Asia defends currencies even as stocks fluctuate wildly

Asian stocks snapped a losing streak Tuesday, after scraping multiyear lows in recent weeks. Japan's Nikkei index closed up 6.4 percent, as South Korea saw a 5 percent hike in its main index. Hong Kong's volatile market posted double-digit growth a day after falling by almost as much.

These fragile gains come in the face of increasingly gloomy forecasts for the region's export-led economies as the US and other rich countries slip into recession. As in other emerging markets, among the heaviest sellers of Asian assets have been US hedge funds and other foreign investors who need to raise cash in a hurry. This flight of foreign capital has dented confidence in stocks, bonds, and other assets.

But while markets have taken a pounding, the outflow of foreign money hasn't triggered a wholesale collapse in Asian currencies, as it did a decade ago when financial panic last swept the region. With the exception of South Korea and India, most Asian currencies have suffered only modest losses against the resurgent US dollar. By contrast, Brazil's real has fallen about 30 percent in the past three months.

Armed with massive foreign-currency reserves, fewer offshore borrowings, and overhauled regulatory systems, Asia is in far better shape to defend its currencies. Investors also seem to be making smarter bets on which currencies are at risk, compared with the contagion of 1997-98, when almost all Asian currencies were tagged as toxic. That pessimism became a self-fulfilling prophecy as capital flight ran down foreign reserves, forcing indebted countries to seek International Monetary Fund support.

This time around, South Korea has mounted defense of its currency, the won, after investors took fright over short-term dollar funding of local banks. It fell Tuesday to a 10-year low against the dollar, even as Korean stocks rose. Elsewhere, India has steadily sold dollars to arrest a slide in the rupee, while Indonesia saw a sharp drop Monday in its currency, the rupiah.

Asian currencies may yet feel the full sting of the global financial crisis if foreign investors continue to pull out and pressure mounts on central bankers, says James MacCormack, head of Asia-Pacific sovereign ratings for Fitch Ratings in Hong Kong. "It adds another layer of complexity to the problem for policymakers," he says. "In an ideal world, central banks would now be lowering interest rates and promoting growth. Lower interest rates in a climate when currencies are weakening could make it worse."

South Korea appears confident, however, that its currency can withstand the pressure. Monday, its central bank unveiled an emergency 0.75 percent cut in its benchmark interest rate. It also said it would loan money directly to struggling banks, as the US and Europe have done.

Cutting rates makes sense, as it lowers the cost of borrowing for Korean companies and boosts their struggling stocks, says Bill Belchere, a regional economist for Macquarie Bank in Hong Kong. He is sanguine about the vulnerability of the won and other Asian currencies, given their ample reserves. More important is to put the brakes on the sell-off of stocks. "In equity markets, people do have liquidity [money], but not the confidence to invest it," he says.

Ultimately, restoring that confidence is a task that goes beyond what any Asian policymaker can do. What began as panic driven by exposure to US mortgage-backed loans has affected most aspects of the global economy.

"[Asian] governments are in good shape, the companies are in good shape, and individuals are in good shape, by and large. It's not a crisis that's been born in this region," says Hugh Young, managing director of Aberdeen Asset Management in Singapore. His firm manages around $35 billion in Asian investments, down from $50 billion at the start of the year.

As some currencies wobble, the Japanese yen has hit highs against the dollar not seen since the 1990s. In an unusual step, the G-7 grouping of rich countries signaled Monday that it supported intervention by the Bank of Japan to cap the yen's rapid rise.

As with the dollar, the yen's rise is underpinned by a repatriation of capital to Japan, including money borrowed when Japan's interest rates were much lower than those of other markets. That spurred a flurry of speculative offshore bets that have become less attractive as the US and other central banks pare rates to aid their wilting economies.

In the 1997-98 crisis, the IMF forced central banks in Thailand, Indonesia, and South Korea to raise rates to defend their beleaguered currencies, a move critics said was ineffective and led to many indebted companies going bankrupt. Since then, Asian countries have accumulated trillions of dollars in reserves as a hedge against another currency crisis.

Last weekend, Asian leaders at a Beijing summit discussed a longstanding proposal to pool some reserves into a regional rescue fund, with Japan, China, and South Korea supplying the bulk of the initial $80 billion. This would provide short-term liquidity for participating countries, such as those facing a run on their currency, but not a US-style banking bailout, says Chalongphob Sussangkarn, who stepped down in January as Thailand's finance minister.

The fund has been touted as an Asian alternative to the US-dominated IMF, and the current crisis should be a catalyst to its formation, says Mr. Chalongphob, director of the Thailand Development Research Institute in Bangkok. "We have huge reserves in this region," he says. "It would be ridiculous if a country in the region went under because it didn't have enough liquidity."