Asian Financial Integration: Next Steps

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Asian Financial IntegrationNext Steps

• Andrew Sheng
• 10 May 2006

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Contents of Presentation

• Review of Progress to Date
• Review of Literature and Views to Date
• Assessment of situation
• Roadmap to Integration
• Risks and Opportunities

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Regional IntegrationSource Padao-Schioppa
(2005)
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Current Status Four PillarsKuroda ( ADB, Dec
2005)

• Sub-regional Cooperation connecting through
  bridges, ports, roads
• Money and Finance Chiangmai Initiative (CMI)
  ABF1 2
• Trade and Investment - FTAs
• Provision of Regional Public Goods funding is
  lacking

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Regional Features ComparedJapans financial
assets are twice rest of Asia put together
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Evolution of Economic IntegrationMario Lamberte
(ADB, 2005)
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Degrees of Integration

• Political Integration the EU Route
• Trade Integration NAFTA Route
• Financial Integration
• Harmonization or
• Mutual Recognition?
• Monetary Integration
• ACU basket of Asian currencies or
• Single currency?

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Financial Integration still early daysde Brouwer
and Corbett (ANU, Oct 2005)

• Financial Infrastructure improving, but still
  disparate
• Savings still bank dominated
• Three advantages for financial integration-
• Internal and external pressure for financial
  reform
• Opportunities to improve access and reduce
  transactions costs for households to global
  instruments
• Stronger voice in global forums and policy-making
• Need to engage private sector in financial sector
  development and reform directions

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Capital Market Integration next stepsde Brouwer
and Allan (Australian Treasury 2005)

• Three steps in advancing cross-border activity
• Create transactions platform for cross-border
  financial trade
• Agree on common standards and principles
• Remove legal or informal restrictions
• Three Constraints
• Lack of political will
• Reluctance of private sector to be involved
• Limited capacity to analyze, formulate and
  implement any consensus on direction, sequencing
  and process

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Market-Driven Regional IntegrationSakakibara and
Yamakawa (Keio Jun 2003)

• Integration in Europe and Asia followed different
  paths. EU was politically driven
• Regional integration is being driven by market
  driven supply chain integration, rather than
  explicit policy
• Japan and China have central roles in this
  production networks
• Asian crisis demonstrated vulnerability of Asian
  financial system and lack of global lender of
  last resort
• Crisis demonstrated that IFIs APEC/ASEAN not
  much help in stopping contagion

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Need for Regional InstitutionSakakibara and
Yamakawa (Keio 2003)

• Asian institution will be countervailing force to
  non-Asian dominance of IFIs and increase global
  voice and competition
• Market fundamentalism in IFIs lack local
  knowledge
• Regional institution can push necessary
  structural reforms essential for regional
  integration EU institutions are strong example
  to transform projects into reality
• If there is no credible global lender of last
  resort, and sole reliance on reserves is
  inadequate, regional cooperative solution can
  help
• Asia needs to integrate to balance strong EU and
  NAFTA politically and economically

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Consensus Building ASEAN-way

• Consensus decision-making, accommodation of
  interest of others,
• Non-interference in the internal affairs of
  neighbours
• Enhancing political stability and neutrality

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Benefits of Asian Bond MarketsMasahiro Kawai
(ADB Institute Oct 2005)

• Deep and liquid Asian bond market can solve
  double mismatch problem currency and maturity
  mismatches
• Local East Asia currency bonds rose from US356
  bn in 1997 to US1.2 trn by 2003, but only 3 of
  global local currency bond market
• ABF development initiative of EMEAP, ASEAN3
  Finance Ministers, APEC Finance Ministers and
  Asia Cooperation Dialogue
• BIS involvement key to technical cooperation

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ABF1 2

• ABF1, June 2003 US1 bn, invested in sovereign
  and quasi-sovereign USD bonds issued by 8 members
  (exc. JP, AU NZ)
• ABF2, Dec 2004 US2 bn, Pan-Asian Bond Index
  Fund (PAIF) investing in sovereign and
  quasi-sovereign local currency bond funds issued
  by 8 members
• Fund of Bond Funds with 8 country sub funds, open
  to investment by public
• 4 ASEAN3 working groups working on new
  securitized debt instruments, credit guarantee
  mechanisms, fx transactions and settlement
  issues, rating systems.

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Financial Integration challenges

• No mechanism to involve regulators in regional
  integration issues securities regulators not
  involved in ABF1 2
• Unintentional barriers against each other
  stronger than against non-Asian financial firms
  e.g. Irish bonds and Luxembourg mutual funds can
  trade anywhere in Asia, but not Asian bonds and
  Asian registered mutual funds
• IOSCO standards exist, but APRC still trying to
  devise implementation strategy, shortage of
  funding
• ASEAN beginning to look at exchange cooperation
  and market integration issues, with ministerial
  working groups set up.

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Asian Bond Corporation (Beyond ABF)Prof. Taka
Ito (Euro 50 Group, Jun 2003)

• Asian Basket Currency (ABC) initiative - Asian
  currencies issue local currency bonds. Asian
  Bond Corporation would buy these bonds, funded by
  ABC bonds. Japanese investors would like
  regional basket bonds because of yield
• As ABC moves forward, introduction of ACU would
  be more feasible.
• Outside currency share in ACU basket would be
  reduced and Asian currency share would be
  increased.

