Framework of Regional Financial Cooperation and Surveillance

Transcription

1 Framework of Regional Financial Cooperation and Surveillance Summary of Research Papers and Policy Recommendations Junichi Goto Naoyoshi Kinukawa Yorikatsu Yoshida Nobuyuki Fukui This chapter deals with the issue of how to further enhance regional financial cooperation, especially in the area of surveillance and monitoring, and the framework that supports it. It summarizes the research papers of the project and provides policy recommendations. The authors hope that these analyses will contribute to further discussions. I Summary of Research Papers It is important to establish the economic rationale for financial cooperation in East Asia to persuade the member countries to promote such cooperation, but earlier studies on the subject have been sketchy so far. Goto and Igawa examined whether East Asia is a suitable grouping for monetary cooperation and integration. They approached this problem from various angles ---- comparison with the EU, using macro economic indicators, studying it from the point of view of trade integration, degree of intra-regional movement of capital and labor, and homogeneity of real shocks. In Economic Preconditions for Monetary Cooperation and Surveillance in East Asia, Goto examines real data on economic interdependence in East Asia in terms of trade and labor, because the closer the region is united in terms of real variables, such as trade and migration, the stronger the case for financial cooperation. He finds that, generally speaking, regional interdependence in terms of trade in East Asia is very strong and international mobility of goods and labor has increased markedly in the 1990s. For example, the analysis of the trade dependency index on East Asia 14 shows, with few exceptions, trade dependence within East Asia has dramatically increased in every country. Goto, relying on the principal component analysis, finds that the real disturbances in the subset of Asian countries, i.e., Indonesia, Korea, Malaysia, the Philippines, Singapore, and Thailand, are pretty much synchronized, and the synchronization of those in the six countries with Japan has increased in the 1990s. Synchronization with Europe shows a similar trend as with Japan, though to a lesser degree. On the other hand, the correlation with the U.S. has been negative, both in the 1980s and in the 1990s. The finding suggests that there is indeed a case for financial integration and cooperation in East Asia, and pegging to a basket of major currencies (or even to the yen) is better than pegging to the US dollar alone

2 In Financial Cooperation in East Asia: A Perspective from Macro Economic Indices and Regional Trade/Investment Dependency, Igawa finds that the trade dependence among Asian members has tremendously increased. Igawa finds that investment channels such as FDI (foreign direct investment) inflows and outflows are also deepening interdependency among regional members. To strengthen these intraregional relations, it is necessary to have a regional financial cooperation system. Surveillance among regional members will be an important component of such a system. Financial cooperation through effective surveillance will contribute to regional financial stability. As we conduct the economic analysis of East Asian financial cooperation and financial surveillance, it is worth investigating the costs and benefits of financial cooperation. The main cost is losing independence or autonomy of monetary policies of a country. However, the cost is small when member countries have similar macroeconomic fundamentals. Macroeconomic similarity is reflected in the narrow dispersion of macroeconomic indices such as inflation rates, interest rates, and government budget deficits. To check macroeconomic indices, member countries inflation rates (CPI) and money supplies (M1 minus GDP growth rate) are compared. According to relative PPP (purchasing power parity) theory, the similarity of these indices suggests that long-run adjustments of foreign exchange rates might not be significant among the members. Those indices are in fact not much different among East Asian members compared with those among EU members. The same results are obtained in a comparison of interest rates and government budget balances (deficits). Compared with EU members differences in interest rates are not great and general government balance (deficit) indicators are rather better among the East Asian members. To check regional trade interdependence, weights of intra-regional imports and exports in East Asian countries are compared with those in Euro members. Intra-regional FDI has also increased in East Asia as well. In sum regional-interdependence through trade and FDI in East Asia is not low, and therefore the benefits of financial cooperation are large and the costs are small in comparison with the case of the EU. The successful introduction of the Euro is an epoch-making phenomenon in international finance and the experience of Europe offers several lessons for East Asia. Through the Kobe-ASEM project, greater exchanges of views and ideas are expected. In Regional Surveillance and Policy Coordination Experience of Europe and Lessons for East Asia, Murase studies the history of the EU from two different viewpoints. The first was the framework for surveillance and policy coordination in the EU. The second was the infrastructure of statistics in the EU. Surveillance and policy coordination play a crucial role in macroeconomic management in the euro area. This is because of the double-decker structure of the EMU in policy formulation and implementation, i.e. unification of monetary and exchange rate -232-

