The Role of an Asian Currency Unit for Asian Monetary Integration Part 2 of 2
Masahiro Kawai -- Dean and CEO, Asian Development Bank Institute
Dollar, Yen, Yuan?
Even when a consensus emerges on the advisability of regional exchange rate policy coordination in East Asia, the question of how to achieve such coordination remains. There are at least two options for achieving similar exchange rate regimes throughout the region and, hence, intraregional exchange rate stability.
The first option is for each economy to stabilize its currency through a joint reference to a common key currency or a common basket of key (and other) currencies. The second option is for these economies to jointly create a regional, cooperative system similar to the Snake or Exchange Rate Mechanism (ERM) in Europe.
The choice between the two options would depend on the degree of economic (particularly macro-economic and structural) and political convergence. Given that economic convergence among the East Asian economies is not sufficiently advanced - and that political relationships are not adequately deep to support the creation of a tightly coordinated regional system - the first option appears more realistic.
Only with sufficient economic convergence - and with strong political consensus - should East Asia move to the stage of joint exchange rate stabilization.
A Currency Basket
Three options can be considered for the region’s target currency for exchange-rate stabilization:
(1) a single currency, such as the US dollar, the yen or the yuan;
(2) the Special Drawing Rights (SDR; a currency basket of the US dollar, the euro, the pound sterling, and the yen) or an SDR-plus currency basket (including the SDR as well as emerging East Asian currencies); and
(3) an Asian Currency Unit (ACU) - an appropriately weighted basket of East Asian currencies, including the yen, yuan, won, baht, ringgit, etc.
Given East Asia’s diverse economic relationships with the major countries and areas in the world, the traditional practice of choosing the US dollar as the region’s sole monetary anchor is no longer the best policy. An obvious alternative is to choose the yen and/or the yuan as a monetary anchor, given the size and importance of Japan and China in East Asia.
However, the yen’s power waned in the 1990s - due to Japan’s lost decade following the bursting of asset price bubbles - though it still has the potential to play a critical role. With China’s strong growth performance, the yuan’s international role will rise over time, but the usefulness of the yuan will remain limited for international settlement, clearance, financing and liquidity holding, due to the lack of full convertibility.
It will take a long time for the yuan to assume an international currency status equivalent to that of the US dollar, the euro, or the yen. This suggests that no single currency would be likely to play a monetary anchor role, at least in the near future. This means it is recommended to introduce a regional currency basket, an ACU, for intraregional exchange rate stability (Kawai, 2007).
Towards An Asian Monetary Union
To pursue policy co-ordination, a gradual, step-by-step approach is appropriate and realistic. The first step is to initiate an intensive policy dialogue covering exchange rate movements, regimes and issues, as part of the region’s economic and surveillance exercise.
The second step is to co-ordinate informally on exchange rate regimes by moving towards greater exchange rate flexibility vis-à-vis the US dollar. The third step is to adopt formal, but loose exchange rate policy co-ordination to promote intra-regional rate stability without rigid co-ordination of monetary policy. The fourth and fifth steps are to progressively intensify formal exchange rate policy co-ordination (see Table 1).
Table 1 - Steps Toward Exchange Rate And Monetary Policy Co-Ordination
The first step is therefore the introduction of intensive policy discussions on exchange rate policy as a part of the regional economic surveillance process. The objective is to develop a culture that views exchange rates as not merely national concerns, but also regional matters, and intensify discussions among policymakers in order to reach a consensus regarding the implications of large currency misalignments within East Asia.
At this stage, an ACU index could be introduced as a benchmark, a tool to measure the value of East Asian currencies as a whole against external currencies - such as the US dollar and the euro - as well as the degree of divergence of each currency’s value from the regional average set by the ACU. Once China moves to a more flexible exchange rate regime, ACU index movements and divergences of component currency values can provide more meaningful information.
The second step is the introduction of informal policy co-ordination to achieve both greater exchange rate flexibility vis-à-vis the US dollar, and improved exchange rate stability within East Asia. This can be achieved by using a basket of SDR-plus currencies as a loose reference (note that an SDR-plus currency basket could be defined as a basket of the US dollar, the euro, the pound and an ACU).
By adopting a managed float policy targeted at an SDR-plus currency basket - as is currently practiced by Singapore - all emerging East Asian economies could enhance the degree of exchange rate stability with each other. The weights of East Asian currencies in the basket could vary from one country to the next, at least initially.
How strictly countries maintain the value of their currency in line with the basket currency could depend in each case on country’s conditions and preferences. National monetary authorities could maintain most of their autonomous policy-making by combining an appropriately defined inflation target policy and a basket-based managed floating policy (Kawai and Takagi, 2005).
The third step is the joint adoption of a formal policy of stabilizing intra-regional exchange rates, using a common basket of SDR-plus currencies as a reference.
The basket stabilization policy should be clearly defined with well-defined rules on exchange rate parity against the common basket, a relatively wide exchange rate band (such as a range of ±10%) around the central rate, and the ability to adjust both the central rate and the band - along the lines proposed by Williamson (2005).
This policy affords the authorities greater exchange rate flexibility vis-à-vis the US dollar at the expense of a lesser degree of national monetary policy autonomy. The ACU index should continue to serve as an important indicator in measuring joint movements and divergences of East Asian currencies, and its use in the financial markets should be encouraged.
