The NEAT Working Group on East Asian Financial Cooperation organized a meeting on East Asian Financial Cooperation in Shanghaifrom April 1 to 2, 2005. The participants included scholars and experts from 11 of the ASEAN +3 countries (Brunei and Cambodia were absent). Ambassador Wu Jianmin, NEAT Co-Interim Coordinator and China's Country Coordinator, moderated the discussion. The discussion was candid, fruitful, and down to the earth. It focused on the present situation concerning East Asian financial cooperation, the main obstacles, and the ways for strengthening such cooperation.

The most important consensus reached at the Meeting is that it is high time that East Asian nations took practical measures for financial cooperation. As a Track II process, NEAT has the responsibility to build on this consensus. Based on the common understanding of the current situation, participants of the Meeting put forward their policy proposals in the hope of promoting the financial cooperation in the region.

 

I. Three Outstanding Issues in the Region's Economic Development

 

1. A high level of economic growth and a low level of risk-fighting capability. East Asia has witnessed a rapid economic growth. The growth rate of East Asia's GDP reached over 7% in 2004, exceeding not only the world average, but also that of the two major economies – NAFTA and EU. It is the most dynamic region in the world. The economic dynamic, however, has not been accompanied by the expected capability of fighting risks. Some of the important factors that caused the 1997 financial crisis have continued to exist. Underdevelopment of an internal financial market and insufficient exchange rate mechanisms are among the factors that keep our risk-fighting capability at a low level. The continued depreciation of the US dollar has made these defects more conspicuous, further exposing our inadequacy in risk-fighting. People expect Asian currencies to be appreciated and a lot of hot money is flowing into the region. The risks are there.

 

2. A high level of foreign exchange reserves and a low level of utilization efficiency. In the past few years, the foreign exchange reserves have soared up. By the end of 2004, the figure reached close to 2.3 trillion US dollars. Only in four years, it has more than doubled, accounting for 2/3 of the world total. It is true that the high level of foreign exchange reserves has made East Asia more competent and laid a more solid foundation for financial cooperation. But at the same time, it is not used effectively. In addition to the low return rate, the continuing depreciation of the US dollar has caused a huge loss to East Asian nations. It is likely that the US dollar will continue to slide. According to a rough estimation, 10% depreciation of the US dollar would cause East Asia to lose 130 billion dollars. This is tantamount to a 2% loss in East Asia's GDP. Therefore the East Asian nations, with the respect for each other's sovereignty, shall combine their efforts to improve the utilization of the foreign exchange reserves.

 

3. A high level of intra-regional trade and a low level of financial cooperation. The development of intra-regional trade is one of the most remarkable events in East Asia: It had reached 54% by 2003, ranking below the 64% of the EU, but above the 46 % of NAFTA. In recent years, trade cooperation centering on FTA has accelerated. The FTA between ASEAN on the one hand and ROK, China, and Japan on the other will be completed by 2009, 2010, and 2012 respectively. The process of East Asia FTA (EAFTA) is also under way. The more integrated the regional trade, the more need for regional financial and monetary cooperation. But the fact in East Asia is that the latter has been lagging far behind. In the past few years, especially since the 1997 crisis, East Asian nations have realized the necessity for such cooperation and made efforts to promote it. The Chiang Mai Initiative is a telling example. However, the overall level of cooperation in this field is still very low. It has increasingly become the weakest link in the process of East Asian economic cooperation.

 

II. Policy Recommendations

 

1. Strengthen and Build on the CMI

 

CMI's Swap Arrangement is the most substantial mechanism for monetary and financial cooperation in East Asia. It was a good beginning and has laid a foundation for further cooperation. Its expansion to include the 10+3 countries has produced positive results. By the end of 2004, the overall size of swap, including 16 bilateral arrangements, had reached 27.5 billion US dollars. On May 4th, 2005, a Joint Communiqué was reached at the 8th Meeting of 10+3 Financial Ministers, in which member states agreed to double the overall size of bilateral swap arrangements and subject the size of specific bilateral swap arrangement to the countries involved. Despite the commitment of CMI's Swap Arrangement to financial cooperation, its inadequacy has revealed itself along with the rapid development in other areas of economic cooperation.

