Emerging Asian regionalism ten years after the crisis

1、emerging asian regionalism:ten years after the crisisby masahiro kawaideanasian development bank i18 july 2007 this paper is prepared for presentation at the international conference, “integrating asian economies: ten years after the crisis,” organized by the asian development

2、bank and the thai ministry of finance, in collaboration with the thai development research institute, in bangkok, 18 july 2007. the findings, interpretations, and conclusions expressed in the paper are entirely those of the author alone and do not necessarily represent the view of the asian developm

3、ent bank, its institute, its executive directors, or the countries they represent.emerging asian regionalism: ten years after the crisismasahiro kawaiasian development bank institute1. introduction: key issuesthe asian financial crisis of 1997-98 devastated the economies of thailand, indonesia, mala

4、ysia and korea and adversely affected several neighboring economies such as philippines and hong kong. the crisis was a combination of currency and banking crises. the currency crisis was a capital account crisis, driven by rapid capital inflows followed by equally rapid outflows of capital. the ban

5、king sector played a critical role in intermediating excessively large amounts of domestic savings as well as external short-term funds in foreign currency for long-term domestic investment, thereby creating potential for bad loans that led to a banking crisis. essentially the forces of financial gl

6、obalization together with inadequately managed domestic banks (and corporations) generated the asian financial crisis. one of the most significant outcomes of the crisis has been the emergence of economic regionalism in east asia. the crisis prompted the regional economies to realize the importance

7、of strengthening regional self-help mechanisms in a cooperative way. for example, the asean+3 memberscomprising asean, china, japan and koreahave begun to undertake initiatives for regional economic surveillance, regional reserve pooling (the chiang mai initiative), and asian bond market development

8、. regional financial cooperation then stimulated regional trade and investment initiatives in the form of free trade agreements (ftas): japan and singapore implemented an economic partnership agreement (epa); asean+china and asean+korea each implemented an fta on trade in goods, and many official di

9、scussions and negotiations for bilateral and plurilateral ftassuch as japan and korea epa, asean+japan epa and asean+india ftaare currently underway. several groups have been set up to facilitate east asian economic regionalism. in the financial and monetary area, asean+3 finance ministers are activ

10、e in pursuing financial cooperation while emeap central bank governors (comprising of eleven east asian and oceanic economies) have played some critical role. in the trade and investment area, asean has been the de facto hub while asean+3 and asean+6 (east asia summit, including asean+3 countries, i

11、ndia, australia and new zealand) are emerging as important larger groups. east asia also works with north america through apec and with europe through asem. hence, it is important to see how east asian economic regionalism might evolve over time and how it reshapes its relationship with north americ

12、a and europe.this paper first summarizes lessons learned from the 1997-98 crisis and discusses the importance of national, global and regional reforms for crisis prevention, management and resolution. next, it reviews the surprising extent of regional economic integration that has progressed through

13、 trade, fdi, and finance and of regional macroeconomic interdependence. it then assesses the past and present economic cooperation initiatives in east asia in the areas of trade/fdi and money/finance. finally, the paper analyzes the issues and challenges for closer economic regionalismor greater ins

14、titutionalization of regional economic integration in east asiathat can potentially lead to the creation of an east asian economic community. it is argued that deeper economic integration in trade, investment and finance and further institutionalization of such integration are mutually reinforcing.

15、2. lessons from the 1997-98 crisis(1) crisisthe thai baht devaluation in july 1997 was triggered essentially by the investor perceptions of deteriorating financial sector conditions and of unsustainable overvaluation of the currency. once the thai baht declined sharply, currency speculation and cris

16、es spread quickly to the philippines, indonesia, malaysia, and korea within a matter of a few months. the speed and extent of regional “contagion” of currency crisis was remarkable. the strong contagion effects within east asia suggest that the economic linkage through intra-regional trade, direct i

17、nvestment and finance was much more pronounced there than in other regions.the asian financial crisis was a combination of currency and banking crises, which severely damaged the market confidence throughout the region. the crisis was a capital account crisis, as opposed to the traditional current a

18、ccount crisis, in that rapid capital inflows and outflows, induced by premature capital account liberalization, created the so-called “double mismatches” in the balance sheets of banks and corporations. currency and maturity mismatchesshort-term borrowing in foreign currency to finance long-term inv

19、estment in domestic currencyexposed banks and corporations to risks of sudden changes in currency values and interest rates. rapid capital inflows led to excess liquidity, over-investment and asset market bubbles, but once the market started to lose confidence about the sustainability of the exchang

20、e rate, equally rapid capital outflows occurred, exerting large downward pressure on the currencies and putting sudden brakes on the over-extended economic activities. it was also a banking crisis in that commercial banks intermediated excessively large amounts of domestic savings as well as externa