3 policies at the Community level and economic policies, in particular budgetary and structural policies, remaining under the national control of member states. The main players in the surveillance process are: the Ecofin Council, the European Commission, the informal Eurogroup, the Economic and Financial Committee, the European Central Bank and the Eurostat. In Europe policy coordination and surveillance have always been important means to achieve objectives given by the Treaty of Rome, but during the 1970s and 80s the purpose was practically to maintain the regional exchange rate system of the joint float or the EMS. The outcome of policy coordination and surveillance, although such efforts were never interrupted, can be considered neither satisfactory nor fully efficient. When the first stage of EMU started in 1990 the importance of economic policy convergence was emphasized and the committee of central bank governors was reinforced for coordination in monetary and other fields of competence. It was, however, after the material norms were given by the Maastricht Treaty and from the second stage of EMU on that policy coordination and surveillance began to be tackled systematically with vigor at national and EU levels for budgetary and other economic policies, as well as between economic and monetary policies. Today, policy makers are fully aware of the vital importance of multilateral surveillance and statistics as part of the basic infrastructure for the coordinated management of the euro-area economy. Statistics that are reliable, impartial and comparable among countries are indispensable in surveillance and economic policy coordination. In the EU, Eurostat and the ECB at the Community level, and national statistical offices and national central banks at the national level, are producing statistics. In order to meet the statistical requirements of the EMU, the European System Accounts (ESA 95, an update of ESA 79) was put into operation in In order to improve the statistics in the EU, so as to fulfill the needs of a single monetary policy and coordination of economic policies, work is underway for statistical improvements following the EMU Action Plan of September Making an overview of the current policy dialogue and considering the possible future framework for monitoring and surveillance are the basic components of the study. Wang/Yoon and Ito have approached the issue from several perspectives. In Mechanism of Regional Surveillance for East Asia and its Prospects, Wang and Yoon review the existing surveillance mechanisms for financial cooperation and seek measures to strengthen surveillance processes through regional policy dialogue. The most important precondition for successful regional financial cooperation is the institutionalization of a monitoring and surveillance mechanism. Currently in East Asia, only shallow forms of financial cooperation are being forged. Under the ASEAN plus three framework, progress has been made in implementing the CMI. Bilateral swap arrangements under the CMI need to be more structured and institutionalized. In particular, policy dialogue, along with a regular monitoring and surveillance process, forms an essential pillar of financial cooperation

4 Surveillance mechanisms must vary with the grade of financial cooperation, because a surveillance mechanism should fulfill particular objectives. A regular monitoring process is essential for the prevention of crises. The collected information will help detect and identify the characteristics of economic and financial vulnerabilities at an early stage so that a proper program of policy actions can be undertaken in a timely manner. Through economic and financial sector monitoring, a close watch should be kept on cross-border capital flows, and institutional and legal changes. An early warning system (EWS) based on this information and processed indicators can diagnose early symptoms of crises. The development of leading indicators presumes that an economy exhibits particular and consistent patterns of behavior prior to a crisis. Hence, selecting reliable indicators is a crucial step in formulating the early warning system, but one would not expect the same indicator to be a good signal for every type of crisis. An EWS itself may not have enough credibility from the perspective of investors in the sense that it is just a statistical exercise without accurate predictability, especially when attention is given to the quality and availability of the published data. In fact, the difficulty with constructing an EWS for developing countries arises from the lack of reliable statistics, which are largely distorted or superimposed upon other non-economic factors. EWS should send a set of signals and impose pressures on participants in financial markets so that they modify their financial positions. As a result, any misalignment in exchange rates can be corrected before it becomes too late. In this context, even the most desirable EWS itself cannot function properly without a degree of market discipline, such that financial markets provide signals and incentives for borrowers to behave in a manner consistent with their solvency. An EWS is basically a surveillance device which serves to enhance market discipline, including statistical transparency, policy consistency, and a resilient financial system. Since the 1997 crisis, the Korean Government has focused its attention on developing an EWS. A set of two early warning models, one based on a signal approach and the other on a World Bank model, was developed. The Korean EWS models can be applicable to other East Asian countries. At the ASEAN plus three meetings, countries agreed to develop a standard EWS model. In Regional Surveillance Mechanisms in East Asia, Ito explores the status of regional surveillance, and makes recommendations for the future. He first reviews current global surveillance mechanisms, and then makes a case for regional surveillance as well as addressing the problems involved. Macroeconomic surveillance has been regularly conducted by the IMF, the World Bank, and OECD (WP-3) for their member countries. After a series of currency crises were triggered by massive capital flows, risk surveillance in the capital and financial markets and soundness of financial institutions have become a priority of economic surveillance. Effectiveness of surveillance is based on peer pressure. In most -234-

