Co-integration of Indian and other major Asian currencies

Abstract

The South East Asian currency Crisis in 1997-98 surprised almost everyone due to its massive scale and more since all the South East Asian “Tiger” economies were believed to have good fundamentals, fiscal policy and stock markets. The Asian crisis led to extreme levels of asset devaluation and currency pressures in these economies. Most of the short term funds which were borrowed were invested in real estate and stock markets. Speculative short selling after the news of export weakening of Thailand baht led to the crisis in stock markets and capital flight from these economies. The crisis spread from Thailand, Malaysia, Hong Kong, Singapore and to finally US and Japan. In US the NYSE had to suspend operations for some time and the Dow Jones fell 554 points. The Chairman of the Federal Reserve Bank of San Francisco recently outlined the four major explanations of the Asian Crisis that have appeared in literature so far. These are: 1. Liquidity crisis where in panic driven global mutual funds and other financial institutions pulled out of Asian economies, 2. Fundamental faults relating to the way short term lending and borrowings were transacted, 3. An explicit or implicit pegging of exchange rates of these economies & 4. Related to the third point above, the “contagion effect” was also studied in literature. Due to the impact of stock index falls which were spectacular across the world, many cointegration studies were carried out using VECM and other econometric tools on stock indices in Asia and rest of the world. There have been other studies of the crisis which researched the effect of capital structure, & ownership issues on firm valuation during the crisis, effect of accounting accruals, and the sovereign bond spread variation. However, the main way the crisis started was due to reducing electrical goods exports due to increasing value of Thai Baht which led to an intense devaluation of Baht in Thailand. Then it spread through the currency and exchange rate fluctuations which arose out of the steps taken to control the crisis. This havoc spread through out the other regional economies. Only Hong Kong which had its currency pegged to the dollar and received help from China survived the crisis but at the cost of a severe recession. It appears that the related variation between the currencies of all these economies (which significantly did not have much trade with each other) was one major reason for the spreading of the crisis. Thus we find it pertinent to study the short run & long run relationships between various major Asian currencies including the Indian Rupee.