Origin

2.1 Perceived Importance of Developing Regional Self-help Mechanism

The 1997–98 East Asian financial crisis was a major event that pushed countries in East Asia to embark on a multitude of regional economic cooperation initiatives. It led to the formation of the ASEAN+3 group (ASEAN plus the People's Republic of China (PRC), Japan, and the Republic of Korea, hereafter Korea), a group that was similar to the East Asian Economic Caucus proposed by the then Prime Minister of Malaysia, Dr. Mahathir Mohamad, back in 1991,¹ However, the proposal never got off the ground as the idea was too radical at that time. However, the 1997–98 crisis provided the appropriate push factors and rationales for economic cooperation among the ASEAN+3 group.

The crisis started in Thailand, and at first it was thought that its impact would remain localized. However, the contagion to nearly the whole region soon became apparent. Indonesia and Korea followed Thailand in having to enter an IMF program, and even countries that did not need an IMF rescue package faced severe economic slowdown or recessions. It became quite apparent that East Asian economies were inextricably linked to each other and could not afford to ignore what was happening elsewhere within the region. However, the proposal never got off the ground as the idea was too radical at that time. However, the 1997–98 crisis provided the appropriate push factors and rationales for economic cooperation among the ASEAN+3 group.

Basically, the countries requiring assistance from the International Monetary Fund (IMF) became insolvent in terms of not having enough foreign currencies to meet their foreign currency obligations. A particularly striking common feature of the three countries requiring IMF assistance compared with other countries in the region, is their very high ratio of short-term foreign debt to foreign reserves (see Table 1 [ PDF 44.3KB | 1 page ]). In the region these three economies were the only ones with a ratio of short-term foreign debt to official reserves of more than 100% at the end of 1996. The ratio for Thailand was 110%, that for Indonesia 167%, and that for Korea 195%. Such high ratios are very dangerous, because if these short-term debts are not rolled over for any reason (for example due to a loss of confidence), then these countries would become bankrupt as a result of possessing insufficient foreign reserves to repay their debts.

The problem prior to the crisis was that countries were viewing the adequacy of foreign reserves with the wrong paradigm. In Thailand, for example, as short-term debt increased, foreign reserves also increased. This increase in foreign reserves was actually considered to be a sign of strength by the authorities. Viewing the situation from a current account perspective, foreign reserves in the few years prior to the crisis amounted to more than five months of imports of goods and services combined. At that time it was not realized that reserves also needed to cover short-term foreign debt, as such loans may not be extended when they become due and foreign currencies would be needed to repay them. Moreover, as indicated above, the situation by the end of 1996 was becoming very risky as total foreign reserves were smaller than total short-term debt, not taking into account the large current account deficit Thailand was running at the time. The country's economic fundamentals weakened considerably in 1996, with a decline in exports compared to export growths of more than 20% per annum in the previous two years . Speculators started attacking the Thai baht, which was under a fixed basket peg at that time, and the situation became untenable as nearly all foreign reserves were used up to try to defend the value of the currency. By the middle of 1997, Thailand's net foreign reserves (net of forward contracts to sell foreign currencies) amounted to only about US$2.8 billion. With about US$30 billion of outstanding short-term foreign debt and a current account deficit of about US$1 billion per month, it was clear that the country was insolvent. The baht therefore had to be floated, and assistance had to be requested from the IMF.

While East Asian economies running saving deficits had to rely mostly on foreign short-term borrowings to fill their saving gaps, the region as a whole was actually running a saving surplus prior to the crisis, amounting to about US$100 billion annually (see Table 2 [ PDF 46.9KB | 1 page ]). The saving surplus of the region was invested mostly in US dollar denominated assets and the countries running deficits had to rely on foreign bank borrowings, which were mostly of short-term maturity.² Some in the region had argued at that time that if the financial resources within the region had been better utilized, to provide liquidity support and longer-term development finance to countries in the region in need of such provisions, then the 1997–98 crisis could possibly have been avoided.

Another factor pushing countries in the region toward greater cooperation was that they had very limited influence on shaping the IMF crisis resolution measures. These measures were largely dictated by the IMF, with the US Treasury and the Federal Reserve exerting influence behind the scenes. The IMF programs were meant to restore confidence and generate increases in foreign exchange reserves to enable countries under the programs to eventually recover from their insolvency positions. But the nature of the conditions imposed by the IMF was rather controversial and was much debated in the aftermath of the crisis.³ Critics pointed to a number of areas, such as;⁴

• The harsh nature of the tight fiscal and monetary policies, with apparent disregard for their social or political consequences. This even led to a change of political regime in Indonesia.
• The conditionality for the various countries tended to be of a “one size fits all” nature, therefore failing to differentiate between the different political and socio-cultural contexts.
• An unwillingness to allow non-market based interventions, such as controls on capital flows.⁵
• An imposition of full guarantees for creditors (mostly foreign) of financial institutions.
• An imposition of relatively rapid structural reform measures, such as stringent financial standards and corporate restructuring, privatization of state owned enterprises and asset sales at what many regarded as “fire sale” prices.

Because of the dissatisfaction with the way the crisis was handled, many in the region felt that if the region had had a greater input into the crisis resolution measures, the crisis could have been resolved with much less pain than had been the case.

