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Misdirected and ineffective: Regional financial cooperation in Asia


... 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. – PowerPoint PPT presentation

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Title: Misdirected and ineffective: Regional financial cooperation in Asia

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
    variablesfiscal, trade and current account
    balancesare 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
  • 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 Koreas deficit of
    8.3 billion.
  • There was a net surplus in the group of 122

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

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
  • 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

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
  • 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

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 IMFs 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
  • The CMI had been killed at the very start.

The problem with CMI
  • Japans 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
  • Fear of Japanese dominance in the regiona 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 IMFs 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 Peoples 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.

  • 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.

  • Despite the creation of an ASEAN 3
    Macroeconomic Research Office no centralised
  • 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

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 countrys 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.

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Two trends
  • While crises are episodes precipitated by capital
    exit, they dont 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.

  • 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

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
  • Credit Guarantee and Investment Facility (CGIF),
    set up as a trust by ASEAN3 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 regions 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.

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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 Chinas 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.
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