East Asia and the Financial System

The Roles of Global and Regional Institutions
The International Monetary Fund. The IMF should and will remain at the center of the international financial system. But it needs to become more representative, more focused in its role, and more flexible in its surveillance processes.

Effective IMF crisis management and prevention requires surveillance. Legitimacy is essential to surveillance. The legitimacy of the Fund suffers from several flaws. Its governance is unrepresentative, not adequately reflecting the distribution of global economic power. Of the Fund’s 182 members nearly two dozen are “systemically significant” to the world economy. But the Fund is currently largely governed by the G-7, mainly the United States. Some important economies, notably Taiwan, are not even Fund members. Moreover, the Fund’s Interim Committee, which performs both institutional governance and surveillance of the international monetary system, has become known as a talk shop. In September, it was finally to some extent refocused and renamed the International Monetary and Financial Committee (IMFC).

The IMFC should be more of an executive committee for the world economy and for crisis management. A new group, the G-20 consisting of the G-7 and a small group of systemically significant economies including China, Indonesia, and South Korea, may set the stage for this to happen. The G-20’s mandate is to promote informal dialogue on key issues and promote cooperation. Its Chair also sees it complementing and coordinating efforts in other forums and overseeing the technical work of the Financial Stability Forum. The political significance of this group should not be underestimated. It could be a modest forerunner for a much needed, globalized G-7.

The surveillance process also needs to become more decentralized within the IMF. As the G-7 has found, informality and frankness are the most highly valued attributes of the surveillance process. These become more difficult as group size increases. To avoid this problem, smaller forums operating on their own might be considered. These would be linked to the IMF in order to secure the basic information needed for surveillance.

The IMF constituency structure could be revised to promote consultation among neighboring countries since these are most likely to be affected by bad policies. Two possible groupings, based around the world’s two major currencies, might be considered: one consisting of Europe, the Middle East and Africa, and the other consisting of the APEC economies including the Americas, East Asia, and South Asia. There is some danger that this division might increase regional awareness at the expense of the global economy, but the more intimate structure may encourage wider involvement and deeper commitment to consultation, policy cooperation, and early warnings of potential crises.

The decentralization of surveillance, more emphasis on strong national financial systems and clearer rules for private capital market participants in crises, in turn, would set the stage for a more focused, smaller IMF in several respects. It could refocus on its traditional concerns about macroeconomic performance and the sustainability of exchange rate systems. It should expand its role in surveillance of national financial systems and their regulation. It would determine whether a crisis is brewing and would still provide capital for crisis-hit countries. This, however, would be clearly for purposes of short-term liquidity, not the large-scale bailout of financial institutions.

Regional Institutions. If this might be the IMF role, does there need to be an “Asianization” of the regional financial system as some have suggested? There are several arguments to be considered. First, as mentioned, is the potential for a stronger Asian voice in the international financial system. The second is the argument for regional institutions. Today, a good part of the region’s substantial savings is intermediated through the world money markets, thus contributing to both extra-regional capital outflows and inflows. These could be intermediated closer to home. A regional institution might also provide the infrastructure to underpin closer monetary cooperation and even monetary integration.

The rationale for a more influential Asian voice in international institutions is a longer-term one. As the Asian developing countries mature and become financial forces in their own right, they will eventually take significant roles at the apex of global economic leadership. This is already a prospect since most of the world’s largest stocks of foreign exchange reserves are found in East Asia.

The rationale for closer regional cooperation is developmental. Asian countries already have a strong stake in each other’s economies. Regional surveillance systems and efforts at macroeconomic cooperation will provide a better opportunity to influence the policy levers of neighboring countries. Investments in these closer relationships should also pay off in terms of early warnings of future crises and in terms of effective crisis management.