For all of these reasons, it was logical for the region to come together after the 1997–98 crisis and the first meeting of the leaders of the Association of Southeast Asian Nations (ASEAN)+3 countries took place in December 1997 on the sideline of the 2nd Informal ASEAN summit in Kuala Lumpur. Since then, the meeting has become an annual event, supported by other ASEAN+3 meetings at ministerial levels as well as meetings among officials. As it was the financial crisis that brought the region together, it was not surprising that the first substantive cooperation agreement was in the area of finance, particularly the Chiang Mai Initiative (CMI), economic surveillance and bond market development (Asian Bond Market Initiatives, ABMI, together with the Asian Bond Funds). This has expanded into numerous ministerial level meetings in areas such as agriculture, energy, environment, ICT and transnational crime. Regional cooperation has also extended to numerous free trade and “so-called” comprehensive economic partnership agreements at the sub-regional level, with many of these involving ASEAN as one of the parties to the agreement. At the summit level, the annual meeting has also been expanded to include India, Australia and New Zealand, the so-called “East Asia summit”. Overall, the 1997–98 crisis created a major impetus for regional cooperation within the region and the extent of this cooperation is still expanding.

2.2 The Chiang Mai Initiatives (CMI)

The first proposal for regional financial cooperation after the crisis was actually the proposal made by Japan at the G-7/IMF meeting in Hong Kong, China in September 1997 to set up an Asian Monetary Fund (AMF). For it to have any chance of success, much background work, many informal discussions, and lobbying of the key stakeholders would have been required. This was not done, however, and the proposal also came at a time when the IMF was already implementing the rescue package for Thailand. It was not surprising, therefore, that it did not receive much support within the region and was strongly opposed by the IMF and the United States. Consequently, the proposal was quickly pushed aside.⁶ Arguments were made at that time that this could create a lot of moral hazard vis-à-vis the IMF. In fact, regional monetary organizations were nothing new, as they already existed in Latin America and in the Middle East,⁷ and they co-existed with the IMF, so this argument was an exaggeration. However, the proposal was simply too radical and came at the wrong time. Yet the idea of East Asia having its own financial and monetary organization did not disappear completely. Twelve years after the original AMF proposal was made, such an organization may eventually still emerge, as discussed below.

Even though the AMF idea did not materialize, key players in the region continued to explore ideas for financial cooperation. At a meeting of Asian Finance and Central Bank Deputies in Manila, Philippines on 18-19 November 1997, the so-called “Manila Framework” was developed. This was to be “A New Framework for Enhanced Asian Regional Cooperation to Promote Financial Stability”. Given the involvement of the United States and also the IMF,⁸ the ideas incorporated into the framework were not very radical and stressed the central role of the IMF. The official Summary of the Discussions stated:

“……Deputies agreed on the need and desirability of a framework for regional cooperation to enhance the prospects for financial stability. 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.”

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. Work on the regional cooperative financing arrangement to supplement IMF resources continued and was eventually agreed in May 2000 at the ASEAN+3 Finance Ministers' Meeting in Chiang Mai on the sideline of the Annual ADB meeting there, and is hence referred to as the “Chiang Mai Initiative (CMI)”.

With the CMI, the ASEAN+3 group expressed "a need to establish a regional financing arrangement to supplement the existing international facilities",⁹ and reached agreement on an expansion of swap facilities¹⁰ among the ASEAN member countries (the ASEAN Swap Arrangement, ASA) and to include bilateral swap arrangements (BSA) with members of the Plus Three group.¹¹ The size of the ASA was expanded to US$1 billion from the level of US$200 million that was in existence at that time.¹² Members were able to draw up to twice their contribution to the ASA, unconditionally,¹³ to be repaid within six months, with the possibility of roll over for a maximum of six months. In addition, a number of BSAs between the older ASEAN member countries and each country of the Plus Three group were to be concluded.

The BSA is a facility in the form of swaps of US dollars with the domestic currencies of participating countries. Repurchase agreements were meant to provide liquidity support through the sale and buyback of US treasury notes or bills with a remaining life of no more than 5 years and government securities of the counterparty country. By October 2003, thirteen BSAs had been successfully concluded with a combined total size of roughly US$35 billion. Under the terms of these bilateral swap arrangements at that time, 10% of the agreed amount could be utilized without any linkage to an IMF program for 180 days. For the rest, the condition was that the country already had to be under an IMF program or would be in the near future. The linkage to the IMF program was meant to ensure that the major part of such swap arrangements was not independent of IMF assistance. This was meant to ease the fears of those who were concerned with potential conflicts with IMF conditionality and moral hazard problems. In 2005, the total amount of swaps under the ASA was raised to US$2 billion. The amounts under the BSAs have also increased, and the latest total amount of swaps under the CMI was US$90 billion, with the various bilateral amounts shown in Figure 1 [ PDF 411.2KB | 1 page ]. The amount that a country could draw without linking to any IMF program was also increased, from 10% to 20%.

While the total of all the various swap arrangements in Figure 1 may appear large, the amount available to each country is in fact not very large, especially if the drawing is not linked to an IMF program. For example, if the latest CMI had been available before the crisis in 1997, Thailand would have been able to draw about US$2 billion from the CMI swap arrangements prior to asking for IMF assistance. This amount is insignificant compared to the scale of problem that Thailand faced in mid-1997, or compared with the size of the IMF package for Thailand (US$17.2 billion). Therefore, the amount of money available under the current Chiang Mai Initiative is still too small to make a lot of difference. The CMI should instead be viewed as a significant symbolic initiative, showing that the countries in East Asia are willing to work together to develop self-help mechanisms to reduce the risk of a future crisis. The CMI was clearly a work in progress, especially given the compromises necessary to bring it about. It needed to be developed into something more tangible and substantive. This has occurred though the evolution of the CMI into the Chiang Mai Initiative Multilateralization (CMIM), even though this evolution was very slow.

Download this Paper [ PDF 552.2KB| 20 pages ].

Comment(s)

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