5 cases, a failure to satisfy recommendations would not lead to any penalty but to embarrassment and loss of influence in the organization. Surveillance requires face-to-face discussions in addition to regular correspondence. The IMF and OECD send missions to the countries under review. When some undesirable policies are detected, a surveillance organization may issue warnings. Sometimes, these warnings may be welcomed in the sense that they may break domestic oppositions by vested interest groups and achieve desirable reforms. In the case of countries that are deeply integrated with other members in the region like the EU, penalties in the form of, for example, suspension of assistance may be necessary, as lack of reform may hurt the other members of the organization. The Asian region traditionally had not had regional groups for financial cooperation. The Asian financial crisis has been a catalyst in thinking about regional financial cooperation. Three aspects are salient in the new trend in Asia. First, the recent preference is to form intra-regional groupings, such as ASEAN plus 3, rather than Pan-Pacific ones, such as APEC. Second, free trading arrangements seem to be the vogue. Third, Japan and China seem to be more enthusiastic about intra-regional grouping than before. Many existing regional groupings started with some sort of preferential trade arrangement. On this front, Asia has been lagging behind other regions in the world. China has proposed a free trade agreement with ASEAN. However, the ASEAN countries responded with a proposal for an ASEAN-plus-three free trade agreement. The ASEAN plus 3 FTA would create a large market in Asia, if it is successfully implemented. Financial cooperation in the region has progressed recently. The support package for Thailand in 1997 was the first joint effort of Asian countries to help each other in an acute financial crisis. There are several reasons why the Asian region started financial cooperation. First, resources at the IMF are limited, so that regional support to a crisis country was desirable. This reasoning was somewhat weakened after the Supplementary Reserve Facility (SRF) was established. The IMF can now finance quite a large support package if necessary. The second motivation for the regional mechanism was to prevent regional contagion. Countries in the same region have more common stakes and mutual interest to help each other and problems in the financially integrated regional economies are best addressed regionally. There are two reasons why regional surveillance is necessary. First, the global mechanism is not enough. Second, the ASEAN plus 3 framework requires surveillance. An approval of financial assistance requires monitoring of capital flows, and high frequency is a key to its effectiveness; Surveillance helps policy soundness. Asian regionalism is not fully endorsed by policy makers and thinkers in the West. Some suspect that a regional FTA in Asia may not be consistent with WTO. The Chiang Mai Initiative may rekindle an old flame of the Asian Monetary Fund with softer conditionality. However, regional arrangements in Asia are planned to be consistent with, and complementary to, the existing multilateral arrangements. In some cases, regional -235-

