Creating an Integrated Market by 2015: Capital Account Liberalization in

ASEAN

Yung Chul Park, Korea UniversityShinji Takagi, Osaka University

Presentation at the 9th NIPFP-DEA Research Meeting on Capital Flows, New Delhi, 15-16 March 2011

Introductory Remarks

• ASEAN is in the process of creating an ASEAN Economic Community (AEC) by 2015

• The AEC is “a region with free movement of goods, services, investment, skilled labor, and freer flow of capital”

• An integrated financial market requires capital account liberalization (CAL) and financial sector liberalization (FSL)

• Of the two pillars, this paper focuses on CAL2

What the Paper Attempts to Do

• Assess the existing state of capital account openness in ASEAN based on information gathered from central banks and a reading of the IMF Annual Report on Exchange Arrangements and Exchange Restrictions

• Propose broad CAL principles to apply in substantially achieving the aims of the AEC by 2015 (and 2020)

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Assessing the Existing State of Capital Account Openness in ASEAN

Capital Flow Freedom IndexIn assessing the existing state of capital account openness, we

use a numerical indicator:• Largely a de jure measure (though some elements of de

facto openness are incorporated)• Largely an ordinal (as opposed to cardinal) measure• Designed in such a way that 25 roughly represents de facto

financial openness (though 100 represents full de jure openness)

• The purpose is to help measure progress within each country and to compare de jure openness across countries

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Capital Flow Freedom Index—Weights

• Portfolio inflows 30• Portfolio outflows 30• FDI 6• Current account 15• Personal transactions 10• Freedom to use currency 5• Freedom to hedge 4

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Capital Flow Freedom Index—Weights

• The weights are by nature subjective, but we believe they are reasonable

• The weights for individual measures are much less subjective (they are largely determined by the number of individual measures within each category”)

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How the Index is Compared to the Rescaled Chinn-Ito Index

The Index is Robust to Different Weighting Schemes

Four Types of Countries

1. Singapore (94) and Indonesia (82)2. Brunei (95) and Cambodia (74)3. Malaysia (66), the Philippines (60), and

Thailand (45)4. Vietnam (33), Lao PDR (30), and

Myanmar (2)

Features of the Capital Account Regimes in ASEAN (1)

1. Many retain restrictions on capital flows2. Controls are tighter on outflows than on

inflows3. All except Myanmar have accepted IMF

Article VIII, but many keep current account-related restrictions (e.g., repatriation requirements and payment formalities)

Features of the Capital Account Regimes in ASEAN (2)

4. Almost all restrict offshore use of their currencies

5. Many place more restrictions on external borrowing than portfolio inflows; many, including Singapore, restrict external lending

6. Many restrict the ability of investors to hedge risks

Features of the Capital Account Regimes in ASEAN (3)

7. Some impose withholding tax on interest income and capital gains from certain types of securities

Steps in Formulating CAL Implementation Plans

Existing ASEAN Frameworks

Any CAL implementation plan must be coordinated with the following existing frameworks:

• AEC Strategic Schedule, through 2015• ACMF Implementation Plan, through 2015• Working Committee on CAL (WC-CAL)

Work Plan, through 2015

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1. AEC Strategic Schedule (selective measures)—Free Flows of Investment

2010-2011 2012-2013 2014-2015

Complete Phase I of the progressive reduction/elimination of investment restrictions and impediments

Complete Phase II of the progressive reduction/elimination of investment restrictions and impediments

Complete the Final Phase of the progressive reduction/elimination of investment restrictions and impediments--realize free and open investment regime with minimal investment restrictions; achieve harmonization of investment measures to facilitate movement of investments

Commence Phase II of the progressive reduction/elimination of investment restrictions and impediments

Commence the Final Phase of the progressive reduction/elimination of investment restrictions and impediments

 

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1. AEC Strategic Schedule (selective measures)—Freer Flows of Capital

  2010-2011 2012-2013 2014-2015

Strengthen capital market development and integration

    Achieve greater harmonization in offering rules, disclosure requirements and distribution rules; facilitate mutual recognition for market professionals; achieve greater flexibility for securities issuance; enhance withholding tax structure; facilitate market driven efforts to establish exchange and debt market linkages

Foreign direct investment

Progressively liberalize, where appropriate and possible, the pre-identified rules for freer flow of foreign direct investments

  Continue to liberalize, where appropriate and possible, any other items related to foreign direct investment

Portfolio investment

2009-2010: Assess and identify rules for liberalization for freer flows of portfolio investments, particularly in debts and equity

2011-13: Progressively liberalize, where appropriate and possible, the rules identified for freer flow of portfolio investments

Continue to liberalize, where appropriate and possible, any other items related to portfolio investments

Other types of flows

2011-2012: Assess and identify rules for liberalization of other types of flows, particularly long-term foreign borrowing and lending

Progressively liberalize, where appropriate and possible, the rules identified for other types of flows, particularly long-term foreign borrowing and lending

Continue to liberalize, where appropriate and possible, any other items related to other types of capital flows

Current account transactions

Adopt IMF Article VIII status Remove and/or relax, where appropriate and possible, restrictions on repatriation/surrender requirements

Continue to liberalize, where appropriate and possible, any other items related to current account transactions 18

2. ACMF Implementation Plan for Regional Integration of Capital Markets (Selective)

  2009-2010 2011-12 2013-2015

Cross-border distribution of primary offerings

Adopt the ASEAN and Plus standards for cross-border primary offerings

Phase out country specific Plus Standards; develop mutual recognition framework for primary offerings

