Improving Approaches to Cooperation and Coordination: Options for Asia

5.1 Optimal Levels of Cooperation: Global, Regional, or National?

In considering new approaches to financial cooperation, the level at which cooperation should take place should be considered first.¹⁶ Europe long grappled with this problem on the way to launching its Single Market Programme. A key idea that emerged was “subsidiarity,” namely that policy should be adopted at the most decentralized level possible. Subsidiarity suggests that trade and competition policy need to be formulated at the EU level, because these activities involve more than one nation, but business-related policies and taxation can take place at the national level provided that they do not disadvantage non-resident member-state participants. Global economic cooperation might embrace the same concept: cooperation at the global (regional, national) level should address policy externalities that are global (regional, national).

Subsidiarity also argues for regional solutions where the externalities are primarily regional. In practice, the policies may have a disproportionate impact on a region, suggesting a corresponding policy role. This becomes even more compelling if political influences are factored in: a policy that may be feasible at the regional level may be difficult or impossible at the global level, due to indifference or opposition by non-regional actors.

Examples are not difficult to find. The EU would gain more from free flows of labor from throughout the world, rather than from just among member states, but such a solution would be politically impossible. Still, the EU is better off with free flows of labor at the regional level than none at all. Similarly, the World Trade Organization members would benefit most from global free trade, a system that they have been pursuing for many decades. Yet regional trading agreements, such as free-trade areas (FTAs) and other forms of deep integration can be productive as well, and have been blossoming throughout the world because global cooperation is often unobtainable. Second-best approaches to cooperation may make sense if they are superior to the status quo and, ideally, can make first-best cooperation at the global level easier.

Figure 1 [ PDF 16.1KB | 1 page ] summarizes ongoing initiatives at the global, trans-Pacific, and Asian levels in the areas of financial and monetary cooperation. Most initiatives at the global level are informal, except for those involving the IMF. The same is generally true at the trans-Pacific level. More is being done at the Asian regional level. ASEAN initiatives have been the most ambitious. The CMIM is also an important concrete initiative emerging out of the ASEAN+3 framework. In fact, The CMIM is an example of an initiative that can promote a stronger regional response to crises. If CMIM is seen as a viable alternative to the IMF and good source of insurance, it will enable countries to undertake more aggressive policies to stimulate their economies and to develop new regional sources of demand. It would do this by reducing the need to accumulate new reserves, and by increasing governments' confidence in their ability to sustain expansionary policies.

5.2 Monitoring and Coordination under the Asian Financial Stability Dialogue (AFSD)

As was noted above, the AFSD, which would include finance ministry and central bank officials, financial regulators and supervisors, and market participants, was proposed by ADB President Kuroda as an early warning system to ameliorate surveillance of the region's financial markets. There is some precedence for this. In the wake of the Asian crisis, the ADB partnered with crisis-affected economies to create the ASEAN Surveillance Process (ASP), which was designed to monitor economic fundamentals of the ASEAN member states and provide an early warning mechanism. The ADB invested significantly in the ASP, including in terms of capacity building for the staff of the finance ministries and the central banks. The ADB also has the “Asian Bond Monitor,” that tracks not only movements in Asian bond markets but the economic fundamentals that drive them.

Expanding, deepening, and nesting the activities of the ASP in the form of a more comprehensive AFSD makes sense from a variety of economic perspectives. First, it would be an effective way to share information and promote dialogue across the finance ministries and central banks in the region. This would help in macroeconomic planning, particularly with respect to potential adverse movements in the markets.¹⁷ Second, an effective monitoring system would improve transparency and would reduce market uncertainty. Third, it could be used as a means of “peer pressure” for economies that need to address underlying macroeconomic problems. Fourth, it could help the region develop joint positions that could reduce external imbalances.¹⁸ Fifth, it could be used as a means to coordinate responses to economic shocks and emerging crises (e.g., “stimulus plans”). Sixth, the AFSD could help Asian economies project joint positions in international forums. And finally, I argue below that the AFSD could be used as a vehicle to enhance regional financial integration.

