Misdirected and ineffective:
Regional financial
cooperation in Asia
C.P.Chandrasekhar
Regulatory lessons from the crisis
Need for regulation at the national level to influence
the behaviour of financial firms and the monetary
authority
Need for supra-national regulation given financial
consolidation and integration through cross-border
flows
An affliction in one country affects others through
multiple means of transmission requiring an insurance
tool-kit and measures of regulation.
Lessons learnt early in Asia
Asia, especially East and Southeast Asia had learnt a
number of lessons at the time of the 1997 crisis.
Deregulation by exposing countries to cross-border flows
determined by decisions in metropolitan financial
centres also exposes them to boom-bust cycles.
Liberalisation makes countries prone to contagion, even
if their own macroeconomic variables—fiscal, trade and
current account balances—are impeccable. When
Thailand slipped so did South Korea.
Liberalisation had not just integrated them, but also
linked them as a combined entity to the rest of the
world.
Some features of the crisis period
The region as whole characterised by savings surpluses, though
there were individual countries that recorded savings deficits. The
savings surpluses were being invested in dollar denominated assets,
and deficit countries were increasingly dependent on capital
flowsfrom outside the region.
The external exposure of these countries prior to 1997 involved
excessive exposure to foreign debt, especially short term debt. The
three countries where such exposure was large in 1997 were
Thailand, Indonesia and South Korea, in whose case short term
foreign debt amounted to 110 per cent, 167 per cent and 195 per
cent of their reserves respectively. When creditors, for whatever
reason, turned wary and choose to hold back on debt rollovers or
provision of new debt, a crisis ensued.
The surpluses
In 1997 only three East Asian countries ran current
account surpluses: Japan, China and Singapore. Their
combined surpluses totalled $135 billion.
The combined deficits of the ASEAN 5 (Thailand,
Indonesia, Malaysia, Philippines and Singapore) stood
at $3.3 billion and the surpluses of the Plus 3 (Korea,
China and Japan) at $125.5 billion, after accounting
for Korea’s deficit of $8.3 billion.
There was a net surplus in the group of $122 billion.
Conclusions drawn
Excess exposure to short term flows relative to reserves, makes
countries prone to crisis.
When one country hit by crisis the affliction spread to better
placed countries in the region, largely because of capital exit.
Given regional surpluses problem could be addressed if crisis-hit
countries had the option of swapping their own currencies for
“hard currencies” and neutralizing the effects of capital flight.
The other response that was recognised but largely ignored, except
for a short period in Malaysia, was to insulate economies from
boom-bust cycles with capital controls.
The first phase of regional
cooperation
Developing an arrangement under which such swaps
were possible.
Defensive action that presumed that the crisis could
not have been prevented in the first place by abjuring
or calibrating financial opening and liberalization, or
by using regional surpluses for financing regional
development projects without relying excessively on
extra-regional finance.
A positive externality
If dependence on extra-regional finance did result in crises
that necessitated turning to organizations like the IMF for
balance of payments support, it was accompanied by
conditonalities that countries in the region, their economic
strengths notwithstanding, had little influence on.
Such conditionalities were not only procyclical, but required
countries to pursue and intensify the same policies of
external and internal financial liberalization that led, in the
first instance, to their difficulties.
This provided a second reason for cooperation based on
regional surpluses. If you could borrow locally,
conditionalities would be more sensitive to country needs.
The real need
Avoiding measures of liberalization that enhanced external
and internal vulnerability.
Adopting such a policy of “avoidance” was also difficult for
any single country independent of the rest
It resulted in regulatory arbitrage, which diverted capital flows
to more “liberal” destinations in the region.
It cut off access of the interventionist regimes to the external
resources needed to pursue development.
That put the hold-out country at a disadvantage vis-à-vis the
rest in terms of the relative ability to retain and exploit even
“useful” and “not-so-harmful” capital flows. Real need for
regulatory cooperation that was ignored.