21、l funds for domestic investment and projects with often doubtful quality, thereby created vulnerabilities that led to a banking crisis. with steep currency depreciation, externally indebted banks and corporations found it difficult in making repayment due to the inflated value of external debt measu

22、red in domestic-currency values and directly or indirectly magnified banking sector problemsas corporations were also bank clients. the underlying factor behind over-extension of bank loans was weak risk management practice on the part of banks and inadequate prudential regulation and supervision ov

23、er banks. essentially the crisis was the result of interactions between massive capital inflows and outflowsfacilitated by global financial integrationand insufficient national policy and institutional frameworks governing the banking and corporate sectors in the affected economies. initially seemin

24、gly benign crises evolved into a full-blown financial and economic crisis in the affected countries in 1998. the crisis deepened because of pervasive weaknesses in the financial and corporate sectors in these economies. indeed, gdp growth in the five crisis-affected economies of east asiakorea, indo

25、nesia, malaysia, thailand and the philippinesdeclined sharply from a pre-crisis average of positive 7.1 percent during 1990-96 to negative 7.6 percent in 1998. the depth of the collapse in indonesia, with gdp contracting by more than 13 percent in 1998, was among the largest peacetime contractions,

26、excluding the experience of several transition economies in the early 1990s. the simultaneous economic contraction in the affected economies in 1998 was another sign of strong regional economic interdependence.(2) recoverythe recession was sharp but short-lived though some had predicted that it woul

27、d take a long time for the region to recover. the v-shaped economic recovery in terms of growth rates from 1999 was solid, facilitated by intra-regional trade linkages and favorable global economic conditions, although post-crisis average growth rates were lower than in the pre-crisis period. in add

28、ition, investment declined sharply and has stayed low since then in most affected countries. the strength and pace of recovery varied significantly across countries; korea saw the fastest and strongest growth with only a temporary loss of output due to the crisis and returned quickly to the pre-cris

29、is output trend, while indonesia suffered the largest declines in the exchange rate, gdp and investment growth, with semi-permanent loss of output, and experienced severe political and social instability.investment declined sharply in the crisis-affected countries, but savings did not so that these

30、countries began to see current account surpluses and accumulation of foreign exchange reserves. many debtors to foreign creditors have repaid or restructured their short-term external debt so that the ratios of short-term external debt to foreign exchange reserves have declined significantly to leve

31、ls well below unity. portfolio investment inflows into the region have resumed, equity prices have gone up, and the capitalization of equity markets has expanded. as a result of these improvements, all countries that were under the imf programs have been able to finish loan repayment to the imf. fol

32、lowing the initial, forced devaluation and the subsequent depreciation of currencies, there has been a general shift toward greater exchange rate flexibility although there are variations across countries. economic recovery was supported by progress in financial and corporate sector restructuring an

33、d reform. significant efforts were made to resolve insolvent banks, recapitalize viable banks, financially stabilize several indebted corporations, and later restructure corporate debt. banking sector health was restored only after significant corporate and debt restructuring, which allowed corporat

34、ions to begin to receive new credits from banks. frameworks of bank regulation and supervision have been substantially upgraded, and more credible insolvency procedures and corporate governance systems have been introduced. the economic recovery has been accompanied by further increases in regional

35、economic integration particularly through trade and fdi. rise of china and its participation in the regional production network have further strengthened the regional economic linkages.(3) crisis prevention, management and responsethere are many lessons to be learned from the crisis. valuable are le

36、ssons from some alleged mistakes committed by national policy makers as well as by the imf which intervened in thailand, indonesia and korea. the most important lesson learnt is that “it is better to prevent a crisis than cure it.” however, if a crisis breaks out, there arise a set of crisis managem

37、ent and resolution issues. crisis prevention, management and resolution have national, global and regional dimensions (see table 1).crisis prevention. the first key lesson is that crisis prevention is better than cure. the major preventive mechanisms include: (i) adoption of a prudent macroeconomic

38、management framework (monetary, fiscal, and exchange rate policies and public debt management); (ii) erection of a robust and resilient financial system, particularly banking sector; and (iii) development of self-help mechanisms.adopting a prudent macroeconomic management framework is the basic requ

39、irement for crisis prevention. this includes among others: pursuit of sound macroeconomic policies (non-inflationary monetary policy, disciplined fiscal policy and good debt management) to avoid boom and bust cycles; avoidance of over-valued exchange rates; avoidance of large current account deficit

