Capital markets and exchange rate stabilization in East Asia: Diversifying risk based on currency baskets

Before and after the Asian crisis, the dollar has been the dominant anchor and reserve currency in East Asia. Due to underdeveloped capital markets and a very limited international role of the domestic currencies, the East Asian countries (except Japan) are likely to continue exchange rate stabilization and accumulation of international reserves. Yet expectations about a further depreciation of the dollar may trigger a broader orientation of exchange rate policies based on basket strategies. While the direction of trade suggests a substantial weight for the Japanese yen in East Asian countries' currency baskets, the role of the euro is enhanced by expectations about its long-term stability. (Rolling) econometric estimations of the basket structures in East Asia suggest growing weights of the euro and the yen in the currency baskets of Indonesia, Korea, Philippines, Singapore, Taiwan and Thailand. In contrast, for China, Hong Kong and Malaysia, the dollar remains the dominant anchor currency.