A lesson from the past
Countries in the East Asian region chose to largely restrict
themselves to the regional borrowing option. This was not
just the soft option but easy to implement because of a
platform from the past.
Even before the 1997 crisis, in August 1977 central banks
and monetary authorities from the ASEAN-5 came together
to establish the ASEAN Swap Arrangement (ASA) with a
corpus of $100 million, which was raised to $200 million in
1978.
This proved to be grossly inadequate at the time of the 1997
financial crisis.
Stage 2
Japan made the first move after the 1997 crisis when in the
IMF meetings in Hong Kong in September 1997 it mooted
the idea of an Asian Monetary Fund (AMF).
The AMF idea came to a quick end and in Manila in
November 1997 finance and central bank officials from Asia
formulated the “Manila Framework” for regional
cooperation to promote financial stability. Others, including
the US, IMF and the World Bank had representatives.
The Manila Framework was endorsed at a meeting of
finance ministers from ASEAN; Australia; PRC; Hong
Kong, China; Japan; Korea; and the United States, in Kuala
Lumpur, Malaysia, on 2 December 1997
The Chiang Mai Initiative
This led in May 2000 to the launch of the CMI, described
as “a regional financing arrangement to supplement the
existing international facilities”.
Its first pillar was an enhanced ASA with funding raised
from $200 million to $1 billion, with members eligible to
borrow up to two times their contribution for a period of six
months (extendable for another six).
The second was a network of bilateral swap arrangements
(BSAs) under which countries could opt for a swap of
currencies upto an agreed amount. Initially any swap in
excess of 10 per cent of the agreed amount required IMF
surveillance. That was raised to 20 per cent subsequently.
Obvious weaknesses
It was estimated in 2010 that if all the BSAs entered
into by Thailand was available to it in 1997, it would
have been able to raise $2 billion from the CMI swap
arrangement. The IMF’s bail-out package for Thailand
at that time amounted to $17.2 billion.
If in addition countries had to accept an IMF
programme or IMF-designed conditionalities, the
second reason for opting for a regional fund was
defeated.
The CMI had been killed at the very start.
The problem with CMI
Japan’s decision to propose an AMF was seen as reflective of the exposure of
its own banks in the region, and the conviction that after the 1997 crisis the
US and the IMF are unlikely to work to restructure Asian debt to save the
banks, as they did in Latin America in the 1980s. However, once mooted the
proposal was seen as reflective of Asian solidarity against the US and the IMF.
In time, two factors worked to undermine the proposal.
Fear of Japanese dominance in the region—a fear which the US is seen as having
exploited, especially via-a-vis China.
Dependence of many ASEAN countries on US markets and US-mediated capital
flows resulted in these countries softening their stance once the US and the IMF
expressed their opposition.
At Hong Kong ASEAN members and South Korea supported the AMF
proposal, Hong Kong and Australia remained neutral, and China was silent.
Manila framework
From summary of proceedings:
“This framework, which recognizes the central role of
the IMF in the international monetary system, includes
the following initiatives: (a) a mechanism for regional
surveillance to complement global surveillance by the
IMF; (b) enhanced economic and technical cooperation
particularly in strengthening domestic financial systems
and regulatory capacities; (c) measures to strengthen the
IMF’s capacity to respond to financial crises; and (d) a
cooperative financing arrangement that would
supplement IMF resources.”
Inadequate funding
In end-2008, though South Korea had $202 billion of
forex reserves, it was exposed to $191 billion of short
term debt, $111 bn in the form of equity investments
and $27 billion in terms of foreign holdings of bonds.
That amounted to a ratio of 61.3 per cent.
Korea could have accessed $18.5 billion under CMI
through its swap agreements with various countries.
However, only $3.7 billion of this (20%) could be
drawn without having to be part of an IMF program.
The CMI multilateralised
Not surprisingly, even the CMI proved inadequate at the time of
the 2008 crisis. Capital exit at that time led to South Korea and
Singapore borrowing from the Federal Reserve and Indonesia
from the World Bank and other lenders.
