Asian Monetary Fund, Take Two

Posted June 18, 2008 

So they finally did it. On May 4 the finance ministers of 13 East Asian countries agreed on the sidelines of the annual meeting of the Asian Development Bank in Madrid to set up a pool of foreign-exchange reserves. The member countries of the Association of Southeast Asian Nations together with China, Japan and South Korea decided that at least $80 billion of the region’s foreign reserves are to be funneled into a regional fund to protect regional currencies against speculative attacks and provide countries in crisis with liquidity. Of the funds, 20% are to be provided by the 10 Asean members and the remaining 80% by the “Plus Three” countries (China, Japan and Korea).

The idea for this regional pooling mechanism, which apparently doesn’t have a proper name yet, goes back to a proposal that was launched by Japan during the 1997 Asian financial crisis. In August of that year—just weeks after the outbreak of the crisis in Thailand—the Japanese government proposed the creation of an Asian Monetary Fund as a framework for financial cooperation and policy coordination in the region. The AMF, which was to be endowed with $100 billion of central bank reserves, was envisaged as a lender to countries in financial distress and a complementary means of defense against financial crises in East Asia. The AMF proposal was well received by several Asian countries, including Malaysia, the Philippines and Thailand. But after massive opposition from the United States Treasury and the International Monetary Fund—which saw the AMF as an agent of conflict and a danger to the IMF’s role in the region and the world—the Japanese government withdrew its proposal.

But the idea of an AMF was revived when the Asean finance ministers met with their Plus Three counterparts on the occasion of the annual meeting of the ADB in May 2000, in Chiang Mai, Thailand. Instead of a fund, they established a system of bilateral short-term financing facilities within the group. This agreement, called the Chiang Mai Initiative, provides for mutual assistance in the event of a financial crisis. The CMI consists of an expanded Asean swap arrangement that includes Asean and a network of bilateral swap arrangements among Asean Plus Three countries. The Asean swap arrangement is now $2 billion in size, while 17 bilateral swap arrangements have been successfully concluded among eight countries with a combined total size of $83 billion. In May 2007, at the 10th Asean Plus Three finance ministers’ meeting in Kyoto, ministers agreed to further develop the CMI and in particular seek multilateralization of the arrangement. This is what just happened in Madrid, potentially transforming the CMI into what the Japanese originally had in mind when they proposed the AMF back in 1997.

The prospects for success are much greater this time around. Not only is the region currently in a position of economic strength, much in contrast to the late 1990s when it got hit by the Asian crisis. East Asian countries can now also look back on a 10-year history of financial cooperation, which has helped, at least partly, to overcome suspicion among East Asian countries and foster general agreement on the usefulness of such a fund. Whereas China, for instance, was highly skeptical of the original AMF proposal as it feared a Japanese quest for regional dominance, it has become one of the main supporters of the CMI. (Allegedly, U.S. emissaries tried to strengthen Chinese fears of Japanese dominance to secure Beijing’s opposition against the AMF plan.) Since 2001, the Asean Plus Three countries have not only launched the CMI, they have also established an Economic Review and Policy Dialogue for exchange of information between governments and better monitoring of developments in the region’s financial market as well as the Asian Bond Market Initiative to foster development of securities markets in the region. Although each of these initiatives might be limited in scope, it is beyond question that regional financial and monetary cooperation has gained momentum.

Moreover, East Asian countries have greatly improved their diplomatic skills. Whereas integrationist rhetoric at times had a rather confrontational tone, East Asian policy makers nowadays like to emphasize that any regional cooperation efforts shall only complement cooperation on a global level. To avoid a second clash with the U.S. government and soothe fears that a regional fund would undermine the IMF’s role, the region has carefully avoided any wording or action that could give rise to such concerns. When the CMI was discussed, for instance, the Asean Plus Three finance ministers made sure that the CMI was not perceived in Washington as a threat to the IMF. To ease concerns that the IMF’s position would be damaged, the ministers agreed to include an “IMF link,” which allowed only 10% of the credit lines to be disbursed without the borrowing country having a lending program with the IMF. In 2005 the portion that could be disbursed without IMF program was increased to 20%. This gradual approach to developing something similar to a regional fund has made it hard for the U.S. government or anyone else to oppose the CMI, especially as the sums involved so far are relatively modest.

