平和
和平
평화
ASIA
15 July 2014
chinese currency 1 yuan

Asia and international financial system

Asia would like to play a more important role in the international financial system. But is it ready?

Asia's economy continues to rise in strength. The region's economic and political leaders would like the region to play a bigger role in the international financial system. But is it ready?

The International Monetary Fund (IMF) and World Bank are part of the international "Bretton Woods" system created by the West following World War 2. The head of the IMF has always been European, while the World Bank has always been led by an American.

Many leading Asian countries have long argued that this is anachronistic, and that the next head of the IMF should be Asian. But when Dominique Strauss Kahn made his disgraceful exit from the IMF in 2011, Asia could not come up with a consensus candidate. The Europeans quickly agreed on France's Christine Lagarde as their candidate, and so the old system continues.

Even though Lagarde will not be there forever, there are no signs of Asia moving its support behind a credible candidate. As some Asian leaders quietly whisper, we have to wonder whether Asia, with all its diversity, exists beyond its geographical conception.

Another source of frustration in Asia is the Asian Development Bank, which has always been headed by a Japanese, with the US sitting just behind as its de facto first deputy. This old school would not countenance a Chinese or Korean head, despite their obvious qualifications.

Western countries also dominate decision making in the IMF and World Bank, through their dominant shareholdings. Reflecting the rise of Asia, in 2010 the G20 agreed on a shift in quota share from advanced economies to Asia's emerging markets and developing economies. The result would see China become the third-largest shareholder in the IMF.

But the ratification of this change on quota share is blocked in the US Congress, and is giving rise to many frustrations in Asia.

Frustrations with the IMF are long and deep in Asia, following its mismanagement of the 1997 Asian financial crisis. The result is the "IMF Stigma", which means that local public opinion would never allow an Asia country could sign up to an IMF program.

One response has been attempts to develop a mechanism, the "Chiang Mai Initiative" (CMI), which could be used as an Asian regional financial safety net. But the CMI has many limitations and has never been activated. Many argue that it is unusable. It is too small, and it is still linked to IMF conditionality. Even though many Asians might complain about IMF conditionality, Asia's richer countries are not keen to hand over money to their neighbors without conditionality.

East Asia has also established AMRO -- the ASEAN+3 Macroeconomic Research Office -- as an independent regional macroeconomic surveillance unit to monitor and analyse regional economies and support Chiang Mai Initiative Multilateralisation (CMIM) decision-making. But AMRO is slowly moving into action, and has not been given enough resources to do its job properly.

The creation of Chiang Mai Initiative and AMRO, are sometimes held up as great examples of Asian cooperation. But they have been just as noteworthy for bringing to the fore rivalries between Asia's great powers, as they jockey for influence and jobs.

Many Asian countries are also losing trust in the international financial system and Western economic elites. Wall Street is seen as driving the IMF's liberalization agenda. Many think that the IMF has gone much softer on Europe in its programs than it did on Asia. And quantitative easing in the US, Europe and now Japan, which will now be withdrawn in the US, has led to volatility in capital flows.

One consequence has been that many Asian countries have built up large foreign exchange reserves as self-protection against crises and volatility. But this is costly for everyone. Asian countries are now sitting on vast quantities of low-earning reserves, rather than spending the money for the benefit of their citizens.

Another consequence has been the Chinese initiative to create an Asian Infrastructure Investment Bank and also a BRICs Development Bank as competitors for the old establishment institutions. One can wonder how quickly these new institutions might get up and running, and how effectively and cleanly they might be managed. But they are clearly a direct blatant challenge to the post-war Bretton Woods system.

And then there is the question of the dollar. The "trans-Atlantic financial crisis" has clearly inspired the internationalization of the Chinese renminbi (RMB). Now some 16% of China's trade is denominated in the RMB. But there are many requirements before the RMB could become a true international reserve currency -- a convertible capital account, deep and liquid financial markets, a flexible exchange rate, sound macroeconomic policy, and trust in domestic institutions. China is still a long way from achieving these conditions, and it is not clear that China is willing to expose its economy to the potential volatility of such an open financial system.

While many might be dazzled by the size of the Chinese economy, size is not the only thing. For example, the Swiss franc is the world's 5th most widely held reserve currency. And while the US economy overtook the British in size in the 1870s, it was not until the 1930s or 1940s that the US dollar displaced the pound sterling. Inertia and "network externalities" hold back change.

We can sympathize with Asia's many frustrations in the financial arena. Asia wants to be treated on an equal basis by the West. The West should also take its moral leadership more seriously.

But the region's lack of financial development is holding it back. Financial systems are still bank dominated. Corporate bond markets are small. Access to financial services to limited in many countries. Regulatory and supervisory systems are a real hodge-podge, which holds back integration. And most countries are reluctant to have reserve currencies.

One of the consequences is that Asian investors are more attracted by Western markets. And Asian borrowers all too often must resort to Western markets, meaning that Asian money often makes a round-trip back home.

All things considered, Asia's relationship with the international financial system is characterized by many frustrations and confusions. But a lot of the solutions boil down to further development of financial systems and integration of regional markets.

This means more liberalization of financial markets, and working together with regional partners. But too many countries will not let go of their financial markets, and are reluctant to cooperate with neighbors.

This is a pity. Because financial development and integration are at the heart of Asia's many development challenges -- graduating from middle income to high income status through innovation-driven growth; coping with aging populations; overcoming inequality; and improving institutions and governance.

Author

John West
Executive Director
Asian Century Institute
Tags: asia, financial system, imf, world bank, renminbi, chiang mai initiative

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