Importantly, coordination under the AFSD would be tricky. It is one thing to dialogue and exchange information; as I note above, it is another thing to impose any decisions and rules pertinent to coordination. As the region embraces a generally common set of macroeconomic goals, coordination in this area may not be as difficult as it would be in the area of financial regulatory measures and norms. The latter would have to be developed cautiously and in a step-by-step manner, in order to create confidence and a solid foundation on which to build deeper forms of cooperation and coordination based on best-practices and the common goal of systemic stability.

As the AFSD is a new concept, there is precious little in terms of relevant literature. One exception is Setboonsarng (2009). He offers a suggested mandate and institutional structure for the AFSD. He suggests that the AFSD should report directly to the ASEAN+3 Summit and the chair of the AFSD should coincide with the chairmanship of the ASEAN-3 FMM, and it would meet at least twice a year. He also recommends the creation of a formal secretariat for the AFSD.

5.3 Interaction with the Financial Stability Board

How would the AFSD relate to the Financial Stability Forum (FSF), which has now evolved into the Financial Stability Board (FSB)? The goals of the FSF, which was founded in April 1999, are closely related to those of the AFSD for the Group of Seven countries, that is, to promote international financial stability. The FSF held regular meetings of national authorities of the G-7 economies responsible for “…financial stability in international financial centers, international financial institutions, sector-specific international groupings of regulators and supervisors, and committees of central bank experts,” (Financial Stability Board Press Release, 15 September 2009, p. 3) to exchange information and dialogue regarding financial supervision and surveillance issues. Three representatives from each of the Group of Seven countries participated, along with representatives from each of the major international groupings and organizations concerned with financial regulation.¹⁹ The FSF promoted the observance of standards and codes of its Compendium, which is a guide to more than 60 sets of standards and codes from a variety of international institutions. Many, including those relating to accounting and corporate governance, involve rules and norms that operate within private-sector institutions as well as having an public-sector dimension. Key developing countries were included in some of the working groups. For instance two countries that had experimented with capital controls, Malaysia and Chile, were included in the Working Group on Capital Flows.

The FSB superseded the FSF with its inaugural meeting 26–27 June 2009, in Basel. It has expanded membership and has a broader mandate to promote financial stability.²⁰ It now includes seven regional economies: it has three participants from Japan (Bank of Japan, Ministry of Finance, and the Financial Services Agency); the People's Republic of China (People's Bank of China, Ministry of Finance, and the Chinese Banking Regulatory Commission); and one participant each from Singapore (Monetary Authority of Singapore) and Hong Kong, China (Hong Kong Monetary Authority); and three participants from India (Ministry of Finance, Reserve Bank of India, and the Security and Exchange Board of India), two participants from the Republic of Korea (Bank of Korea and the Financial Services Commission), and one from Indonesia (Bank Indonesia). Most major international financial institutions, international standard setting, regulatory and supervisory groupings, and committees of central bank experts, as well as the European Central Bank and The European Commission, are now members.

According to the FSB's inaugural press release (27 June 2009), it:

The FSB's mandate is to assess vulnerabilities affecting the financial system; identify and oversee action needed to address them; promote coordination and information exchange among authorities responsible for financial stability; monitor and advise on market developments and their implications for regulatory policy; advise on and monitor best practice in meeting regulatory standards; undertake joint strategic reviews of the policy development work of the international standards setting bodies; set guidelines for and support the establishment of supervisory colleges; manage contingency planning for cross-border crisis management; and collaborate with the International Monetary Fund (IMF) to conduct Early Warning Exercises.

In addition to an FSB Plenary group, the new structure would include a steering committee and three standing committees: Vulnerabilities Assessment, Supervisory and Regulatory Cooperation, and Standards Implementation. The FSB's first meeting focused on the global economic crisis but was also forward looking in consulting about exit strategies from the extraordinary monetary and financial policies put in place during the global economic crisis.

In sum, potentially there could be a good deal of overlap between the AFSD and the FSF. However, addressing such an overlap and issues of mutual interest at the regional level can have some additional advantages over cooperation at the global level, just as FTAs may complement the World Trade Organization even though they should have the same goals. There is some common membership across the groupings and the objectives of the two groups are similar, though the AFSD would be more focused. Clearly, there would be a good deal of potential for collaboration on various financial stability and regulatory issues across the two groups. Still, the AFSD would be able to give priority to issues that affect its member economies the most. For example, while the FSB may place a high priority on coordinating with the IMF on early warning exercises related to inflation and budget deficits in Latin America and Africa, these issues would be less relevant in the Asian context. On the other hand, developing and applying best practices in regulatory regimes would obviously be a high priority in Asia.