But also the U.S. government has moved and changed from a negative to a more neutral attitude toward East Asian monetary integration. This change in attitude can be attributed to the realization that any attempt to undermine East Asian monetary and financial cooperation would only backfire and further diminish the reputation and influence of the U.S. and the IMF in the region, which have already been tarnished since the Asian crisis. Also, with China’s ascent, the U.S. would rather see a regional monetary fund where Japan, its most important ally in East Asia, is involved rather than an agreement solely centered around China.

So does that mean the path forward is clear for an AMF? Maybe, but the Asian finance ministers still need to agree on the details, which might prove tricky. In the statement they released after the Madrid meeting, the they concede that they still have to “further accelerate…work in order to reach consensus on all of the elements which include concrete conditions eligible for borrowing and contents of covenants specified in borrowing agreements.” In other words, they might have agreed on the general line, but now they have to get down to the nitty-gritty. And as always, the devil is in the details.

Borrowing conditions and the contents of covenants are the most important aspects of such an agreement, and also the most controversial. Every lender wants to ensure that he or she gets repaid, thus ruling out moral hazard through a straightforward lending agreement is key. The IMF has always been blamed for tough lending conditions and interference in its borrowers’ sovereignty. Parts of the idea for creating a regional alternative to the IMF was exactly to make it easier for countries in crisis to quickly access liquidity. Still, the main contributors to the pooling arrangement—Japan, China and South Korea—will want to make certain that their money is not recklessly misused.

Assuming they succeed in agreeing on an arrangement that all Asean Plus Three countries can live with, a last question remains: what is the purpose of all this? One of the original criticisms that was directed at the Japanese AMF proposal was duplication of institutions, i.e., why would you need a regional fund when there already exists an International Monetary Fund? The answer back then, at least by supporters of the AMF idea, was that a regional fund would provide a second line of defense against crisis and that the specific regional expertise of AMF staff could help identify a looming crisis before it breaks out. Ten years after the Asian crisis the situation looks very different. Most East Asian countries experience current-account surpluses and have turned into net creditors. Central banks are hoarding foreign-exchange reserves, and most countries have loosened their exchange-rate links to the U.S. dollar.

East Asian currencies today are facing appreciation pressure, and a currency crisis seems unlikely. At a time when the East Asia region boosts with cash and the IMF is running out of lending business and its very existence is constantly being questioned, one might thus be inclined to ask: Why need two funds to watch over East Asia, a regional and an international, when already one is too much? Hasn’t demand for IMF credit dried up completely so that the once mighty Fund had to start laying off staff? And aren’t we regularly told that with the sums traded in today’s foreign-exchange markets IMF credit lines would be nothing but a drop in the ocean?

It is true that East Asia today cannot be compared with the East Asia before the 1997-98 financial crisis. The region has become much more resilient and even the U.S. subprime crisis doesn’t seem to have any significant impact on the East Asian economies so far. Still, before the Asian crisis occurred, most observers were lulled by stories about the East Asian miracle so that the crisis caught them by utter surprise. It is not only wise but paramount that policy makers think ahead and take precautions for bad times while times are good. Therefore contemplating appropriate crisis responses when no crisis is in sight is just the right thing to do and might even help to ensure the crisis will never arrive. Asean Plus Three finance ministers and central bankers are thus well advised to strengthen their efforts in developing an early warning system and crisis response mechanisms. If a regional monetary fund is part of such a package, it is hard to see why this should harm; East Asia needs more financial and exchange-rate cooperation, not less.

It is also hard to see why a regional fund in East Asia should undermine the IMF’s position. The World Bank is also coexisting with institutions such as the Asian Development Bank, the African Development Bank, the Inter-American Development Bank and the European Bank for Reconstruction and Development. Similarly, regional pooling arrangements have been in place in several other regions for years, without any notable problems between the IMF and arrangements such as the Latin American Reserve Fund, the North American Framework Agreement, the Arab Monetary Fund or the European Union Medium-Term Financial Assistance Facility. Indeed, competition between these arrangements and the IMF might not only lead to better availability of emergency lending in a time of crisis, it could also spur a competition for ideas.

It still remains to be seen if and when Asean Plus Three will eventually create a full-fledged regional fund, and whether the sums involved would exceed the currently envisaged $80 billion to make it really relevant. But for all one can tell now, most East Asian leaders have come to understand the importance of better regional economic cooperation. A regional monetary fund, if properly designed, could be a helpful means for strengthening cooperation and financial stability in the region.

Mr. Ulrich Volz is senior economist at the German Development Institute.