Outlook

The section discusses the roles that CMIM and the ISU could play in providing liquidity support to countries in need of it and in terms of regional surveillance. Suggestions are made on how to make these roles as effective as possible.

4.1 The Provision of Foreign Exchange Liquidity to Countries in Need of It

Given the large accumulation of foreign reserves in the region, and the lessons learned from the 1997/98 crisis about key variables to monitor and manage in order to minimize the risk of another crisis, foreign exchange liquidity shortages should be less of a problem for East Asian economies now than in the past. However, as the recent sub-prime crisis showed, foreign exchange liquidity shortages can develop unexpectedly and quickly. During the last quarter of 2008, severe liquidity shortages in money markets in the US and other advanced economies led to a global liquidation of much of the portfolio investments by various investment funds worldwide. Proceeds from sales of these assets were then converted into foreign currencies (mostly US$) to take back to the West. This led to severe liquidity shortages of US dollars in many economies. The situation for Korea was particularly severe. Although it had more than US$200 billion of foreign reserves, it also had large amounts of short-term foreign debt and large foreign holdings of stocks which could be easily liquidated to take money out of the country. Korea's foreign reserves were not sufficient to cover short-term foreign debt and short-term contingent liabilities from foreign holdings of portfolio investment which could be quickly liquidated (see Table 5 [ PDF 31.3KB | 1 page ]). To a lesser extent this was also the case for Indonesia, and Singapore too faced severe US dollar liquidity shortages.

While the CMIM was not yet operational, the CMI was. Korea could have accessed US$18.5 billion under CMI through its swap agreements with various countries. However, only US$3.7 billion of this (20%) could be drawn without having to be part of an IMF program. Given the experience with the IMF in the aftermath of the 1997/98 crisis, it would probably have been political suicide for Korea's government to take the country into another IMF program, even though during the sub-prime crisis IMF conditionality had become much more loose under the new so-called “Flexible Credit Line (FCL)”, introduced in March 2009, for countries it regarded as having strong fundamentals and sound macroeconomic policy track records.

Instead, Korea entered into a swap agreement with the US Federal Reserves for US$30 billion. The same was true for Singapore. Indonesia also wanted to have a swap agreement with the US Federal Reserves. The US, however, did not agree to this, and Indonesia ended up with swap agreements with PRC and Japan.¹⁶

Given other sources of liquidity support, particularly through central bank swaps, that countries in the region had access to during the sub-prime crisis, the importance of the CMI and CMIM would seem to have substantially declined, especially given their links with IMF programs. However, East Asian countries have pushed ahead with the CMIM in spite of having other central bank swaps. This is likely due to the realization that developing a liquidity support mechanism in the form of a regional public good mechanism is the most effective option, both economically and politically. While the US Federal Reserves is always in a position to provide US dollar liquidity if it chooses to do so, it would be a major mistake to rely on such agreements in the future. The important point is that who the US chooses to give swap agreements to will be driven mainly by US interests. For example, the swap may allow US investors to more easily withdraw funds from some country at a time of severe liquidity shortages, such as during the sub-prime crisis, without suffering additional losses from large depreciations of the local currency because the country has foreign exchange shortages. Furthermore, there is no guarantee that the US will indeed grant the swap, such as in the case of Indonesia. More generally, relying on ad hoc bilateral swap agreements can create political frictions, such as in cases where swaps are refused, and can also give the impression of bilateral dependence, which can easily develop into a sensitive political issue.

The region has pushed ahead with CMIM, and it is now close to fruition. However, to make the CMIM fully effective, we suggest a number of implementation steps. First, the mechanism must be de-linked from the IMF. There is now such a stigma attached to the IMF in many parts of the region that even with the new FCL it would be politically very risky for a government to enter into an IMF program. So unless CMIM is de-linked from the IMF, countries in the region are unlikely to make use of the CMIM. Instead, they will be inclined to resort to various central bank swap arrangements, with the US or other regional central banks. As such the CIMM will be bypassed and rendered useless.¹⁷

Second, the CMIM borrowing quota may not be enough if a country gets into serious problems. To address this issue, it should be made possible for CMIM funds to be supplemented with additional contributions from countries in the group. This would be similar to borrowing under an IMF package. For example, when the IMF arranged a borrowing package of US$17.2 billion for Thailand in 1997, only US$4 billion of that was the IMF's own money (or 23.25%); the rest came from contributions by various countries in the region. If similar contributions are possible for CMIM, then the total size of resources available for liquidity support in the region would be more like US$400–500 billion and not just the US$120 billion of the CMIM pool.