40、s over an extended period; minimizing “double mismatches” (in currency and maturity) in the balance sheets of banks and corporations; and establishment of orderly capital account liberalization.erecting a robust, resilient financial system, particularly a banking sector, is the second requirement fo

41、r crisis prevention. this includes among others: strong risk management capacity and incentives on the part of commercial banks through adequate bank regulation and supervision and greater competition at the national level; improved information disclosure in financial and corporate sectors; good cor

42、porate governance for financial institutions and corporations; and capital market development, particularly for local currency-denominated bonds, as an alternative source of financing. with a relatively weak macroeconomic management framework an inadequately supervised financial system, several prec

43、autionary measures are useful. one is a capital control to prevent free flows of cross-border capital, particularly of a short-term nature, thereby preventing large capital inflows and outflows from generating boom and bust cycles. the other is a set of self-help mechanisms such as the accumulation

44、of adequate foreign exchange reserves to cushion external financial shocks.crisis management. once a currency crisis breaks out, it is important to ensure that the crisis does not magnify or prolong. crisis management mechanisms include: (i) mobilization of timely and adequate external liquidity; (i

45、i) adoption of appropriate macroeconomic and structural policies to reflect the specific conditions and reality of the economy; and (iii) involvement of international private investors.at the time of a currency crisis, timely provision of large-scale international liquidity of sufficient magnitude,

46、supported by appropriate policy responses, is needed to prevent the economy from slipping into a serious economic contraction. a financing facility that can rapidly mobilize a large amount of liquidity to contain a crisis or contagion in the early stage is an obvious benefit if it is the result of i

47、rrational herd behavior. for such a financing facility to be effective in restoring market confidence, its provision must be accompanied by an appropriate adjustment programincluding macroeconomic (monetary and fiscal) and structural policiesas lending “conditionality.” such an adjustment program sh

48、ould be contingent on the particular conditions and reality of the economy, rater than taking a “one-size-fits-all” approach. bailing-in international private investors through official or involuntary stand-stills, in the form of a temporary suspension of debt payments, can constitute an integral pa

49、rt of crisis management. this procedure functions as a floodgate that helps stop the decline in the currency value and enables the authorities to buy time to put in place a credible adjustment program and to organize creditor-debtor negotiations. official stand-stills are quite useful if the authori

50、ties wish to avoid tight monetary policy, over an extended period of time, in the presence of balance sheet vulnerabilities (double mismatches) and banking sector weaknesses.crisis resolution. once a currency crisis evolves into a full-blown economic crisis, with systemic damages to the banking, cor

51、porate and social sectors, it is vital to quickly resolve the systemic consequences of the crisis. crisis resolution measures include: (i) establishment of domestic mechanisms for resolving impaired bank assets and corporate liabilities; (ii) introduction of international mechanisms for resolving pu

52、blic and private external debt; and (iii) cushioning the effects of crises on low-income groups through social sector protection.to resolve a systemic crisis in the banking and corporate sectors, affecting real economic activity at large, domestic mechanisms for resolving impaired bank assets and co

53、rporate liabilities need to be firmly established. resolution of nonviable banks (liquidation, closure, nationalization, merger and acquisition, etc.) and revitalization of viable banks (recapitalization, carving out of npls and their transfer to asset management companies, etc.) are two key strateg

54、ies. in the early stage of resolution, closure of insolvent banks must be done in an orderly way with a view to protect depositors, short-term creditors and viable borrowers and to restructure impaired corporate debt. key to facilitating early corporate restructuring are: (i) creation of enabling en

55、vironments by eliminating legal and tax impediments to corporate restructuring; (ii) strengthening of court-based bankruptcy, reorganization and foreclosure laws, and legal protection of creditor rights; and (iii) establishment of voluntary, out-of-court frameworks for corporate restructuring based

56、on the “london rules.” for a voluntary process of corporate restructuring to work, a clearly defined insolvency procedure should be introduced as a credible, alternative threat to an out-of-court agreement.as debt is often cross-border, establishing an international collective framework for orderly

57、external-debt workout is useful. the purpose of introducing such a framework is to promote debtor-creditor negotiations for international debt workout and to reach restructuring agreements that allow rollovers, extension of maturities, and possibly debt and/or interest reductions, while suspending p

58、ayments on foreign debt during the “standstill” period. the mechanisms for such collective action by creditors and debtors can help minimize the risk of moral hazard by requiring both private creditors and debtors to share the burden of losses.cushioning the negative impact of crises on socially vul

59、nerable groups through social sector policies would be necessary to mitigate the social impact of an economic crisis. during the east asian crisis, however, the governments found it difficult to implement social assistance to the adversely affected people (children who dropped out of schools for work, poor who lost jobs, etc.) beca