No. 20 — May 19, 2000

 

Weekly Review

EAST ASIA ESTABLISHES CURRENCY-SWAP ARRANGEMENT TO GUARD AGAINST FINANCIAL CRISES
--- by Marc Castellano

Finance ministers from the 10-member Association of Southeast Asian Nations, the People's Republic of China, Japan and South Korea have agreed to set up a regional financing facility. It will expand an Asean currency-swap arrangement that is designed to help prevent regional economic crises. Convening under the "Asean+3" framework, officials achieved this consensus on the sidelines of the May 6-8 annual meetings of the board of governors of the Asian Development Bank in Chiang Mai, Thailand.

Finance Minister Kiichi Miyazawa, a leading proponent of enhanced monetary cooperation in East Asia, introduced the proposal. The so-called Chiang Mai Initiative builds on an agreement reached in March, under which Asean nations — Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar (formerly Burma), the Philippines, Singapore, Thailand and Vietnam — pledged to set up a regional fund to protect their countries' economies from currency speculators (see JEI Report No. 13B, March 31, 2000). The current plan, which adds China, Japan and South Korea, involves a network of bilateral swap and repurchase agreements. The goal is to help participating economies avoid balance-of-payments crises by making emergency liquidity readily and easily available.

Last year, Tokyo agreed to swap the equivalent of $7.5 billion with Seoul and Kuala Lumpur as part of the Miyazawa Plan, the massive government aid initiative for East Asia introduced in October 1998 to help regional developing economies restore stability and growth (see JEI Report No. 6A, February 12, 1999). Those arrangements essentially allow the central banks of South Korea and Malaysia to trade their national currencies for dollars, yen or other in-demand currencies held by the Bank of Japan. Tokyo now will extend the scheme to the nine other Asean countries plus China.

Currency-swap arrangements certainly are not new to the region. A similar, if much weaker, infrastructure was put in place after Mexico's peso collapsed in 1995. Central banks in East Asia agreed at the time to transfer liquidity during financial emergencies. While well-intentioned, the program proved to be not only ineffective but also counterproductive. Market players interpreted use of the facility as a sign of weakness, which only aggravated the speculative pressures that governments were trying to avoid. Some observers maintain that the program contributed to the July 1997 devaluation of the Thai baht, which sparked the financial and economic crisis that gripped much of developing East Asia for two-plus years.

How the Chiang Mai Initiative will address similar problems remains an open question. Indeed, the idea of establishing a regional facility to help prevent financial upheavals traditionally has been problematic for this as well as other reasons.

Opposition from Western economic powers forced Tokyo to shelve its plan to create an Asian Monetary Fund in November 1997 (see JEI Report No. 47A, December 19, 1997). The International Monetary Fund and Washington, its largest and most influential shareholder, contended that establishing an alternative source of emergency funding would undercut the IMF's mandate to assist members in trouble and reduce its leverage to effect change. Periodic attempts have been made to revive the AMF idea, but all eventually have lost steam in the face of resistance from the Clinton administration and elsewhere.

However, the discussions that did occur helped to develop the necessary backing for the current agreement, the first of its kind to show real promise. Notably, a joint statement issued after the ADB meetings carefully pointed out that the Chiang Mai Initiative is designed to complement, not replace, existing international financial-support mechanisms.

Although American objections to an East Asian self-help facility may have softened, they have not been entirely eliminated. A senior Department of the Treasury official who attended the annual ADB meetings indicated that while Washington tentatively supports the Chiang Mai Initiative, it is waiting for additional information before providing an official reaction. Asean+3 officials left undecided such important details as the amount of money involved and what conditions, if any, will govern utilization of the swap arrangements. Skeptics caution that much work still needs to be done. Asean's secretariat was tasked with hammering out the details, but it was given no deadline or timetable.

Not surprisingly, Mr. Miyazawa praised the Chiang Mai Initiative. He suggested that regional monetary cooperation would lead to improved regulatory frameworks, better accounting systems, enhanced transparency and, ultimately, stronger economies in East Asia. Western critics tempered their comments with the caution that a currency-protection plan is no substitute for reform. According to them, stable banks, good corporate governance and sound economic policies are the keys to crisis prevention.

Although still at a formative stage, the East Asian currency-swap arrangement is significant because two essential elements back it: sufficient resources and credible commitments. Japan has the world's largest gold and foreign currency reserves — $339 billion worth at the end of April, although a significant share of this total is invested in U.S. government securities. With access as well to China's holdings, which also are substantial, a lack of funds should not pose a problem. Moreover, Japan and China are two of the world's largest economies.

The Chiang Mai Initiative represents the first step toward creating a viable regional crisis-prevention mechanism. A high level of cooperation has been needed to get this far; more of the same will be required to work out the details. East Asia's determination to lessen its dependence on Western financial resources and to gain more clout on the world stage could supply that momentum.

The views expressed in this report are those of the author
and do not necessarily represent those of the Japan Economic Institute

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