6 arrangements go deeper in integration and cooperation than the multilateral minimum standard. The Chiang Mai Initiative itself is a mechanism to provide temporary hard-currency liquidity to a country under pressure. The bilateral swap arrangements will be complementary to the IMF in the sense that they will be largely linked to an IMF program. Moreover, this arrangement will make it necessary to maintain closer economic dialogue among the thirteen economies. There are several obstacles that should be overcome. The membership issue should be resolved. The right grouping depends on the area of economic and financial integration as well as political affinity. How fast cooperation and surveillance should proceed depends on the speed of financial integration. The more integrated, the more important that the governments cooperate regionally. It is important to start the surveillance process quickly in order to further develop the Chiang Mai Initiative process. To proceed further it is necessary to create a secretariat for surveillance. In the long run, political leaders should have a vision and that will guide the current generation to be motivated for the future. Regulation/supervision in the banking system and in the capital markets are the two concrete areas where the countries in East Asia could work together. In Prudential Regulation and Supervision in the Financial System of East Asia, Kishi & Okuda examine some remaining issues of the financial infrastructure in China, Korea, Japan, and four ASEAN countries after the reforms following the Asian crisis --- the lack of applicable laws on closure and bankruptcy, ineffectiveness of newly established regulations, prudential supervisory procedures, insufficient disclosure of banks and delay of privatization of commercial banks etc. Based on this examination, they make proposals for prudential regulations and supervision of financial institutions in East Asia (excluding China). First, it is necessary to establish an efficient and healthy financial system based on the market principle. In this regard, elimination of government intervention, creation of a competitive market environment, privatization of family-owned financial institutions, and enhancement of the transparency of information on financial institutions are all needed. Second, in order to implement market-based prudential regulations, the international best practice, specifically the Basel Core Principles, should be adopted. Care is needed, however, when applying best practice set by advanced countries, such as an internal risk management model because a certain level of management skills is required. Prudential regulations should be used in detecting difficulties of financial institutions. The CAMEL system should be introduced and its workability should be improved where it has already been introduced. Also a unified supervisory system that covers both banks and non-bank financial institutions should be established, and the central bank and the supervisory authority should consult with each other to avoid inconsistency

7 Third, a mechanism for prompt resolution of failed financial institutions is necessary. PCA (prompt corrective actions) must be implemented in a highly transparent manner without arbitrariness, if problems are found in the management of a financial institution. Establishment of an AMC (asset management company) that disposes of non-performing loans of failed financial institutions would also be helpful. There should also be standards for determining the purchase price of non-performing loans in accordance with transparent rules and to minimize moral hazard problems. Fourth, improvement of the effectiveness of supervisory and regulatory systems is necessary. In this regard, it is particularly important to solve the shortage of staff, to carry out extensive personnel training both at financial institutions and the supervisory authority, to introduce personnel systems that give an incentive to acquire skills, to raise the salary of supervisors to attract talented persons, and to promote information exchange between the supervisory authority and financial institutions. Also, in order to cope with the lack of a framework that supports financial supervision and regulation, it is important to set practice guidelines on how to apply new systems to practical business and to define punitive rules applicable to those who failed to comply with the requirements laid down. Fifth, international cooperation is necessary. Reciprocal supervisory systems of home and host countries need to be widely introduced. To set global standards for supervisory and regulatory systems is important. Information exchange must be promoted among supervisory authorities of each country. The role that development of capital markets, mainly bond markets, could play in stimulating active economic and financial transactions in the region should be studied as well as supervision of capital markets. After the Asian crisis, the Asian countries have made efforts to foster the bond markets in the region. The importance of developing efficient bond markets in parallel with banking and equity markets has been widely recognized in the region as an important step to promote stable growth. In Development of Capital Markets and Surveillance in East Asia with Particular Reference to Bond Markets, Mori reviews the reforms currently pursued in the Asian government bond markets and draws lessons from the unification process of the financial market in the EU. Various measures have been adopted to strengthen bond markets in Asia. The review of the current situation of the government bond markets in Korea, Thailand, Malaysia and Japan suggests that the Asian countries have common problems in their efforts to reform their bond markets. These problems are found in the primary and secondary markets, clearing and settlement mechanisms and tax treatments. They also have a common agenda of the need for wider and more diversified investor bases. In order to solve these common problems and to achieve efficient bond markets, the Asian countries can exchange their experiences and make joint efforts. Since the launch of the Internal Market Program in the mid-1980s there have been continuous efforts to integrate various national markets in the EU. The introduction of the euro has stimulated investor interest in cross-border financial activities within the -237-

