Advantages of a regional monetary fund

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By Yang Mu and Chen Shaofeng (China Daily)
Updated: 2009-06-12 07:49

The meeting of finance ministers of 10+3 (ASEAN plus China, Japan and the Republic of Korea - ROK) in Bali, Indonesia, on May 3 decided to set up a $120-billion East Asian foreign reserve (EAFR) to provide loans to member states in times of economic difficulty. China's contribution to the fund would be $38.4 billion, with an equal amount coming from Japan. The ROK will contribute $19.2 billion, and the 10 ASEAN members, $24 billion.

THE EAFR is similar to the International Monetary Fund (IMF) and aims at stabilizing foreign exchange rates and adjusting temporary disparities in the balance of payments of its member states. Hence, many experts regard it as "East Asian Monetary Fund".

But the EAFR differs from IMF's principle of "the more a country contributes, the more capital it can withdraw", which favors rich economies. China and Japan both have agreed that they will not be able to withdraw more than half their contributions, but the ROK can withdraw the same amount as it contributes. And ASEAN countries would be able to withdraw 2.5 to 5 times their contributions. Hence, the EAFR is designed to strengthen ASEAN countries to counter foreign exchange risks and boost their development prospects.

The Asian financial crisis has left a lasting impression on Southeast Asian countries. When ASEAN countries turned to the IMF for loans, they had to accept harsh conditions such as curtailing government spending, raising interest rates and selling State-owned companies, which further hurt their economies.

In fact, as early as September 1997 the then Japanese finance minister had proposed setting up an "Asian Monetary Fund (AMF)", which could be used to help countries during a currency crisis. But inadequate fiscal capabilities of East Asian countries at the time forced them to borrow a large chunk of the capital for "AMF" from the international capital market. And then the proposal faced a wall when the US and the IMF objected to it.

A decade on, the subprime mortgage crisis has seriously undermined the US financial market. To help address the liquidity shortage, the US Federal Reserve and the Treasury have to spend billions of dollars, and US and European firms have either sold or are trying to sell their overseas assets. It is almost certain that the US dollar will depreciate in the mid- to long-term, though in the short-term deleverage efforts of financial institutions might increase its strength. The effect of a strong dollar aggravated the financial crises of many small- and medium sized countries and some emerging nations.

When the IMF could no longer help, some countries realized the need of an "AMF". Although at the G20 Summit in April, countries agreed to contribute extra funds to the IMF to enlarge its coffers to $750 billion, the global monetary body still looks much poorer compared with the almost $4-trillion foreign reserves of East Asian nations.

But East Asian countries should be aware that without an organization like a monetary fund, their huge reserves can not protect them against a financial crisis. Because of the flight of foreign investment, a sharp drop in exports and financing difficulties in the world financial market, the central banks of the ROK, Vietnam and other East Asian countries had to sell their dollar assets. As a result, by the end of January this year, the foreign reserves of the ROK had shrunk by 23 percent and that of Indonesia from more tnan $60 billion in July 2008 to $51 billion.

To avoid a repeat of such a predicament, the 10+3 special finance ministers' meeting in Phuket, Thailand, decided on February 22, 2007, to expand their regional foreign reserves from $80 billion to $120 billion. And Consensus was reached on the specific fund-raising scheme during the Bali 10+3 meeting last month. In a way, the global financial tsunami expedited the EAFR scheme. To push the scheme to fulfill its goal, more agreements are needed to address three key problems.

First, benign interaction among all the 10+3 members is necessary. The 10+3 formation has proved that ASEAN has to be in the driver's seat, and to retain its position it has to push forward the East Asian cooperation scheme, making it the most crucial promoter and facilitator of East Asian cooperation.

There are similarities between East Asian cooperative mechanisms and post-World War II global cooperative arrangements, which included those of the UN, World Bank, IMF and the World Trade Organization (then called General Agreement on Tariff and Trade). For instance, the 10+3 summit is concerned about regional security and stability in East Asia, while the Asian Development Bank's aim is to alleviate poverty and promote infrastructure construction in the region.

On a similar note, the EAFR is designed to preserve financial security and stability of regional foreign exchange rates, while the East Asian Free Trade Agreement is aimed at setting up a free trade area in East Asia.

The selection of the chief executive and site of the headquarters of the above institutions, if considered individually, would be a difficult political issue to resolve. But consensus could be reached through equal participation and rotating administration. As the largest shareholders of the ADB and EAFR, China and Japan could be suitable candidates to take turns to fill the top administrative positions of the two organizations.

Second, the EAFR should be more proactive. The world now seems to be stepping out of the financial crisis. East Asian countries may feel less inclined to borrow urgent loans from the EAFR. Nevertheless, a timely and responsive reserve cannot only prepare East Asian countries for potential crisis, but also provide a platform for them to have a larger say in the world monetary market.

East Asian countries hold huge foreign reserves and US Treasury bonds, and hence they need a platform to help protect their interest as creditor nations. There is also a need to look into the necessity of having a common floating exchange rate system to cope with a likely sharp depreciation of the US dollar and promote the setting up of an East Asian free trade area.

Third, though the EAFR has IMF-like cooperation programs, it should tread a distinct path. Indeed, the IMF can be a useful reference for the EAFR in aspects such as funding structure, share distribution, loan issuing methods, risk prevention, decision-making and monitoring means. So the EAFR can collaborate with the IMF in issuing early warnings and in preventive and salvation efforts to help stabilize the world financial system.

But as seen in previous financial crises, the IMF's mechanisms are not without defects. First, neither the IMF nor the US or the European Union can be fully relied upon at crucial moments. A more independent regional self-rescuing mechanism is needed. Second, East Asian countries are in a disadvantageous position because of their over-dependence on the US dollar under the dollar-centric international monetary system. Third, emerging economies do not have a say in the IMF. And a systematic overhaul of the IMF in the short-run is unrealistic given strong opposition from vested interests.

Yang Mu is senior research fellow at East Asian Institute (EAI), National University of Singapore. Chen Shaofeng is visiting research fellow at EAI.

(China Daily 06/12/2009 page9)