The subsequent steps entail the launch of more systematic exchange rate and monetary policy co-ordination to create a regional monetary anchor. Here, two approaches are possible - the ‘European’ approach and the ‘parallel currency’ approach (Eichengreen, 2006). Under the ‘European’ approach, a common basket peg similar to the snake or exchange rate mechanism (ERM) could be introduced.
A Multi-Track Approach
All regional currencies will become fully flexible vis-à-vis external currencies - such as the US dollar and the euro - but maintain intra-regional stability through joint stabilization of individual currencies to the ACU. It would be necessary at this stage to create a credible regional monetary anchor within East Asia, as well as a fully elaborated short-term liquidity support arrangement that is sufficiently large, flexible and speedy enough for frequent interventions in the region’s currency markets.
Under the ERM of the European Monetary System, the deutschmark emerged as a de facto anchor currency despite the system having been designed as a symmetric exchange rate stabilization scheme.
In East Asia, it is also possible for the yen, the yuan, or another currency to play such an asymmetric, monetary anchor role, but the choice of which one emerges will be left to the natural evolution of non-inflationary policy-making and credibility of the region’s central banks.
The private use of ACU should be encouraged and an ACU clearance and settlement system must be developed.
The final stage is complete monetary policy integration and a full delegation of monetary policy-making to a regional supra-national authority. In this ultimate phase, a single regional currency may be introduced. But this remains a long-run possibility for the region.
A practical path toward policy co-ordination (and, ultimately, policy integration) is to take a multi-track, multi-speed approach, whereby economies ready for deeper policy co-ordination begin the process while others prepare to join later.
A group or pairing of economies that are sufficiently integrated - Japan and Korea; China and Hong Kong; or Singapore, Malaysia, and Brunei Darussalam - and that also possess sufficient political commitment, may at this stage wish to initiate sub-regional currency stabilization schemes.
Each sub-regional group could intensify exchange rate and monetary policy co-ordination within the group while allowing the possibility, or even crafting a road map, for others to subsequently join them. Over time, these groups may start negotiations to integrate into a larger monetary zone.
Sharing A Long-Term Vision For The Future Of East Asia
Judging from the OCA criteria, one can argue that the entire East Asian region - the ASEAN+3 group plus Hong Kong and Taipei, China - is not an optimum currency area. For example, low-income ASEAN economies have yet to develop their basic institutions and policy frameworks, needed prior to becoming legitimate members of the group that embarks on regional monetary policy co-ordination.
Though China is deepening its economic integration with other East Asian economies in terms of trade and FDI, it has yet to open its capital account and internationalize its currency in order to integrate itself fully with other East Asian members.
Nonetheless, several economies in the region - including Japan, Korea, Singapore, Malaysia, Thailand and Brunei Darussalam - are well-integrated with each other in terms of trade, finance and macro-economic activity. Indonesia and the Philippines are close to joining the level of this league. For example, at least from an economic perspective, Singapore, Malaysia and Brunei could form a currency area today, as could Japan and Korea.
The most serious impediments to the formation of an East Asia-wide single currency may include:
Differences in the stages of economic and institutional development, in the quality of governance, and the diversity of economic and political systems
Reluctance to surrender national sovereignty over economic policy-making
Lack of sufficient integrationist tradition, mutual trust, political commitments, and the necessary, regional support institutions.
Sharing a long-term vision for the future of East Asia helps to strengthen regional economic policy co-ordination and, in this regard, the recent initiative to create an ‘East Asia Economic Community’ will be a positive step. In addition, greater economic integration is expected to promote an Asian identity and build trust, a process that would benefit the creation of regional institutions.
Creating New Institutions
Several co-operative institutions could be created. Firstly, East Asia does not have a region-wide trade agreement, though it has a series of uncoordinated free trade agreements (FTAs). It is time that the region accelerated co-ordination in the area of trade and investment integration by creating an East Asia-wide FTA, an important precondition for the formal institutionalization of financial and macro-economic integration (Kawai and Wignaraja, 2009)
Secondly, East Asia does not have an effective institution for regional financial co-operation, though it has undertaken several formal initiatives - such as for regional reserve pooling (the Chiang Mai Initiative - CMI), regional economic surveillance, and Asian bond market development.
It is time for the region’s finance ministers and central bank governors to work closely to transform the CMI into an Asian monetary co-operation fund - administered by a strong professional secretariat - in order to promote regional financial stability.
Finally, it is time to initiate exchange rate policy coordination. The immediate step would be for the regional economies to discuss exchange rate issues as part of enhanced economic surveillance and policy dialogue, for which an Asian Currency Unit (ACU) index will be a useful instrument.
The next step is to enhance convergence of exchange rate regimes in East Asia in order to achieve some degree of intra-regional exchange rate stability; the most realistic option is for regional economies to adopt similar managed floating regimes - rather than a pure float or a rigid peg to an external currency.
An example of how this can be done would be through the adoption of a common SDR-plus currency basket system based on the US dollar, the euro, the pound sterling and the ACU.
Greater political support for economic policy co-ordination could eventually lead to more formal mechanisms for intra-regional exchange rate stability based on the ACU. But before doing this, substantial convergence will have to be achieved across countries in the region in terms of political, economic, institutional and social conditions.
The findings, interpretations, and conclusions expressed in the paper are entirely those of the author alone and do not necessarily represent the views of the Asian Development Bank, its Institute, its executive directors, or the counties they represent.