Policy Challenges for East Asia's Finance

There are several key policy challenges for East Asian finance.

Strengthening regional reserve pooling and economic surveillance. As the size of the CMI further expands, its IMF linkage is further reduced, and swap arrangements are multilateralized, the quality of economic surveillance (ERPD) needs to improve so that independent lending conditionalities can be formulated in the event of CMI activation. For this purpose, the following recommendations may be made:⁵

• Clarify rules for activating a multilateralized CMI;
• Move beyond the simple "information sharing" stage to a more rigorous "peer review and peer pressure" stage, and eventually to a "due diligence" stage, to improve the quality of economic surveillance.
• Establish a joint forum for East Asian finance ministers and central bank governors to intensify policy dialogue; and
• Set up a professional secretariat that supports regional economic surveillance (ERPD), CMI activation, and independent conditionality formulation.

Development of sound, resilient financial systems. The lack of sound, resilient financial systems was one of the most important factors behind the Asian financial crisis. Establishing resilient financial systems at the national level is essential to ensure national and regional financial stability. In addition, financial systems must play key roles in channeling the pool of regional savings for regional investment needs. For these purposes it is crucial to accomplish the following:

• Make further progress on ABMI and ABF to deepen the size and liquidity of local-currency bond markets;
• Strengthen the risk management capacity of financial institutions, particularly deposit-taking banks, through better regulatory and supervisory frameworks (including early implementation of Basel II) and greater competition; and
• Improve corporate governance of both financial institutions and their clients—corporate borrowers.

Exchange rate policy coordination. Currently no consensus exists, even within ASEAN or ASEAN+3, on a regional exchange rate arrangement. Given the deepening economic interdependence within East Asia, however, a certain degree of intra-regional exchange rate stability is increasingly desirable. In a possible unwinding process of global payments imbalances, or in the face of large capital inflows to East Asia, there is a risk of sharp and disorderly depreciation of the US dollar against East Asian (and other major) currencies. If East Asian economies must accept currency appreciation vis-à-vis the US dollar, they had better do so collectively, while maintaining intraregional exchange rate stability.

To prepare for this type of policy coordination, East Asian economies may consider adopting policies to stabilize their exchange rates against a common basket of external and internal currencies—comprising the US dollar, the euro, and the Asian Currency Unit (ACU)—to achieve relative stability of their effective exchange rates and intra-regional exchange rates. An ACU index can measure the degree of joint movement of East Asian currencies and the divergence of individual component currencies from the regional average given by the ACU rate.⁶ Once the PRC moves to a more flexible exchange rate regime, ACU movements and divergence indicators may provide more meaningful information.

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