Third, instead of just borrowing from the CMIM, countries should also be able to arrange swap facilities with the CMIM, in a similar manner as with central bank swaps. This would make it much more flexible and quicker to use CMIM in situations of short-term liquidity shortages.

Fourth, it should be made possible for other members of the East Asian summit not part of the ASEAN+3 (Australia, India and New Zealand) to participate in CMIM activities.¹⁸ Given the difficulty in reaching agreements on country contributions to CMIM, it would be difficult to add these three countries as full contributing members. But one way of allowing these countries to participate would be to make them “Contributing Partners” or “Associated Members” of CMIM. As such they could contribute to specific future borrowing programs to supplement money from the CMIM fund as other ASEAN+3 members can (as discussed in point two above). As contributing partners, they would be able to participate in all the technical programs to be carried out in the future under the CMIM umbrella, such as surveillance and activities to support the integration of the region (see below). This might be the best approach to take at this stage as it would not disrupt what has already been agreed upon and will also make ASEAN+3 and ASEAN+6 (East Asian summit members) activities in the financial area more unified.¹⁹

Fifth, and most importantly, the CMIM needs full time professional staff to provide substantive support to the member countries in areas such as surveillance and implementing and monitoring mechanisms. Although it is commendable that the ISU is to be set up initially as AMRO, it will be a pity if the ISU²⁰ simply remains a research office. It should evolve into a regional monetary organization for East Asia, similar to the Arab Monetary Fund in the Middle East and the Latin American Reserve Fund in Latin America.²¹ It is also important to note that this organization would not simply be performing a role as a regional IMF in East Asia. It should also carry out a multitude of activities to support various aspects of financial cooperation in the region, which may include macroeconomic policy coordination, regional financial regulatory frameworks, capital market development as well as long-term regional financial and monetary integration. This would be similar to the Arab Monetary Fund, which has a broad range of objectives covering: 1) correcting disequilibria in the balance of payments of member States; 2) striving for the removal of restrictions on current payments between member States; 3) establishing policies and modes of Arab monetary co-operation; 4) providing advice, whenever called upon to do so, with regard to policies related to the investment of the financial resources of member States in foreign markets; 5) promoting the development of Arab financial markets; 6) paving the way towards the creation of a unified Arab currency; and 7) promote trade among member States.²²

Being completely new, the ISU would need time to develop expertise and gain credibility. It should develop close links with other regional organizations such as the Asian Development Bank, the Asian Development Bank Institute and the ASEAN Secretariat. It should also have close links with global international financial institutions, such as the IMF, the World Bank and the Bank for International Settlements, and with monetary organizations in other parts of the world. In particular, even though the CMIM borrowing should be de-linked from the IMF, as indicated above, the IMF can still have an important role to play in providing technical assistances and capacity building support to the ISU.

Finally, financial support for the operation of the ISU should come from pro-rata contributions by the ASEAN+3 countries. The CMIM contributions are “self-managed” which means that the funds are still managed (invested etc.) by the various central banks (or ministries of finance in some cases)) and interest earnings from these funds belong to the various country agencies. To operate the ISU and its related activities, each country should contribute a small amount of interest earnings on these CMIM funds for ISU operations. For example, 0.05% of the contributed amount per year would amount to US$60 million per year (initially the amount could be much lower).

4.2 Regional Surveillance Process

Within ASEAN, the global surveillance process of the IMF was supplemented by the ASEAN Surveillance Process (ASP) after the 1997/98 crisis. This was meant to be an informal process based on a peer review system that would complement the regular surveillance by the IMF. A unit was set up within the ASEAN Secretariat to assist with coordinating the work of the ASP and to prepare a series of semi-annual ASEAN Surveillance Reports, and the ADB provided technical support for the operation of the ASP. The peer review of the ASP is conducted at the ASEAN Finance Ministers meeting, which is held twice a year.²³ At the level of the ASEAN+3, surveillance is conducted through the Economic Review and Policy Dialogue (ERPD). This is held at the Deputies' level twice a year to discuss economic and financial developments in the region and is reported to the ASEAN+3 Finance Ministers' Meeting which is held annually.

