A Roadmap for East Asian A Roadmap for East Asian

Monetary IntegrationMonetary Integration

Kyungtae Lee and Deokryong Yoon

2006. 10

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List of Contents

I. Introduction

II. The Need: Why Are We Talking about Monetary Integration in East Asia?

III. The Feasibility of Monetary Integration in East Asia

IV. The European Experience and Implications

V. A Roadmap for Monetary Integration in East Asia

VI. A Common Vision as the Basis for a Roadmap

VII. Conclusion

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II. The Need

1. To stabilize the exchange rate- High proportion of trade in GDP- Avoid competitive devaluation

2. Contagion Effect- High intra-regional trade: 16.1%→23.7% (China, Japan, Korea, 1993~2003)- High intra-regional investment: 8.1%→18.7%n(China, Japan, Korea, 1993~2003)

3. Speculative Attack

- Small sized currency is easier to attack.

4. Efficient use of regional resources- East Asia is the largest capital exporter and importer

5. New engine of economic growth

- Asia accounted for over half of the world’s growth since 2001(in ppp)

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II. The Need: Why Are We Talking about Monetary Integration in East Asia?

Source: IMF. 2006. Direction of Trade Statistics Database.

<Table 1> Weights of Exports and Imports among China, Japan, and Korea

Country Korea Japan China

Year 1980 1990 2005 1980 1990 2005 1980 1990 2005

Exports

Korea - - - 4.1 6.1 7.8 0 0.7 4.6

Japan 17.4 19.4 7.8 - - - 22.2 14.7 11.0

China 0.1 0.9 24.6 3.9 2.1 13.4 - - -

Imports

Korea - - - 2.2 5 4.7 0 0.4 11.6

Japan 26.3 26.6 18.9 - - - 26.5 14.2 15.2

China 0.1 3.2 14.2 3.1 5.1 21.0 - - -

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III. The Feasibility of Monetary Integration in East Asia

• Three criteria to appraise the feasibility: Self-sustainability, Optimum-Currency Area, Non-economic conditions

1. Self-sustainability- Size: almost equal GDP in ppp, to Europe, North America,

2nd greatest trade volume but rapid growing/Largest foreign reserve (See Table2)

- External dependency: external dependency decreased and influence of East Asia increased

→ 1% economic growth of world economy induced 1970s: 1% , 1980s: 0.2% economic growth in East Asia

→ 1% economic growth of US economy induced 1970s: 0.8% , 1980s: 0.2% economic growth in East Asia

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III. The Feasibility of Monetary Integration in East Asia

2. OCA-Criteria

• Openness: Higher intra-regional trade in East Asia (23.7%) than in Europe (21.3%)

• Inflation: East Asia(6.0%) shows higher average inflation rate than the Europe (4.3%), but stabilizing trend.

• Volatility of real exchange rate: higher in East Asia than in Europe

• Business cycle synchronization: Lower degree of co-movement in East Asia

• Degree of financial integration: East Asian countries invest 14.3% in the region whereas European countries put 57.2% in the region.

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III. The Feasibility of Monetary Integration in East Asia

3. Non-Economic Conditions

• A broad spectrum of political systems

• Historical legacy

• Low profile of regional identity

• Lack of experience for cooperation

• Different religious/cultural backgrounds

• Low expectation to receive external support

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III. The Feasibility of Monetary Integration in East Asia

* East Asia includes Japan, NICs (Korea, Taiwan, Singapore, Hong Kong), ASEAN 4 (Indonesia, Malaysia, the Philippines, Thailand), and China.

** GDP (market exchange rates) was calculated with the data provided in WDI 2005. Sources of other data: IFS (International Financial Statistics), IMF; World Factbook (http://

www.odci.gov/NS-search-page=results), CIA; WDI (World Development Indicators).

<Table 2> Economic Indicators of the Three Blocks (2004)

(billion dollars)

  *East Asia 10 EU15 NAFTA

 **GDP (market exchange rates)

   GDP (purchasing power parity)

   Trade (with the rest of the world)

   Foreign Reserves (excluding gold)

 9,167

14,875

 2,359

 2,202

9,141

11,552

3,371

 236

12,978

13,779

 1,312

  174

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* Each number shows the result of rolling regression using the economic growth of ten years (by that year) of the East Asian economy without Japan. Source: Rhee (2004).

<Figure 1> East Asian Economic Dependency on External Economies*

III. The Feasibility of Monetary Integration in East Asia

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<Table 4> Trade-GDP Relations (1990–2003 Average)* (percent)

Country

Trade Partners

US Europe Japan East Asia 9 World

Japan 2.1 1.4 . 3.2 8.3

China 3.9 3.4 3.7 9.6 20.6 Hong Kong 12.8 14.0 10.6 53.0 119.8 Indonesia 3.3 4.1 6.1 8.6 24.7 Korea 5.5 3.6 4.6 7.3 27.7 Malaysia 15.3 11.7 13.9 36.9 82.6 Philippines 9.6 5.3 7.3 13.0 35.7 Singapore 22.3 18.8 16.6 55.4 141.0 Taiwan 11.2 6.3 9.2 16.9 51.1 Thailand 6.7 6.6 8.6 12.7 41.8 Average (East Asia 9) 10.1 8.2 9.0 23.7 60.6

Average (Europe) 2.3 21.1 0.9 1.6 31.2

United States . 1.9 1.1 1.8 9.0 * The figures show the relation of average exports and imports between two countries to GDP.