The crisis has spawned greater Asian participation in the IMF as well as other institutions. The Pacific Asian economies, except Taiwan, are represented in IMF constituencies. Those with major reserves are members of the New Arrangements to Borrow and some central bank representatives attend regular meetings organized in parallel with the G-10 central bank governors meetings at the BIS. As indicated, China, Indonesia, and South Korea as well as Japan are in the G-20. Australia, Hong Kong, and Singapore participate in the Financial Stability Forum. All are members of the World Bank and Asian Development Bank.

East Asia, however, has no “track two” financial groups (unlike trade) and a dearth of official regional financial institutions. One important reason is the lack of an accepted regional leader. Despite Japan’s economic size, it does not have an internationalized currency and its financial institutions are not strong enough to intermediate regional capital flows efficiently.

Prior to the economic crisis there were only two regional financial institutions: the APEC Finance Ministers meeting and a regular meeting of central bankers called the Executives’ Meeting of East Asian and Pacific Central Banks (EMEAP). The former had met only a few times before the crisis and dealt with everything from social safety nets to capital flows. It is a pan-Pacific rather than an East Asian institution. The EMEAP was organized in the early 1990s by Japan and Australia. It has no secretariat; rather meetings are rotated to one or another organizing bank. However, it does have a solid record of technical cooperation to develop best practice templates and build the infrastructure of central bank cooperation.

After the economic crisis, the Manila Framework Group (MFG) was convened just before the 1997 Vancouver APEC Leaders Meeting to address crisis issues and fill the vacuum left by the demise of the Japanese-proposed Asian Monetary Fund. The MFG has initiated regular macroeconomic surveillance discussions at the senior official level and discusses “financial architecture” questions such as dollar—yen fluctuations and the role of the HLIs. This is also a pan-Pacific group including the U.S. and Canada. It is regarded as a useful surveillance forum as well as a valuable link between the developing Asian economies and the G-7. It also has a link with the IMF, receiving IMF surveillance reports and reporting through its Finance Secretaries and Central Bank Governors to the Managing Director of the Fund. An Asians-only grouping consisting of ASEAN members plus Japan, China, and South Korea, known as “10+3,” has more recently gathered momentum and has an ambitious economic and non-economic agenda that reflects a regional “identity.”

Can these embryonic forms of cooperation lead to eventual monetary integration and a regional currency? Theoretical studies suggest that even today the risks of adopting one monetary policy and a regional currency still outweigh the benefits. The absence of necessary institutional and political preconditions and will for such an approach, however, dooms it in any near-term future. To realize the benefits of monetary union, countries must have similar macroeconomic policy objectives, their central banks should have some institutional similarities and be independent of political pressures; they must have similar economic structures; trade and capital markets must be increasingly closely integrated; and labor must be mobile. Although trade and investments flows are increasing, the other preconditions for a monetary union are far from being met.

If monetary union is some way off, there are intermediate options such as use of a common basket currency peg or Asian currency unit (ACU). In both these proposals, participating economies select a basket of currencies based on trade shares with major trading partners and peg to that basket and to each other’s currencies. The common basket would suffer from some of the same problems as de facto pegs, as the yen and US dollar shares in the basket would be large. The ACU proposal is more flexible in that, like the ECU, each country’s currency would be pegged to the common currency unit. This could be composed of the yen, dollar, euro, and home country currencies. Or it could be composed only of the home country currencies and linked to a currency basket of the yen, dollar, and euro. This link could be within an exchange band. Thus monetary authorities would be obliged to intervene in foreign exchange markets to keep their home currency exchange rates within a band against the ACU and each other. They would also intervene to keep the ACU in a band relative to the yen/dollar/euro basket.

Without a regional monetary institution, it would be difficult to undertake this second stage of intervention. It is also difficult to see markets finding such an arrangement understandable and credible, and thus an improvement over the status quo.

The above discussion suggests that although regional financial architecture is still rudimentary, considerable work is underway and the road map is fairly clear. Further steps will be needed as national and regional institutions mature and deepen. These steps will be essential to the development of the regional institutional structures that are required to proceed with monetary integration....