,2001 Reflections on the Foreign Exchange Market

PRESS RELEASE Jun 15th,2001

Reflections on the Foreign Exchange Market

In the first five and half months of 2001, the supply of foreign currencies consistently exceeded demand in the foreign exchange market. During this period, the NT dollar exchange rate was highly stable. Since May 18, the volatility of the exchange rate has increased significantly as unsubstantiated rumors began to create distortions in the market. It appears that a small number of forecasters at home as well as some foreign investment banking analysts have made exchange rate predictions that are inconsistent with economic fundamentals, perhaps due to the lack of sufficient information or understanding. This paper sets out to analyze some of the factors affecting the supply and demand in the foreign exchange market. Our aim is to dispel some common misconceptions that might have misled currency investors.

Balance of Payments in Good Shape

1.Taiwan's current account has been in surplus since 1981.

2.Trade surplus for the first five months of 2001 reached US$4.89 billion, much higher than the US$1.84 billion recorded during the same period last year.

3.The overall balance for the first quarter of 2001 was US$5.67 billion in surplus.

4.Foreign exchange reserves were valued at US$106.7 billion at the end of 2000. This figure rose to US$110.6 billion at the end of May 2001.

5.The value of net foreign assets held by the private sector (net of foreign portfolio investment in Taiwan) reached the region of US$150 billion.

6.The value of outstanding forward foreign exchange contracts held by the corporate sector reached US$11.7 billion on June 14. As these contracts come into maturity, with the exception of a few rollovers, the demand for foreign currencies in the spot market is likely to fall substantially.

7.a. The private sector currently holds some US$35.5 billion in foreign currency deposits. Since the US dollar no longer enjoys an interest rate advantage, the weight of US dollar in the investment portfolio of the private sector is unlikely to increase further. In fact, by May 18, some US$1.8 billion worth of foreign currency deposit has been converted to NT dollar this year.

b. Between the end of 1995 and the end of 2000, 10 listed companies in Taiwan provided equity investors with an average annual rate of return of more than 50%, 24 more than 30%, 42 more than 20%, and 86 more than 10%.

c. Based on current market prices, more than 52 listed companies are expected to report earnings in excess of 8% per share. Given that the one year fixed NT dollar deposit rate is currently 4.2% and share prices can rise by as much as 7% in a single day, investors are likely to adjust their investment portfolio in favor of equities.

8.At least US$4 billion in ADR will be issued by listed companies in Taiwan in 2001.

9.a. The NT dollar exchange rate is the external price of the NT dollar. This price is determined by supply and demand. Some commentators fashion the idea that the external value of NT dollar should follow that of the Japanese yen. Japan is not Taiwan's sole export competitor, however, and there is no reason why the NT dollar should track the yen. In assessing the appropriate level of the NT dollar exchange rate in relation to the currencies of Taiwan's major trade rivals, the real effective exchange rate, which incorporates a basket of currencies as well as inflation differentials, should be used. Between 14 June 2001 and 30 June 1997 (the eve of the Asian financial crisis) the real effective exchange rate of the NT dollar depreciated by 15.05%* and 14.4%, according to calculations made by the Central Bank of China and the Taipei Forex Inc., respectively. The calculation made by the Council for Economic Planning and Development also shows a depreciation of 10.9% between May 2001 and June 1997.

b. Some commentators advocate that the exchange rate between the NT dollar and the Japanese yen should be, and ought to be maintained at, 1 to 4. If this proposition were valid, the NT dollar exchange rate on June 14 should have been 30.49 (121.95/4) instead of 34.395.

c. Between 14 June 2001 and 30 June 1997 the NT dollar has depreciated by 19.14%, 13.77%, 18.61%, and 19.27% against the US dollar, the Japanese yen, the Hong Kong dollar, and the RMB, respectively. During the same period, the NT dollar appreciated against the Thai baht, the Malaysian ringgit, and the Korean won. All three countries were, however, at the center of the Asian financial crisis, and the depreciation of these currencies has largely been offset by high inflation.

10.The media has often pointed out, quite rightly, that the trading volume in the Taipei foreign exchange market is low when compared to Hong Kong and Singapore. As regional financial centers, both Hong Kong and Singapore process considerably more dollar/yen, euro/dollar, and euro/yen trades than Taipei. HK dollar and Singapore dollar related foreign exchange transactions accounts for a small portion of all foreign exchange trades in Hong Kong and Singapore.

11.The Taipei foreign exchange market has a comprehensive reporting system in place. Details on atypical FX trades are passed on to the relevant authorities for further investigation.

12.Looking ahead, the demand for foreign currencies is likely to fall as the outstanding forward FX contracts gradually come to maturity, while the supply is likely to pick up thanks to a growing trade surplus and the ADR issues scheduled in 2001. The exchange rate is determined by supply and demand. Currency analysts ought to focus on the factors affecting the supply and demand in the market, instead of stretching their imaginations.

*Based on the calculation made by the Central Bank of China the current level of the NT dollar real effective exchange rate is close to its lowest level since the establishment of the Taipei Foreign Exchange Market in