III. The Feasibility of Monetary Integration in East Asia

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<Table 5> Average and Standard Deviation of Inflation 1975–89, 1990–2003 (percent)

Country1975-89 1990-2003

mean s.d. mean s.d.

Japan 3.6 -0.2 2.4 1.6

China 3.8 5.3 3.9 6.7 Hong Kong, China 8.7 2.6 4.1 6.1 Indonesia 13.0 13.8 8.9 17.8 Korea, Rep. 13.3 5.5 8.5 3.4 Malaysia 3.9 3.3 5.5 2.5 Philippines 13.3 8.2 11.7 3.3 Singapore 3.2 1.2 3.3 2.9 Taiwan 4.9 1.5 4.8 2.2 Thailand 5.6 3.5 3.2 3.1 Average (East Asia 9) 7.7 5.0 6.0 5.3

Average (Europe) 10.5 3.3 4.3 2.2

United States 5.6 2.2 2.6 0.8

III. The Feasibility of Monetary Integration in East Asia

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<Table 6> Indicators of Price Synchronization*

1975–1989 1990–2000

US Europe Japan East Asia 9 US Europe Japan East Asia 9Japan 0.1328 0.1052 . 0.1393 0.0986 0.1485 . 0.1327

China 0.1094 0.1384 0.1561 0.0987 0.1479 0.1985 0.172 0.1975Hong Kong 0.0643 0.0965 0.1303 0.0754 0.0322 0.1076 0.1053 0.1423Indonesia 0.1149 0.1794 0.1890 0.1250 0.2976 0.3082 0.2572 0.2354Korea, Rep. 0.0902 0.1200 0.1233 0.0839 0.1441 0.1594 0.1114 0.1204Malaysia 0.0548 0.1096 0.1356 0.0774 0.1492 0.194 0.1564 0.1394Philippines 0.0734 0.1273 0.1526 0.0746 0.1197 0.1258 0.1231 0.1267Singapore 0.0409 0.1043 0.1249 0.0719 0.0699 0.0991 0.0857 0.1115Taiwan 0.0866 0.1088 0.1236 0.0819 0.0693 0.1026 0.0955 0.1114Thailand 0.0512 0.0978 0.1186 0.0662 0.0863 0.11 0.0879 0.1123Average (East Asia 9) 0.0762 0.1202 0.1393 0.0839 0.1240 0.1561 0.1327 0.1441

Average (Europe) 0.1047 0.0643 0.1052 0.1202 0.1133 0.0554 0.1485 0.1561

United States . 0.1047 0.1328 0.0762 . 0.1133 0.0986 0.124

* The figures are calculated according to Alesina, Barro, Tenreyro (2002) and the high figure implies low synchronization.

III. The Feasibility of Monetary Integration in East Asia

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<Table 7>Product (Net GDP) Synchronization

* A high figure means low synchronization of the business cycle.

1975–1989 1990–2003

US Europe Japan East Asia 9 US Europe Japan East Asia 9Japan 0.0296 0.0251 . 0.0376 0.0249 0.0270 . 0.0381

China 0.0619 0.0614 0.0584 0.0656 0.0395 0.0429 0.0403 0.0516 Hong Kong 0.0397 0.0486 0.0495 0.0484 0.0423 0.0483 0.0350 0.0396 Indonesia 0.0323 0.0400 0.0311 0.0422 0.0521 0.0560 0.0428 0.0389 Korea, Rep. 0.0342 0.0439 0.0383 0.0483 0.0565 0.0572 0.0489 0.0457 Malaysia 0.0337 0.0356 0.0375 0.0424 0.0289 0.0345 0.0277 0.0344 Philippines 0.0504 0.0424 0.0349 0.0469 0.0325 0.0366 0.0312 0.0403 Singapore 0.0409 0.0414 0.0338 0.0433 0.0432 0.0523 0.0433 0.0535 Taiwan 0.0251 0.0373 0.0361 0.0400 0.0235 0.0318 0.0294 0.0419 Thailand 0.0278 0.0327 0.0190 0.0389 0.0525 0.0571 0.0448 0.0397 Average (East Asia 9) 0.0384 0.0426 0.0376 0.0462 0.0412 0.0463 0.0382 0.0428

Average(Europe) 0.0320 0.0321 0.0251 0.0426 0.0230 0.0256 0.0270 0.0463

United States . 0.0320 0.0296 0.0385 . 0.0230 0.0249 0.0412

III. The Feasibility of Monetary Integration in East Asia

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<Table 8> East Asia’s Stock of Financial Assets (2003) (million dollars )

