Building an Asian safety net

by Michael Richardson

Asian finance ministers have agreed to build a regional safety net to help countries withstand currency weakness and avoid a financial meltdown. However, they appear to be making haste slowly when the deepening global recession demands decisive action.

Meeting in Phuket, Thailand, on Feb. 22, ministers and senior officials from the 10 member-states of ASEAN, the Association of Southeast Asian Nations, as well as China, Japan and South Korea, confirmed that a currency swap arrangement would be enlarged and extended to $120 billion, from $80 billion, with Northeast Asia supplying 80 percent and ASEAN countries the remaining 20 percent. But details on the contribution of each government remain undecided and the scheme will only be finalized at another meeting later this year in Bali.

It seems odd that 13 Asian states with more than $3.6 trillion in official currency reserves, about half the global total, are taking so long to build defenses against the financial instability contributing to the deepening economic slump.

In May last year, well before the crisis intensified, finance ministers from the ASEAN plus-3 group met on the sidelines of an Asian Development Bank meeting and agreed to link a series of bilateral currency swap arrangements. The aim was to create a pool of at least $80 billion in reserves, which could be tapped by regional nations if they needed to protect their currencies.

In November, after the global financial system had been severely shaken by the collapse of Lehman Brothers investment bank in the United States, ASEAN plus-3 deputy finance ministers discussed expanding the currency pool to $120 billion.

The arrangement is designed to ensure that central banks and monetary authorities of the 13 participating states have access to major trading currencies (chiefly dollars, euros and yen) to shield their local currencies from speculative attacks like those that depleted the foreign exchange reserves of Indonesia, Thailand and South Korea in the Asian financial crisis of 1997 and 1998.

Countries hit by the Asian crisis had to turn to the International Monetary Fund for over $100 billion in bailout loans. In return, governments had to cut spending, raise interest rates, sell state-owned companies and accept other belt-tightening measures. No regional government wants to go down that humiliating path again.

But as foreign investment dries up and exports collapse, some Asian countries are starting to feel the heat. South Korea’s reserves declined 23 percent, to just under $202 billion in the year to Jan. 31, as the central bank sold dollars in an attempt to defend the won, which lost nearly 32 percent of its value in the period. The currency reserves of Indonesia, Southeast Asia’s biggest economy, slid to just under $51 billion at the end of last month, from over $60 billion in July, as its central bank intervened to slow the rupiah’s decline.

Neither South Korea nor Indonesia are waiting for the expanded ASEAN plus-3 currency swap, known as the Chiang Mai Initiative, to be put in place. Both have worked out stand-by arrangements with other countries that have a strong stake in their stability. In Indonesia’s case, the World Bank and the Asian Development Bank, as well as Australia and Japan, have also been involved. In South Korea’s case, Japan and China have stepped in with offers of currency support.

Still, having a regional safety net for currencies would be a significant advance in Asian financial cooperation and foreign exchange coordination. However, Asian Development Bank President Haruhiko Kuroda told the finance ministers meeting in Phuket on Sunday that a multilateralized and expanded Chiang Mai Initiative would only be a critical first step if it was put into operation quickly.

A bigger question is where the regional currency swap might lead: to an Asian Monetary Fund and a common currency in an increasingly integrated pan-Asian economy? Asian supra-nationalists would like to move in this direction. However, they know that it took Europe 50 years to come together in a monetary union and that Europe had to overcome significantly less political, economic and cultural diversity than in Asia.

Political disarray in Thailand, which is the current chair of ASEAN, has delayed the complex process of completing the regional currency swap program. But behind the scenes, a bigger game is being played by China and Japan for regional leadership and influence.

Between them, the two Asian giants control about $3 trillion of the ASEAN plus-3 reserves. China, with nearly $2 trillion, now has double Japan’s reserves. In the Asian financial crisis just over a decade ago, Japan was the region’s financial and economic top dog. Tokyo proposed that an Asian Monetary Fund be set up to rescue the region, but this was blocked by the U.S., the IMF and China, among others.

In the current crisis, Japan is supporting an expansion of the IMF’s global role as a lender of last resort to governments in financial and economic trouble. Last Friday, Tokyo signed an agreement to offer up to $100 billion in extra funding to the IMF, which has eased its lending terms in some cases and wants to double its lending pool to $500 billion, from $250 billion in case it has to backstop more countries.

Meanwhile, China has refused to allocate any of its huge reserves to the IMF, arguing that the organization should first be reformed to increase the influence of developing countries — and reduce the power of the U.S., Europe and Japan.

Michael Richardson is a visiting senior research fellow at the Institute of Southeast Asian Studies in Singapore.