8 EU and has led to increased efforts to complete the integration of national financial systems. The EU Commission issued the Financial Services Action Plan (FSAP) in 1999 as the blueprint for the integration of the financial markets. What is remarkable about the FSAP is that mechanisms are put in place to promote reforms by enabling various institutions to work for this purpose. The EU Commission is also entrusted to produce progress reports. In the EU the private sector is active in the process of planning and reviewing the unification of the financial markets. The most prominent case is the Giovannini Group. What are the lessons Asia can learn from the EU experiences? First is the way in which medium to long-term goals were determined in a concrete and clear way. Second is the way in which the follow-up mechanism was applied to overcome the problems in member countries. Third is the extensive involvement of the private sector. The vicious cycle works in Asia. There is not enough infrastructure to invite mutual investment in Asia. This leads to a lack of investment and that, in turn, chills the effort to create infrastructure for mutual investment in the region. The public and private sectors should work together to break this vicious cycle. Mori suggests that with ASEAN plus three at the core, the experts from the private sector need to work closely with the government authorities. In Policy Recommendation on How to Strengthen Financial Cooperation in East Asia, Wang Tongsan proposes the following three phases for regional currency integration. This is a concrete proposal on how to further integrate the region, but there is room for other approaches on the subject. Phase I is the initial stage for discussions and program designs to create a single Asian currency, which should be completed by This phase includes establishing an East Asian free trade area, establishing an Asian Monetary Fund (AMF), promoting further studies on a single Asian currency, designing specifications of the Asian single currency, promoting monetary cooperation under the framework of ASEAN plus three, establishing a mechanism of financial cooperation in Asia and strengthening the coordination of national monetary policies. Phase II is the transitional and preparatory period for a single Asian currency, which should be completed by It includes establishing a big integrated market, strengthening international economic cooperation to reduce national economic disparities and achieve economic convergence, establishing an Asian monetary system, strengthening regional coordination of financial, monetary and economic policies, and establishing an Asian Central Bank and related agencies to strengthen cooperation among national central banks and define the legal framework of an Asian single currency. Phase III is the final period that begins in It includes the launching of an Asian single currency and the establishment of an Asian economic and monetary union. The Asian Central Bank will be responsible for stipulating and implementing the policies of the single currency

9 II Policy Recommendations 1 We would like to conclude this paper with four policy recommendations, based on the research papers, the workshop in Seoul and the symposium Regional economic co-operation in Asia: Challenges for Europe in Vienna ( the Vienna symposium ), held by the Vienna Institute for International Economic Studies (WIIW) in cooperation with the Japan Center for International Finance (JCIF). In order to enable Asia to establish itself as a growth center of the world again and to contribute to international stability, we need further cooperation. (1) Recognize the importance of surveillance Surveillance is important from three viewpoints and it is essential for leaders in the region to have a common understanding of these three points. First, surveillance contributes to crisis prevention by enabling participating countries to conduct candid exchanges of views on their peers, detect early signs of economic vulnerabilities, and adjust policies to reduce likelihood of a crisis. Second, surveillance makes it easier for countries to prescribe appropriate remedies for crises, once they occur. It is impossible to prevent all crises in the complex world of today. However, when surveillance is carried out adequately and regularly, then countries may react to such crises without a big delay and with correct remedies. Third, surveillance strengthens institutional capabilities in the region. In order to make surveillance more credible and policy recommendation more reliable, it is important to build institutions and capacities. Surveillance accelerates this process for gathering statistics and analyzing them in the region. In this regard, it should be emphasized that Korea recognized the importance of an early warning system ( EWS ) and started to develop it shortly after the Asian crisis. Korea has been developing its own EWS not only on a national level but also on a regional level. Yet more improvement and experience are necessary. We think EWS is valuable, since it provides a tool for policy makers to understand market conditions and detect the economic weaknesses of countries. (2) Start with ASEAN+3 as a basis for surveillance in East Asia The main finding of the Vienna symposium is that the time is ripe for regional cooperation in East Asia. The summary of the symposium says: While in the past the existing disparities in incomes, ethnicity, religion, political systems etc. were considered to rule out prospects for meaningful economic co-operation in Asia, the view has changed dramatically since the Asian financial and economic crisis of 1997; closer co-operation is now considered an important factor of greater stability in the region. 1 The opinions are those of the authors, not of the participating scholars in this project, and do not represent the opinion of the PRC, Korea or Japan