Source Country Portfolio assets held in each region

TotalUS Europe Japan East Asia 9

Japan 620208 608173 . 21871 1721314

Hong Kong 46670 90297 10443 44243 334912 Indonesia 450 276 3 202 1814 Korea 7961 2871 243 1125 17343 Malaysia 301 389 19 744 1664 Philippines 2535 716 14 242 3681 Singapore 22605 55973 3457 25638 143875 Thailand 1764 563 0 80 2748

Average (East Asia 9) 11755 21584 2026 10325 72291

(16.3) (29.9) (2.8) (14.3) (100)Average (Europe) 94025 308524 15562 7210 539183

(17.4) (57.2) (2.9) (1.3) (100)United States . 1700000 291850 155239 3134244

III. The Feasibility of Monetary Integration in East Asia

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<Table 9>International Investment in East Asia, 2003 (million dollars)

Host Country Portfolio assets held in each region

TotalUS Europe Japan East Asia 9

Japan 291850 264562 . 14179 640846

China 13738 10419 2518 22319 53891 Hong Kong 37661 37873 7181 4949 101780 Indonesia 5072 3120 141 2685 17673 Korea 53429 35848 5289 15733 124184 Malaysia 7953 8101 1705 11748 32608 Philippines 5046 4873 1314 2033 14837 Singapore 25001 15075 2707 6536 55692 Thailand 7339 7253 1016 6271 25402

Average (East Asia 9) 19405 15320 2734 9034 53258 (36.4) (28.8) (5.1) (1.7) (100)

Average (Europe) 97382 308524 35775 8887 509626 (19.1) (60.5) (7.0) (1.7) (100)

United States . 1600000 620208 82286 2822191

III. The Feasibility of Monetary Integration in East Asia

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IV. The European Experience and Implications

1. The European Experience

• The process of monetary integration:<Policy coordination and exchange rate cooperation> →<A

Common exchange rate system> → <Monetary union>

• Policy coordination and exchange rate cooperation: channels to share important information and to avoid policy- conflict

• Common exchange rate system: EMCF – precondition for interventionSnake – problem of double bands (internal and external)EMS – ECU, ERM, EMCF (three pillars)

• EMU: EMI, ECB, Convergence criteria⇒ What is important is political initiative!

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IV. The European Experience and Implications

2. Major components of a Roadmap

• The process of monetary integration:

Information sharing and policy dialogue Loose exchange rate cooperation and policy coordination → Close exchange rate cooperation and policy coordination → A fixed exchange rate system → A currency union through substituting national currencies with a common currency

• Timing and sequencing

- Multi-track approach- Need conditions to select the countries which can go over to next stage

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V. A Roadmap for Monetary Integration in East Asia

1. Current cooperation mechanism• Policy dialogue: Economic Review and Policy Dialogue (ERPD) • Financial Arrangements: Chiang Mai Initiative (CMI) → Post-CMI⇒ Crisis prevention mechanisms, not for accelerating

monetary integration

2. Suggestions• Rana(2006) - develop CMI into Asian Monetary Cooperation Fund (AMCF), then

Asian Central Bank (ACB) - AMCF can issue Asian Currency Unit and introduce exchange rate

mechanism - ACB issues single currency

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V. A Roadmap for Monetary Integration in East Asia

2. Suggestions• Haihong (2006)- Short term: institutionalize policy dialogue and surveillance mechanism- Medium term: AMF and regional exchange rate mechanism- Long term: Monetary union

3. European experience: Three stages-1st stage: Creation environment for coordinated policy making-2nd stage: Establish common exchange rate mechanism-3rd stage: Create regional central bank

⇒East Asia needs a detailed Road Map for monetary integration.

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<Table 3> The Three Stages of the Monetary Integration Process

Stages Stage I Stage II Stage III

ObjectiveEnvironment for

coordinated policy making

Common exchange rate mechanism

Single currency

Tasks

Multilateralize CMIInstitutionalize policy

dialogueCreate a system for information sharing

Exchange rate cooperation

Introduce a regional currency unit

Create financing facilities for intervention

Create an Asian central bank

Substitute national currencies with a

regional currency unit

V. A Roadmap for Monetary Integration in East Asia

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VI. A Common vision as the Basis for a Roadmap

• Monetary integration will take a long time → Setting a long term Asian vision will be necessary

• To use RCU in the private sector, the official use must precede it. → Long term vision of monetary integration needed

• Long-term vision of monetary integration will encourage the countries to introduce regional exchange rate mechanism

• Declaration of a vision would not incur any costs, but high profit.

• Start the monetary cooperation process with setting a common vision

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VII. Conclusion

• East Asian countries realize the need of regional cooperation

- To prevent a possible recurrence of crisis

- To maintain exchange rate stability

• Lack of roadmap and lack of common vision

• The most important thing to start the monetary integration process is to arrive at a common vision for East Asia and draw a roadmap to realize the vision.

Thank you for your attention!