Adjustments of the Financial and Corporate Sector to the Changes in Exchange Rate Volatility and their Policy Implications in the SEACEN Countries

This collaborative project, which is participated by 8 SEACEN member banks, aimed to examine exchange rate volatility faced by the member countries and to study its impact on the domestic economy with emphasis on adjustments of the corporate and financial sector. The project also investigated how the adjustments could contribute to the overall financial stability. The last decade was the end of explicit commitment to the fixed exchange rate regime. Although, it is still debatable whether exchange rate should move or not, the lesson learnt from the 1997 Asian crisis was that a fixed exchange rate regime ould have serious implications when the economy is not protected from severe exchange rate movements. The regime could undermine the resilience of the financial and corporate sector due to the commitment to stability of the exchange rate. Nevertheless, in the decade since the crisis, SEACEN economies have adjusted to an environment of more volatile exchange rates. The gradual decline in volatility could have contributed to economic performance and exchange rates adjusting to new levels. The managed float seems to be the main adopted regime and in some countries, the exchange rate has almost returned to the pre-crisis level. The financial sector has increased capitalisation in response to the volatile exchange rate environment, boosting profitability and the capacity to absorb shocks including exchange rate volatility. Financial stability has increased as a result of accumulated foreign reserves by the monetary authorites, helping to raise foreign investors' confidence in bringing back capital to the region and allowing the economy to leverage the international financial market. The corporate sector is always aware of exchange rate risk and is investing in instruments that allow it to mitigate exchange rate volatility. Financial derivatives are some of the instruments used widely. Empirical evidence reveals that exchange rate volatility does not influence corporate value significantly, due perhaps to the successful risk mitigating strategies by the corporations and also partially because of more prudent exchange rate policy. This study used the industry specific exchange rates for the analysis of exchange rate exposure and its impact on non-financial corporate sector in the participating SEACEN countries. The calculation of real effective exchange rate indices for each industry using trade weights specifically for that industry is more useful for the analysis of exchange rate pressure on the real economy. The economy wide aggregate real effective exchange rate would not be able to capture the pressure of exchange rate when half of the economy is importing and the other half is exporting. With more precise data on trade of each industry, the real pressure generated through exchange rate change can be captured more accurately. From the empirical analysis of some industries, it is noted that industry specific real effective exchange rate could be used for further analysis. On the whole, the conclusion reached is that corporate value is not affected by exchange rate exposure and this is in line with the conclusion reached in other studies. The corporate sector adopts strategies which mitigate exchange rate risk. The strategies vary depending on the availability of instruments. Larger companies are utilising financial instruments such as forwards, swaps and netting off cash flows that match balance sheet exposures. Smaller companies, however, have to face risks if there is no option to hedge. The cost and access to hedge instruments is an issue of infrastructure which allow companies to leverage on them. Authorities' efforts to establish an efficient infrastructure was discussed in the case of Philippines. Similarly, the Indonesian non-deliverable forwards market is being developed. Finally, it was found that there have been few adjustments made in recent times to mitigate the volatility of exchange rate. The major adjustments were made mostly right after the crisis period and presently, markets have become increasingly efficient in dealing with the impact of exchange rate volatilities. The most important contributions by the authorities are measures to ensure resilience of financial institutions, improvement of the efficiency of market, development of legal and technical framework for financial instruments that help both financial and corporate sectors to diversify risks and ensuring that exchange rate policy is prudent which would not lead to misalignments that create excessive exchange rate exposure.