10 We also came to the conclusion that East Asia is an appropriate area for regional cooperation and ASEAN+3 is a good platform for such financial cooperation. ASEAN+3 is a region bound historically and geographically. Based on the fact that real sector integration of trade, labor and capital movement is progressing and with the common experience of the Asian financial crisis of 1997/98, financial cooperation is now more realistic and imminent. ASEAN+3 is building up a framework for financial cooperation in the region, namely the Chiang Mai Initiative, a financial facility with swap agreements among member countries. For this facility to function effectively and prevent crises, surveillance and peer pressure should be in place. In turn the existence of this financial facility gives member countries good incentives to cooperate on regional surveillance. We also recommend a realistic approach. ASEAN+3 has member countries with a range of economic development. At the first stage of regional surveillance, it would be realistic for Indonesia, Thailand, Malaysia, the Philippines and Singapore to join the surveillance mechanism with the PRC, Korea and Japan, and for other ASEAN countries to build their capacities through technical assistance to enable them to conduct effective surveillance. (3) Set up an ASEAN+3 Surveillance Secretariat The surveillance process should focus on the following three points: The first is the monitoring of the macroeconomic and structural policies of member countries and capital movements, which affect foreign exchange rates of the member countries currencies. The second is the improvement of statistics in terms of coverage, frequency and accuracy. The third is the strengthening of financial and capital markets in the region. An independent secretariat should be established for regional surveillance activity. The ADB and other organizations like the Manila Framework Group, APEC and EMEAP are already conducting regional surveillance. However, these organizations have different foci, have not been conducting adequate surveillance, and have not been supported by strong technical staff. It is important that professional economists support the surveillance process. Economists from within and outside of the region should be recruited at the secretariat and they should work independently of the political interventions of member countries. The secretariat should be established soon. The long history of EU surveillance shows that building a surveillance process cannot be achieved overnight but needs many years of effort. It is important, therefore, to start the process now, and to accumulate experience and knowledge over the years. The ASEAN Surveillance Process and the ASEAN+3 Surveillance Secretariat should maintain consistency and coherence with each other. The two might eventually be merged into a unified operation. It is also essential that the Surveillance Secretariat maintain constant dialogue and good working relationships with the international financial institutions ( IFIs ). A periodical exchange of information and views with the IFIs is essential for the regional -240-

11 surveillance system to function effectively and efficiently. In this way the ASEAN+3 Surveillance Process can complement the existing IFIs. It is also important that the Surveillance Secretariat and member economies maintain constant dialogue with the private sector. This would strengthen communication channels between the officials and the private sector, contribute to the strengthening of financial markets in the region, and help contribute to crisis prevention, management and resolutions. (4) Political leaders in the region should develop a long-term vision We emphasize the importance of having a long-term vision for regional cooperation. A long-term vision of political leaders would serve to guide and motivate current and future generations. We propose to set up a policy forum in the region. This forum will be a working group to prepare a long-term vision and will consist of specialists from the official and private sectors including academics, policy makers and business leaders in East Asia. Deeper integration depends on true reconciliation among members, in particular the PRC, Korea and Japan. As is pointed out by the Vienna symposium, it would also be essential for the three, as core countries in East Asia, to lead the process of economic and financial integration, as France and Germany played a central role in the integration of Europe. A realistic and at the same time a targeted approach will be desirable. The policy makers, academics and practitioners in the region should aim at a long-term consensus and then set out a stage-by-stage approach. A long-term view could be to aim for an economic and monetary union in the region in 30 years. Then the question arises --- what should be done in 5 years or 10 years? Discussion would start and deepen in due course. Though reaching a consensus view in East Asia may not be easy at this early stage, many possible targets and possible paths to them must be discussed. Deepening discussions in the region in this manner could be very effective. With a persuasive vision it would be easier to gain public support to make cooperation more effective