A case in point regards the first missions of the FSB, which have been assigned by the Group of Eight. For example, the FSB and its chairman, Mario Draghi, were first tasked with investigating issues related to bonuses in the financial sector. This is certainly an important issue in light of the current global financial crisis and an obvious area in which the FSB should have expertise. But bonuses are not an issue for Asian financial policymakers. These latter policymakers may be much more concerned with financial issues related to rebalancing, the future role of the dollar, concerted capital-market deepening, and the like. There are a sufficient number of critical issues of high priority in Asia but that are lower in importance at the global level, and vice versa, to justify an institutional cooperative structure such as the AFSD. The same is true in the context of EU economies: while the FSB is an important forum, it is complementary rather than competitive with the many EU bodies related to financial cooperation.

5.4 The Case for Closer Financial Integration in Developing Asia

As a final issue under the topic of options for regional cooperation, I consider the case for financial integration in Asia, particularly from the perspective of its developing member economies. Given the nature of the global economic crisis and the incentives facing Asian economies to diversify their respective financial structures, promoting regional financial markets is attractive. I argue above that this needs to be done mainly through reform and institutional building at the national level, but that regional approaches could strengthen this process, such as through the AFSD. I summarize the case for improving regional cooperation and integration of financial markets in particular below.

First, I can identify a number of incentives regarding the bond market. As a vibrant bond market can be a sine qua non for the development of deep equity markets, it needs to be a high priority for developing Asian economies.

1. Growth in demand for bonds internationally offers myriad opportunities for East Asian/ASEAN countries to attract the attention of international institutional investors, investment banks, multinational lending institutions, and the like. Deeper domestic bond markets and facilitating cross-issuances and integration across Asian bond markets would increase investors' interest in the region; harmonization and liberalization that would be necessary in building such a regional market would also render the local markets more attractive, hopefully building the necessary critical mass to put them on the international radar screen.
2. As part of their respective financial reform programs, Asian countries have been trying to diversify their heavy reliance on the banking sector in favor of other financial intermediation vehicles, including equity and fixed income markets. Over-reliance on the banking system has created many risks that could otherwise be avoided (as discussed in Section IV, there is also an important moral hazard problem). In particular, over-reliance limits the way in which a financial system can price risk efficiently, and reduces the options open to investors and borrowers. Allowing for greater cross-issuances of assets could deepen local markets and therefore enhance the financial integrity of the developing Asian countries, thereby mitigating or avoiding financial crises in the future.
3. Demand for bonds by the private sector and central banks in the region has been growing significantly, but Asian public and private investors tend to purchase them from outside the region when seeking portfolio diversification and high yields. This is a problem that the Asian Bond Fund is designed to address, but as noted above, it is only a fledgling initiative. I have argued that indicators point to a strong increase in this demand in at least the medium and certainly the long term, due to high savings rates, medium-term growth prospects, demographic change, and financial development in Asia. Facilitating cross-border purchases of Asian economy bonds would allow greater regional intermediation of this projected boom in investible funds, and would serve to increase the attractiveness of local markets. Both would serve to reduce any currency mismatches. It will also allow for additional investor portfolio diversification options. Moreover, higher levels of cross-border debt issuance and trading activity would enhance liquidity in the local market, which in turn would increase their attractiveness.
4. Growth in the supply of bonds in Asian economies over the past two decades has been impressive, but the medium/long term potential for bond debt issuances is even greater. Asian countries will no doubt continue to be among the fastest-growing regions of the world, with a strong demand for credit for (physical and human capital) infrastructure and investments by the private sector as the economy modernizes and grows. Asian countries have also seen significant—though, arguably, under control—fiscal deficits, a phenomenon that is rising in importance during the global economic crisis downturn and stimulus packages and will likely continue into the medium run. Tapping regional and national funds through improved regional and local markets for these investments, rather than merely relying on international capital flows, will also permit the region to avoid the currency and maturity mismatches that created and fed the Asian financial crisis in the past. Moreover, by increasing liquidity and diversity of bonds in the market, this process will lead to more reliable and longer yield curves, which would allow for better pricing of risk in the market and improve debt-management options in both the private and public sectors.
5. A key problem in fostering financial development in the region has been lack of transparency in national systems. As suggested by Adams (2008), the situation has improved over time, but regional banks continue to receive low marks from credit rating agencies. Moreover, the diversity of the region in terms of treatment of fixed income securities taxation, restrictions on foreign participation in bond markets, and various idiosyncratic investment laws in the Asian economies has made cross-border investment difficult. Asian investors often find that markets outside the region are much easier to navigate, have far lower transactions costs, higher liquidity, and lower principle and credit risks. Integrating Asian fixed income markets will create a far more attractive environment by increasing transparency and efficiency, reducing transactions costs by lowering taxes and making the tax structures within (i.e., between the bond and other capital markets) and between markets more equitable and understandable, and harmonizing policies making cross-issuances and purchases of bonds much easier.
6. In developing Asia, corporate bond markets tend to be small, and where they are fairly large, they tend to be dominated by a few large, well-established companies and often lack dynamism. Much needs to be done to broaden and deepen participation in the corporate markets. There are at least four specific advantages to improving the corporate bond market: First, it can help to avoid the "double mismatches"; second, a vibrant corporate bond market lowers the cost of borrowing by providing an alternative (competitive) vehicle in the financial markets (and, for well-established firms, interest rates on corporate bonds tend to be lower than interest rates applied in the banking sector); third, if the secondary market is well developed, corporate bond market development improves the efficiency of the financial sector by establishing accurate price signals in the market; and fourth, in times of a crisis and its aftermath, less of a reliance on the banking system allows firms to continue to borrow funds from the market when the banking sector is facing its financial restructuring difficulties. Moreover, once the corporate bond market reaches a threshold of sufficient liquidity, economies of scale will reduce transactions costs and lead to a "virtuous cycle.” Policies that need to be adopted in order to allow for greater integration will not only facilitate cross-issuances of corporate bonds, but will also help increase participation and liquidity in the local bond markets.