 

There are some major deficiencies. Its function cannot satisfy the expanded need. Its initial design was to provide short-term liquidity assistance to solve immediate payment problems. Even for this function, its start-up procedure, which links 90% of capital to the conditionality of the IMF, is often too complicated to be effective. An agreement was reached at the recent 10+3 Financial Ministers Meeting that the percentage of the capital unlinked with the conditionality of the IMF be raised from 10% to 20%.

 

In addition, its size is insufficient. Twenty-seven billion is not enough for short-term liquidity assistance, let alone prevention and solution of other related problems in the region. Based on the experiences gained from the 1997-1998 Financial Crisis, even if the size of swap arrangement doubles as the recent 10+3 Financial Ministers Meeting has required, it still can't play its role effectively.

 

In addition, its bilateral arrangements reveal inadequacies. Since 2001, 16 bilateral agreements have been signed. An effective and efficient multilateral framework shall be set up to coordinate the 16 bilateral agreements. Such a framework is more likely to meet the need of the region as a whole and strengthen the risk-resisting capability of the East Asian nations.

 

To strengthen the CMI mechanism, three specific measures may be considered.

 

First, explore the possibility to expand the functions of the CMI such as enhancing short-term liquidity assistance, stabilizing the exchange rate, sustaining the development of the financial market and strengthening surveillance on the financial and economic situation. Thus complement the functions of the existing international financial arrangement at the regional level.

 

Second, expand the size of the CMI. The committed financial assistance from the international community during the 1997-98 financial crises was 110 billion US dollars and the size of the proposed Asian Monetary Fund was 100 billion. A reasonable size for performing the functions mentioned above is thus between 100 and 110 billion.

 

Third, set up a multilateral framework. The existing bilateral agreements need to be upgraded to a more effective multilateral framework within the 10+3 nations for facilitating the coordination and providing sufficient funds when necessary. If a member state that doesn't have adequate short-term liquidity suffers from a capital attack before the multilateral framework is built, all the countries that have bilateral arrangements with it shall make a collective decision whether to make relevant swap arrangements or not so as to avoid multiple negotiations and improve the efficiency.

 

2. Further Develop the Asian Bond Market

 

At present, the major problems concerning the development of the Asian Bond Market include institutional barriers and technical hindrances. Tight exchange control, underdevelopment of the credit grading system, imperfect settlement mechanisms, and lack of attractive investment projects have impeded the further and healthy development of the Bond Market. In 2003, the Asian Bond Market Development Initiative (ABMI) was signed and six working groups were set up, under which some actions had been taken or are going to be taken to tackle the above-mentioned issues.

 

To further develop the Asian Bond Market, the following possibilities may be explored.

 

First, enhance the coordination mechanisms. The terms of reference for the six working groups need to be expanded to include in-depth research on infrastructure development, investment opportunities, accounting systems, and information sharing. The meetings of the financial ministers and central bank governors should put this work on its agenda and coordinate the development of domestic and regional bond markets.

 

Second, increase the size. Asian Bond Fund II should be completed at the earliest possible time and expanded to 8 billion dollars to enable an increased investment in the regional bond, especially the bond issued by governments and financial institutions. Measures shall be taken to attract investors both in and outside the region.

 

Third, increase the bond supply. The Asian Development Bank may issue more bonds in denominations of local currencies or basket currency in East Asia so as to boost the regional bond market and to provide benchmark bond prices for the Bond's development. Well-performing transnational corporations are encouraged to issue regional bonds to expand the size of the bond market.

 

Fourth, enhance information exchange and surveillance. It is necessary to entrust an independent institution or use the exiting secretariat arrangements to gather information and monitor the progress of the Asian Bond Market.

 

3. Deepen the Dialogue on Exchange Rate Policy Coordination

 

Policy coordination, information exchange, and surveillance are important. At present, there exist 8 policy dialogue processes, involving financial ministers and central bank governors. They have played an important role in coordinating policies, but they perform overlapping functions. Thus the lack of coordination of these coordinating processes is itself a big problem. In addition, since exchange rate is a more sensitive issue for sovereign states, lack of institutional discipline and self-restraint seems to be a problem we have to face now. Thus the dialogue mechanism at the ministerial level and other existing process shall be strengthened for discussion and coordination on the exchange rate policy.

 

Conclusion

 

Financial cooperation is a critical, yet a very weak link in the process of economic integration in East Asia. The Meeting agreed to welcome all positive contributions to the process in the belief of open regionalism. And the Meeting was keenly aware that efforts of 10+3 should be concerted to make financial cooperation a facilitator rather than a hindrance to the regional integration.