This experience resulted in one more round of expansion when
the CMI was multilateralized and became the CMIM. The
members now include: Brunei, Cambodia, Hong Kong,
Indonesia, Japan, Laos, Malaysia, Myanmar, the People`s Republic
of China, Philippines, Singapore, South Korea, Thailand,
Vietnam.
The facility with a corpus of $120 billion was established in March
2010, with the ASEAN-5 contributing 20 per cent and Korea,
Japan and China providing 16, 32 and 32 per cent respectively.
The size of the corpus was doubled to $240 billion in 2012.
The CMIM
When faced with balance of payments difficulties a
country can swap its currency for US dollars through
the facility.
Each country's borrowing quota is based on its
contribution multiplied by its respective borrowing
multiplier. The borrowing multiplier was set at 5 for
Brunei Darussalam, Cambodia, Lao PDR, Myanmar,
and Viet Nam, at 2.5 for Hong Kong, Indonesia,
Malaysia, Singapore and Thailand, at 1 for Korea, and
0.5 for Japan and China it is 0.5.
One more failure?
The CIMM has not emerged a major alternative to balance of
payments financing from the IMF or developed country sources.
One factor seen as responsible for this is the troubled relationship
between the two major funders, China and Japan.
They would prefer to be seen as directly supporting distressed
nations rather than doing so through an ‘impersonal’
organizational form.
Though the size of the corpus or common liquidity pool available
under CMIM is defined, it remains a reserve pooling arrangement
under which the commitments made by various countries
remained with their central banks to be made available in the
event of a crisis. The fund was made up of promises to pay by
these central banks.
AMRO
Despite the creation of an ASEAN + 3 Macroeconomic Research
Office no centralised monitoring.
Tensions were seen as ensuring that neither of the major donors
were in a position to ensure that the funds accessed by member
countries would be put to proper use. Any attempt to impose ex
ante or ex post conditions on use of the resources would risk
alienating the borrower and losing influence.
The major donors settled for a system in which large volume
borrowing from the facility required an IMF programme (though
now a country was allowed to borrow up to 30 per cent of its
quota without submitting to IMF conditionality). This meant that,
when financing requirements were large, countries would choose
to approach the IMF directly.
Meek recognition
There are now plans to create a CMIM Precautionary
Line (CMIM-PL), which will operate in parallel with
the CMIM mechanism (now renamed the Stability
Facility, or CMIM-SF).
While CMIM would require IMF clearance, the
Precautionary Line would reportedly be based on ex
ante conditionality, or an assessment of the quality of a
country’s economic polices (without being subject to ex
post performance targets). But whether “quality” would
be defined by the IMF and correspond to typical IMF
type conditions is not too clear.
Autonomous integration
With no effort to reduce dependence on external capital flows,
autonomous trends led to a greater degree of financial integration
between Asian countries as a group and the world as a whole.
Three surges of capital inflows into Asia over the last twenty five
years:
First from the early 1990s till 1997, when Southeast Asia was hit
by a crisis
The second from 2002 till the global financial crisis of 2008
The third from 2008 to 2010 which coincided with the easing of
monetary policy in the US.
In each of these periods, the ratio of net capital inflows to GDP
rose steeply, followed by a period of capital exit or flight.
Two trends
While crises are episodes precipitated by capital exit,
they don’t preclude the possibility of a revival soon
thereafter. When the exit occurs and when it is
reversed is a result of decisions outside the ambit of
policy.
While in the early 1990s the inflows into Asia were
focused on the NICs and second-tier industrialisers,
the phenomenon is more generalized now making the
region as a whole prone to boom bust cycles.
Intra-regional flows
Interestingly despite the availability of large surpluses in the
region intra-regional portfolio flows are still small.
Countries prefer to invest in dollar denominated assets
(especially US Treasury bonds), rather than in regional
assets that investors from the developed countries seem to
covet.