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Asian Monetary Institute as precursor to AMFK.
Fukushima (NRI, Feb 2004)

• Functions of AMI
• Provide intellectual infrastructure for ASEAN3
  cooperation
• Study and make proposals for financial
  cooperation
• Educate public and disseminate information
• Hub of a network
• Eventual creation of Asian Lender of Last Resort
  (Japan willing to take that role)

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What Next? 6 Degrees of Separation

• Sharing of Information
• Arrangements to lend money
• Improving local financial infrastructure
• Stabilize Exchange Rates
• Domestic policies adjusted to meet explicit
  exchange rate goals
• Monetary union single ACU
• Glenn Stevens (RBA, Oct 2005) we are currently
  in steps 1-3.

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Chinese ViewsYu Yongding (KIEP/PRI, Dec 2004)

• AMF 1997 was stillborn because of lack of
  communication
• China cannot consider serious regional monetary
  or financial integration until capital account is
  liberalized and internal financial fragility
  resolved
• Complete liberalization of capital account should
  be final step of Chinas economic transformation.
  If liberalization before financial house is put
  in order, the 5 swing of Chinese household
  saving deposits would be sufficient to trigger a
  currency crisis in China (Goldstein 2004)
• Main function of East Asian financial
  architecture should include exchange of
  information, promoting transparency and providing
  rescue packages.

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Chinese MoF/CASS studyYu Yongding (Dec. 2004)

• Focus of efforts in promotion of exchange rate
  coordination in East Asia should shift to
  construction of fundamentals, while studies of
  coordination are continued-
• Formal and regular dialogue on exchange rate
  policy should be introduced ASAP
• Regional exchange rate stability should be
  jointly announced. More stable exchange rate
  between USD and Yen should be achieved through
  US-Japan bilateral efforts
• Set of financial integration arrangements and
  domestic financial reform plans can be introduced
  e.g. ABF
• Regional investment bank can be introduced
• Establishing ACU would be ultimate goal, but this
  implies that East Asians are aiming at Asian
  Economic Union. This is beyond economics.

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Hong Kong viewsTony Latter (HKIMR, Jun 2005)

• Joseph Yam noted possibility of monetary union to
  strengthen regional financial stability (Oct
  2004), but AMU not formally on agenda.

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Korean viewsYung Chul Park (Korea University,
Jun 2003)

• Liquidity arrangements under CMI cannot be taken
  seriously as means to fend off future crises.
  CMI must move towards AMF despite EU/US
  opposition.
• Two basic problems in deciding whether Asian
  Monetary Integration is desirable-
• No tradition of integrationist thinking in Asia
• Status of any Asian monetary integration in world
  economy (stumbling block or building block in
  global integration?)
• Difficult to see China-Japan military conflict -
  rivalry between two will be defined by economic
  interests and politics will be put aside.

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Thai viewsThirachai (Bank of Thailand, Jun 2003)

• Five points
• Events not leading towards monetary union from
  Thai point of view. Economic integration is not
  as tight - Asians are still more competitors than
  cooperative members
• Financial integration is already high, even
  though economic integration is not.
• CMI insufficient to deal with capital flows, but
  local bond markets will help.
• ABF is to get local bond markets to become viable
  alternative to capital flows
• Real benefits of ABF will come from local
  currency bond issuance.

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AMU Next StepsTony Latter (HKIMR Jun 2005)

• Should focus only on three issues
• Construct operating framework for AMS as first
  step to AMU
• Make institutional preparations for Asian
  monetary institutions
• Examine what sort of monetary regime might
  prevail
• Three possible approaches
• An outside currency basket
• A major currency basket
• An internal currency basket

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A Modular Approach to CooperationMario Arturo
Ruiz Estrada (June 2005)
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SWOT Analysis
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Realistic Next Steps

• Discussion cannot outrun the politics
• Currently no political will, no leadership nor
  widespread support for AMU
• Common grounds-
• Fear of another crisis
• Want more say in global architecture
• But in reality, Non-Asian trade still more
  important than intra-regional trade
• Hence, more jaw-jaw and movements at the margin
  e.g. ABF3 or political agreement to accelerate
  regulatory mutual recognition as basis for
  financial integration

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Roadblocks

• Japan-China dialogue US/EU views
• Will the Asian Lender of Last Resort please stand
  up?
• Too many internal silos and institutional
  rivalries MoF, Central Banks, Financial
  Regulators, Local Lobbies
• Private sector hardly brought into picture
• No pan-Asian NGO to play catalytic role of
  researching and stimulating debate Asian
  Monetary Institute?

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Network Perspective

• Three layers Code, Infrastructure and Network
  Behaviour
• Global Codes are now available Asians can
  implement Global Codes e.g. Basle II, IOSCO
  Principles etc through mutual assistance and
  mutual recognition not harmonization
• Infrastructure Again, implementation of
  CPSS/G30, mutual recognition of Asian products
  (e.g. ETFs and ABFs) to facilitate regional
  market
• Not clear that ACU will prove to be superior
  standard vs. Euro or USD. Hence, leading
  components of ACU basket have to be prepared to
  offer substantial benefits to others for links to
  ACU to occur.

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Bottom-Line Assessment

• Conditions for AMU are not quite ready, but
  financial and trade integration already
  proceeding
• Asians need to define-
• Real benefits of AMU
• Objectives and realistic outcomes
• Strategic assessments of global fit
• Reform is a process, but for it to succeed, time
  has arrived to put issues on the table and to map
  out process to manage the roadmap, where final
  destination is still not clear.

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• Thank you. Q A