In terms of equity markets, interest in stock market integration arises primarily because financial theory suggests that an integrated regional stock market is more efficient than segmented national capital markets. Capital market efficiency in Asia has become even more important since the Asian crisis as regional economies seek to reduce their traditional dependence of firms on bank loans, and at the same time hunt for new capital from outside the region.

With an integrated regional stock market, investors from all regional economies will be able to allocate capital to the locations in the region where it is the most productive. With more cross-border flows of funds, additional trading in individual securities will improve the liquidity of the stock markets, which will in turn lower the cost of capital for firms seeking capital and lower the transaction costs investors incur. These suggest a more efficient allocation of capital within the region.

From the perspective of a portfolio investor outside the region, stock market integration suggests that separate markets move together and have high correlations, so there is less benefit from portfolio diversification across countries. However, an integrated regional exchange could be more appealing to investors from outside the region who would find investment in the region easier or more justifiable. As shares become more liquid and transaction costs fall, fund managers become increasingly willing to take positions in the stocks. In addition, outside investors may take notice of the regional stock exchange instead of dismissing a collection of small national exchanges: the whole (one regional stock exchange) might be greater than the sum of the parts (individual country exchanges). This particularly holds promise in the context of ASEAN economic integration.

In sum, regional cooperation in Asia can support the development of assets markets in the region. It could expand opportunities for savers and investors, lower the cost of capital to firms and governments, reduce currency mismatches, enhance liquidity and intermediation in the region, and reduce regional exposure (at least at the margin) to non-regional economic shocks. The process will lead to the development of better financial institutions and create a strong incentive for the development of “best practices.” I would argue that the potential in this area is so high that the AFSD might consider (micro) regional cooperation and coordination issues as a core functional area.

Download this Paper [ PDF 280.6KB| 29 pages ].

Comment(s)

There are [0] comment(s) for this entry. Post a comment.