For example, the share of developing Asia in the aggregate
portfolio investment by the ASEAN + 3 grouping, while
rising, is still only 15 per cent. And much of this goes to the
ASEAN + 3 itself. Financial liberalization strengthens links
with developed country, especially Anglo-Saxon, markets
rather than between markets in the region.
Consequence
The increase in the presence of foreign capital has necessitated
changes in the regulatory framework governing finance in these
countries. Governments in the region have adopted more liberal
rules with regard to the functioning of different kinds of markets
and institutions, provided greater space for new instruments such
as derivatives, and shown a willingness to shift to globally accepted
rules for regulation.
The message seems to be that if countries choose to adopt a policy
framework that emphasises the need to attract large volumes of
foreign capital, reform of the regulatory structure governing
finance in a common, globally dictated direction seems to be a
prerequisite.
This exposes these countries to new kinds of vulnerability.
Impact on the cooperation effort
Cooperation to improve and exploit markets.
Financial liberalisation undermines the ability of governments to
finance capital intensive, long gestation lag projects either directly
through the budget, as China and South Korea did for long, or
through government and central bank supported funding by
development finance institutions, as in India.
This has given rise to a second, parallel effort at regional financial
cooperation that seeks to develop regional bond markets as a
means of mobilising savings for long term, less liquid investments,
such as in infrastructure. Bonds and securitised instruments are
considered to have better risk sharing characteristics and as
facilitating the diversification of risk.
Asian Bond Market Initiative
Launched by ASEAN + 3 in 2003 with two initiatives.
Credit Guarantee and Investment Facility (CGIF), set
up as a trust by ASEAN+3 and the Asian Development
Bank (ADB) in 2010, which provides guarantees for
bonds issued by firms facing constraints in securing
long-term funding from the local bond market.
Strengthen the mutual fund infrastructure, providing
smaller savers with the option of buying into liquid
mutual funds that in turn invest in debt securities.
Has it worked?
Even where local currency bond markets are developed,
government securities seem to account for a significant
share of all securities issued in the domestic market.
Bond market growth largely the result of capital inflow,
with foreign investor interest in Asian bonds rising.
According to Deutsche Bank Research: “Corporate
bond market capitalisation reached 24.2% of the
region’s GDP by 2012 from just 16.7% in 2008. In
value terms, the stock of outstanding corporate bonds
amounted to USD 3.2 trillion by Q3 2013 – almost
triple the value recorded at the end of 2008.”
A new initiative
China mooted and successfully managed to get 21
Asian nations to come together in October 2014 to
establish the Asian Infrastructure Investment Bank
(AIIB) with headquarters in Beijing.
Starting with a capital base of $50 billion contributed
by China (out of the authorized capital of $100
billion), the AIIB appears a poor cousin to the Asian
Development Bank with around $160 billion of capital
and the World Bank with around $220 billion. But
this is just the beginning and significant for an
institution that is expected to focus on infrastructure.
A role for politics
Clearly an instance of China’s push for dominance in the
Asia-Pacific.
America has lobbied against the creation of the AIIB, Japan,
which leads the ADB, is out of the AIIB, and Australia and
South Korea stayed away. So did Indonesia initially, only to
change tack and join the club.
While it is too early to even speculate on how the AIIB
would evolve, to the extent it reduces Asian dependence on
external finance in general and the World Bank and IMF in
particular, it would increase the ability of countries in the
region to regulate cross-border flows and reduce their
vulnerability to boom-bust cycles.
Concluding remarks
Regional cooperation in regulation would be substantive and can
make any difference only if it involves imposing controls that help
avoid boom-bust cycles rather than finding ways to adjust when
confronted with crises.
Only then can the effort to build a regional financial network
catering to regional interests is possible.
Discussions also need to focus on how the internal financial
structure in these countries should be shaped, given their levels of
development, requirements, and the availability of large investible
surpluses.
The AIIB is only a small and as yet half-formed step in that
direction.