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Financial regionalism and the rebalancing of global economy

The integration of markets on a regional and global basis seems to have motivated the evolution of regional economic arrangements designed to maximize the benefits, as well as to reduce the risk of a globalizing economy

John A. Prasetio (The Jakarta Post)
Jakarta
Tue, April 20, 2010

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Financial regionalism and the rebalancing of global economy

T

he integration of markets on a regional and global basis seems to have motivated the evolution of regional economic arrangements designed to maximize the benefits, as well as to reduce the risk of a globalizing economy.

Within East Asia, the share of intra-regional trade was around 55 percent in 2007, and post global crisis, it is expected to continue to be rising steadily.

In developing Asia, deepening economic integration has been in part driven by linkages through regional production network as a result of global strategy of multinational corporations.

In North East Asia, intra-trade among China, Japan and Korea has become quite intense. They have become the most important or the second most important trading partner with each other.

While a de facto real sector integration has been quite advanced, financial integration in East Asia is still at an early stage. The volume of intraregional autonomous capital flows as well as cross border portfolio investment is relatively limited compared with that of North America or the EU.

Partly because Asia financial markets are mostly underdeveloped, a substantial portion of Asia’s savings has been invested outside the region and recycled back through the intermediation of financial centers outside the region. The cost of such intermediation through global financial centers is well over 300 basis points.

Following the collapse of Lehman Brothers in the US in September 2008, a crisis of confidence and a decline in risk appetite spread all over the world. As a consequence, many countries in East Asia experienced a sudden reversal of capital flow, and a drying up of foreign funds, which put substantial pressure on their currency and stock markets. As trade finance contracted sharply, cross border trade activity was also disrupted significantly.

Indeed, a notable feature at the beginning of the global financial crisis was the ability of the US to temporarily drain foreign capital from all over the world as its banking sector began with the de-leveraging process. As a consequence, a range of emerging economy sovereigns and corporates in Asia for a few months’ period lost most of its access to international funding from outside the region.

Although the global financial crisis has now been under control, the experience of financial meltdown toward the end of 2008 was a stark reminder to most countries in East Asia on the need for regional collaboration to reduce the country’s vulnerability to financial contagion, and to enhance their capacity to keep a regime of stable exchange rate.

Effective March 24 this year, under the Chiang Mai Initiative Multilateralization (CMIM), a total size of currency swap arrangements of US$120 billion has been made available to provide ASEAN+3 countries and Hong Kong with a framework of mutual assistance to safeguard against the risk of short term liquidity difficulties.

Indeed, this CMIM is by far the most important milestone in the process of establishing an East Asian financial architecture. To support the implementation of CMIM, ASEAN+3 Finance Ministers have agreed to put in place an independent regional surveillance unit to be operational by early next year.

Not less than Ben Bernanke, chairman of US Federal Reserve Board, who had come to suggest that the issue of savings glut and investment drought in the East was a root cause of global financial imbalances. He also argued that massive surpluses of savings piled up in one place could impose unemployment on the rest. Indeed, there is more or less a consensus that global imbalances in trade, savings, investment and debts were partly responsible for the recent global financial crisis.

Unfortunately, despite efforts of a number of Asian economies to reconfigure its development model to focus more on domestic consumption, and the drive for America to live within its means, the build up of global imbalances seems to persist, raising concern that a more severe disorderly unwinding may still take place in the future.

Currently, Asia lends, America borrows. Asia produces and exports its products, America consumes and import goods from Asia. While America attempts to reduce its huge national debt and spending, many Asian countries continue to be holding large quantities of US government bonds for their savings. According to a recent UBS report, around 65 percent of China’s reserves are in dollar assets.

Indeed, in emerging Asia, the official sector is a net exporter of capital which it directs primarily toward safe, liquid assets, obviously with low yields, whereas the private sector is a net importer of risk capital from outside the region, obviously at premium rates.

Insofar as financial markets in Asian countries are relatively underdeveloped, the corporate sector will continue to depend upon loans and capital from outside the region, and the official sector will continue to seek for safe, liquid assets outside the region.

In their Hanoi meeting in early April 2010, the ASEAN+3 Finance Ministers have actually agreed to further develop the Asian Bond Fund and the Asian Bond Market Initiatives (ABMI) as a way to encourage the recycling of Asian savings efficiently into Asian investment. In fact, they have recently proceeded with the establishment of the Credit Guarantee and Investment Facility as a trust fund of the Asian Development Bank aimed to make it easier for firms to issue local currency denominated long-term bonds.

Further, ASEAN Finance Ministers have also pledged to renew their commitment to implement the new roadmap of the ABMI, which includes steps to promote dual listing of securities and cross border offerings of debt securities, a review of withholding tax issues affecting regional capital market development as well as harmonizing financial rules, accounting and auditing standards, among others.

The progress in the building of infrastructure to facilitate bond trading and increase the size and liquidity of bond markets has been uneven throughout Asian countries. In addition, Asia lacks regional investment bank to help increase the volume of intra-regional cross border capital flows, and to support Asian economies seeking to raise funds for their development projects.

In fact, the flows of savings from Asia to the West such as in the US Treasury Bills have always been mediated by Wall Street. By the same token, Asia corporate sector funding from outside the region was significantly mediated by Wall Street.

Maintaining the status quo of a fragile financial system with a high degree of dependence upon global financial centers appears not to be a sustainable policy option for Asia. There is an urgent need for Asia to broaden and deepen its to circulate Asia savings within the region to meet Asia’s investment requirements and to boost its spending.Asia also needs to further promote regional financial integration to mitigate its vulnerability to financial contagion from outside the region. Advancing the CMIM as a platform to enhance financial stability is therefore a matter of common regional interest. It is true that greater financial integration in Asia will help create a more stable financial world and also help rebalance the global economy, and thus benefit both the region and the world.

Maintaining status quo of a fragile financial system with strong dependence on global financial centers is not a sustainable policy option for Asia.


The writer is deputy chairman of Kadin Indonesia for International Economic Relations, Chairman of the APEC Business Advisory Council (Indonesia), and a board member of East Asia Business Council.

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