NONLINEAR ADJUSTMENT OF REAL EXCHANGE RATES TOWARDS PURCHASING POWER PARITY AND THE ASIAN FINANCIAL CRISIS

This paper investigate s the underlying dynamics of the adjustment proce ss of the deviations of two selected ASEAN exchange rates from the lon g-run equilibrium level as suggested by the well-known purchasing power parity (PPP) hypothesis. To accomplish this task, we estimate the standard line arit y test statistics as suggested by Lukkonen, Saikkon en and Terasvirta (1988), which has power against the Exponential Smooth Transition Autoregressive (ESTAR) model. Using quarterly data series, our results reveal that both the bilateral Indonesian rupiah-U.S. dollar (lDRJUSD) and Singaporean dollar-U.S. dollar (SGD/USD) adju st nonlinearly towards the PPP equilibrium level. Another intere sting insight from this study is the relationship between the adju stment proce ss and the recent Asian Financial Crisis. The results reveal that an exchange rate with a high speed of adjustment such as the bilateral SGDIUSD tends to be less adversely affected by the crisis. On the other hand, for an exchange rate characterised by a low speed of adjustment as in the case of IDRJUSD, most of the deviations are left unadjusted or only partially adjusted . Until one stage whereby the accumulated deviations are no longer sustainable, tremendous market correction in action, leading to a tremendous plunge in value as we observed in the IDRJUSD during the 1997 crisis.