From the author's own experiences in these processes, the current surveillance mechanisms are not very effective. The resources available to support the mechanisms are very limited and the officials involved in these processes only carry out the tasks on a part-time basis alongside many other regular jobs. Ministers Meeting mostly “rubber stamp” what the officials have prepared through the Deputies Meetings. Even making slight changes to the Ministers Declaration, drafted by the officials, can be complicated, as officials may have spent a lot of time negotiating over wordings in the Declaration that all countries (as represented by the Deputies) could agree with.

The key to the success of any kind of surveillance mechanism within the region is to have a strong professional secretariat to support the process. This presumably would be a key role of the ISU, which could make a strong contribution by becoming the dedicated technical secretariat of the ASEAN+3 Finance Ministers process. The ISU should aim to provide high quality technical input into the regional surveillance process, supporting the Deputies Meetings and the Finance Ministers Meetings. In fact, once the ISU is established, one should take the opportunity to reform the economic surveillance and financial cooperation institutions of the region to make them more integrated and more effective. Within the region, although the membership group is slightly different to the ASEAN+3 or ASEAN+6, there is another important consultative forum among central banks officials, the EMEAP process.²⁴ Like the Finance Ministers process, EMEAP does not have a permanent secretariat either, but is a cooperative process with rotating host economies providing local logistical support. Once strong enough, the ISU could also assume the role of secretariat of the EMEAP process.

The memberships in the Finance Ministers process and the central banks process should become more unified. As was suggested regarding the CMIM, Australia, India and New Zealand, could become associated members and participate in key activities of the ISU, including regional surveillance and other regional financial cooperation activities. Hong Kong, China can already participate in CMIM as it is a contributor within the quota of PRC . This means that if EMEAP were to be expanded to include all the central banks of the newer ASEAN member countries (Cambodia, Lao PDR, Myanmar and Viet Nam) and India, the expanded CMIM and EMEAP would have exactly the same membership. This would make the two processes the focal points for regional surveillance and other financial cooperation initiatives that may develop in the future. The consultative regional financial institutional infrastructures might be as follows; a meeting of the expanded EMEAP central bank governors every quarter, a meeting of the expanded CMIM Finance Ministers every six months, and a joint meeting of the expanded CMIM/EMEAP Finance Ministers and central bank governors once a year.²⁵

Consultation and cooperation activities around the (expanded) CMIM/EMEAP and the ISU will be important contributions to those at the global level.²⁶ As the sub-prime crisis originated outside the region but ended up having a large indirect impact on the region, East Asia's surveillance activities cannot simply be an internal surveillance of the region. The region also needs mechanisms for surveillance of the more advanced economies that have the potential to negatively affect the region indirectly. And as East Asia is a major creditor of the Western economies, it is in East Asia's interest to carefully monitor the markets in which its economies have invested a large part of their resources.

In this respect, the CMIM/EMEAP regular meetings of central banks and Finance Ministers could develop into an important focal point of the global financial system; no less important than meetings of the US Federal Reserves or European counterparts. The CMIM/EMEAP meetings should become much more visible than they are at present. The region's central banks can play a key role in coordinating the region's monetary policy, exchange rate policies, and foreign reserves investment policies. All these, particularly the latter two, can have major global implications. Given that East Asia is a region with very large financial resources and can strongly influence important global financial variables, such as exchange rates and bond yield curves, the world should be anxiously anticipating the outcomes of key financial meetings in East Asia in the future.

Regular meetings of CMIM/EMEAP may also result in important policy coordination necessary to tackle major global problems such as the global imbalance. If the sub-prime crisis brings about an easing or reversal of the global imbalance, then all well and good. However, if a global recovery sees a recurrence of the global imbalance or even increases it, the risk of another major financial crisis will return. In such a case the direct cause of the crisis would probably be very different from the sub-prime crisis. But it would be very rash to assume that the global imbalance could continue to exist without resulting in major disruptive adjustments.

While the global imbalance is a global problem, and adjustments are needed from both those countries with surpluses and those with deficits, a major variable affecting the global imbalance, the exchange rates among relevant currencies, are more under the control of East Asia (the surplus region) than the US (the major deficit country). Without coordination, each country will try to prevent its currency from getting too strong in order to protect its export sector. This would mean that the global imbalance is likely to remain and may even increase. Under the current regional institutional infrastructure there is no effective forum or mechanism that can deal with exchange rate cooperation or coordination. This is why the new regional institutional frameworks that could be built up from the CMIM, EMEAP and ISU have the potential to make a real difference to the policy processes within the region, with major regional and global implications.

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