BASEL (AFX) - The Bank for International Settlements said Asian central banks which have intervened to limit currency strength may be forced to raise interest rates or let their currencies appreciate as inflation pressures grow.
Central banks have been able to keep interest rates low during the large-scale foreign exchange market intervention of recent years, because other structural factors such as increased competition and excess capacity have limited inflationary pressures.
But this situation is unlikely to last, the BIS said.
'The concern would be that these structural forces might recede or eventually be overwhelmed by the inflationary pressures arising from expansionary monetary conditions,' it said in its latest quarterly review.
'Growth since 2002 has reduced excess capacity in the global economy, and commodity prices have risen strongly across the board. In such circumstances, central banks may have to raise interest rates and allow their currencies to appreciate at a faster rate than in the past,' it said.
The scale of intervention in recent years has been unprecedented, resulting in reserve accumulation at a rate of 250 bln usd a year by emerging market economies between 2000 and 2005. This represents 3.5 pct of their combined annual GDP, the BIS said.
Reserve accumulation has been particularly rapid in China, South Korea, India, Malaysia and Taiwan, and also in Russia, it said.
Intervention has been aiming at offsetting some of the upward pressure on the countries' currencies resulting from their large current account surpluses.
Because the domestic money supply expands when a country sells its own currency in interventions, this would normally be expected to lead to additional inflationary pressures.
But these pressures can be offset if the authorities 'sterilise' the intervention by issuing securities to mop up the resulting extra liquidity.
But in the case of some central banks, recent interventions have not been fully sterilised, the BIS said.
In India, South Korea, Malaysia, Singapore and Taiwan, between 85 and 95 pct of intervention was sterilised between Jan 2000 and May 2006, whereas the figure was just above 70 pct in China and 60 pct in Russia, it said.
'Many central banks may have used reserve accumulation opportunistically to expand the monetary base to support their choice of a more accommodative monetary policy stance,' it said. steve.whitehouse@afxnews.com sw/ak COPYRIGHT Copyright AFX News Limited 2005. All rights reserved. The copying, republication or redistribution of AFX News Content, including by framing or similar means, is expressly prohibited without the prior written consent of AFX News. AFX News and AFX Financial News Logo are registered trademarks of AFX News Limited