[ppi] [ppiindia] Reserves could hasten Asian integration

** ppi-india **
Reserves could hasten Asian integration

By PRADUMNA B. RANA
Special to The Japan Times

Aside from a few indicators such as poverty levels that remain above
precrisis levels (though they are coming down), East Asia's rebound from the
Asian crisis of 1997-1998 is more or less complete. The capital-account
crisis -- which was both a currency and banking crisis -- and Asia's
increasing integration into the global financial market, with its inevitable
surges and reversals of private capital, has led the region to initiate
actions at national and regional levels to prevent a recurrence.
At the national level, structural reforms in the financial and corporate
sectors have enhanced resilience, although much more remains to be done. At
the regional level, there has been progress in initiating policy dialogue,
sharing resources and developing bond markets.

One example is the ASEAN-plus-Three Economic Review and Policy Dialogue,
under which staff of finance ministries and central banks of the 10
countries in the Association of Southeast Asian Nations plus China, Japan
and South Korea, meet twice a year to review policies.

There is also the Chiang Mai Initiative of bilateral swaps and the
ASEAN-plus-Three Asian bond market initiative, in which for the first time
actions are being taken at a regional level. Like cooperative efforts in
Europe, these efforts are designed to complement rather than compete with
ongoing global efforts.

A more advanced form of macroeconomic cooperation would involve
exchange-rate policies and a single currency, but this is not yet in sight
for East Asia. Although exchange-rate coordination would promote
intraregional trade, one of the drivers of East Asia's rebound, it is not
yet feasible because it requires macroeconomic coordination. With further
progress in policy dialogue and resource sharing, cooperation on exchange
rates will become increasingly feasible.

In addition, East Asia's accumulation of reserves -- which have more than
doubled since the crisis to an unprecedented $1.4 trillion -- could provide
a fillip to monetary and financial cooperation. Large current account
surpluses and, more recently, capital inflows and foreign-exchange
intervention policies account for the jump.

Last year, East Asian reserves rose by a whopping 35 percent, mainly due to
surges in Japan, China and South Korea. The situation has raised questions
about the optimal amount of reserves and their management.

A recent International Monetary Fund study concluded that the reserve
buildup in East Asia after 2001 has perhaps been excessive. The former IMF
chief economist likened it to "building Noah's Ark." But the optimum size of
reserves cannot be assessed by conventional economic criteria alone. In a
world of heightened uncertainties, the extra cushion provided by reserves
may be warranted.

Given the opportunity costs of holding reserves in U.S. dollars (the
difference in yields between U.S. Treasury bills and risk-adjusted emerging
market paper of similar maturity), East Asian countries are starting to
diversify reserves out of U.S. assets into Europe. South Korea has set up an
agency to facilitate this process.

So far, under the Chiang Mai Initiative, 13 bilateral swap arrangements
totaling $33 billion have been signed by ASEAN-plus-Three countries. Later
this year there could be efforts to strengthen resource sharing and
economizing by multilateralizing the bilateral swaps, with each country
earmarking reserves for member countries in case of speculative attacks.

Eventually, multilateralized swaps could be institutionalized into a reserve
pool similar to the European Monetary Cooperation Fund of the 1970s and
early 1980s. The recent Asian Bond Fund I and the soon-to-be established
Asian Bond Fund II represent further efforts toward a centralized pool.

The reserve buildup has led to calls for countries to relax their "leaning
against the wind" policies and permit more flexibility in nominal exchange
rates. In fact, one of the important lessons of the financial crisis is that
 smooth adjustment to global integration requires a judicious combination of
monetary and fiscal policies, together with greater flexibility of exchange
rates. The crisis also illustrated how devastating the balance sheet effects
of currency realignments and volatility can be, especially when the
financial sector and corporate entities are weak.

East Asian countries are, therefore, right to focus on sequencing -- more
reform of the financial sector and state-owned enterprises may be needed
before flexible exchange rates.

Although exchange rates were freed up in the aftermath of the crisis,
various studies suggest that many countries are heading back to pegging
currencies either to the dollar or a basket of currencies, while avoiding
either a hard peg or free float. They are likely to adopt an intermediate
regime based on a basket of currencies perhaps in combination with a band
and a crawl. China recently announced it is considering such a possibility.

Calls for more exchange-rate flexibility, which would mean a quicker
transition to a more flexible regime in East Asia, could provide a boost to
monetary and financial cooperation. Rising intraregional trade would provide
an incentive for other countries to follow suit in adopting a basket-pegged
regime. This could eventually lead to the East Asian region adopting a
common basket comprising the U.S. dollar, yen and the euro -- and, in the
longer term, a single currency.

Hence, the process of monetary and financial cooperation is being propelled
not only by new institutional arrangements put in place since the crisis,
but also by pressures to free up exchange rates. Integration is therefore
for real in East Asia but, as in Europe, it will likely be a slow process.

Pradumna B. Rana is director of the Asian Development Bank's Regional
Economic Monitoring Unit. His views do not necessarily reflect those of ADB.

The Japan Times: Feb. 24, 2004
(C) All rights reserved




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