Adopt harmonized ASEAN disclosure standards for primary offerings

Cross-border distribution of products

Allow distribution of listed products on ASEAN exchanges to non-retail investors

   

Facilitate investment by non-retail investors

Identify restrictions to be removed for non-retail investors; allow cross recognition of ASEAN exchanges

Develop harmonized criteria for non-retail investors; remove restrictions that prevent them from investing freely in ASEAN

 

Develop single passport/licensing for market intermediaries

Identify any policy/legal impediments for cross-border provision of services by market intermediaries

Develop mutual recognition for products and services by market intermediaries to non-retail investors

Establish mutual recognition for products and services by market intermediaries to non-retail investors; expands mutual recognition to all investors

Establish the electronic trading link

Implement ACE bilaterally through a phased approach

ASEAN exchanges endeavor to achieve full linkage to ACE gateway

 

Implement depository linkages

When ready, ASEAN exchanges develop depository links

   

Coordinate listing rules

Take necessary steps to promote cross listings on ASEAN exchanges

Harmonize listing rules to lower costs and ensure timely and contemporaneous disclosure by cross-listed entities

 

Promote regional products and regional market intermediaries

    Allow issuers and investors to freely issue and trade across the region; accelerate the development of regional intermediaries to serve ASEAN investors

  Facilitate ratings comparability within ASEAN

Design a regional strategy for ratings comparability

 

  Strengthen capital income taxation; enhance withholding tax structure to promote the broadening of investor base

Analyze differences in national tax regulations and establish best practices for tax system

 

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3. WC-CAL Work Plan

  2010-11 2012-13 2014-15

Current account liberalization

Achieve IMF Article VIII status

Remove/relax restrictions on repatriation/surrender requirements

Continue to liberalize current account transactions

Foreign direct investment Liberalize the identified list of rules

Liberalize the identified list of rules

Further liberalization

Portfolio investment: debt and equity

2009-10: Assess and identify rules for liberalization

2011-13: Liberalize the identified list of rules

Further liberalization

Other types of flows: long-term foreign borrowing and lending

2010-11: Assess and identify rules for liberalization

Liberalize the identified list of rules

Further liberalization

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Coordination With Existing Frameworks

• The ASEAN Strategic Schedule is too general to be of practical use

• WC-CAL Work Plan still at an early stage, hence of little practical use at this stage (lists of specific rules are being prepared by national authorities)

• ACMF Implementation Plan—principles of harmonization and mutual recognition to promote regional flow of financial products

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Principles of Sequencing• The conventional wisdom is that outflows should

be liberalized after inflows• The conventional wisdom does not apply to

ASEAN because financial integration is a two-way process

• Outflows must be liberalized early in the process to facilitate financial integration

• The principle of mutual recognition can be invoked to promote outflows (within the region) without violating the global rule of non-discrimination while containing risk 22

Principles of Sequencing (Continued)

1. Current account and FDI related measures should be liberalized immediately

2. Inflow measures should be removed—given the high degree of de facto openness (usually through purchases of domestic securities by non-residents), removing impediments to inflows should not necessarily create additional risks

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Principles of Sequencing (Concluded)

3. Outflow measures to be removed—first with respect to other ASEAN countries, through mutual recognition principle; eventually to all countries; distinction can be made between non-retail and retail investors in specific instances

4. Creating enabling environments, including ease of using currency; ease of hedging; and removal of withholding tax; freedom of personal transactions—this can come at a later stage or not at all

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2011-15 2016-20Current account and FDI related Eliminate payment formalities for invisibles

Portfolio inflows

Portfolio outflows

Other flows

Other measures Rationalize withholding tax for foreign investors subject to mutual tax arrangement

Rationalize withholding tax for all foreign investors

Brunei (95)

2011-15 2016-20Current account and FDI related Eliminate payment formalities for invisibles

Portfolio inflows

Portfolio outflows

Other flows

Other measures Rationalize withholding tax for foreign investors subject to mutual tax arrangement

Rationalize withholding tax for all foreign investors

Cambodia (74)

2011-15 2016-20Current account and FDI related Eliminate payment formalities for invisibles

Portfolio inflows

Portfolio outflows

Other flows

Other measures Rationalize withholding tax for foreign investors subject to mutual tax arrangement

Rationalize withholding tax for all foreign investors

Indonesia (82)

2011-15 2016-20Current account and FDI related Eliminate repatriation/surrender requirements for

export proceeds as well as payment formalities for invisibles

(i) Eliminate surrender requirements for FDI inflows; (ii) substantially liberalize FDI outflows

Portfolio inflows Allow resident firms and financial institutions to issue securities abroad, subject to mutual recognition principle

Substantially allow resident firms and financial institutions to issue securities abroad

Portfolio outflows Liberalize foreign portfolio investment by banks and institutional investors, subject to mutual recognition principle

(i) Allow nonresident firms and financial institutions to issue securities in the domestic market, subject to mutual recognition principle; (ii) substantially liberalize foreign portfolio investment by banks and institutional investors

Other flows Liberalize external borrowing within the context of ASEAN financial services liberalization

Liberalize external lending within the context of ASEAN financial services liberalization, including through giving residents greater freedom to hold bank deposits with banks located in other ASEAN member states

Other measures Allow some personal capital transactions to be conducted freely

Lao PDR (30)

2011-15 2016-20Current account and FDI related (i) Eliminate repatriation requirements for export proceeds, as

part of the overall liberalization process; (ii) fully liberalize FDI outflows by eliminating quantitative limits for those without own foreign currency funds

Portfolio inflows Substantially eliminate the limit on the issuance abroad of debt and money market instruments by residents

Portfolio outflows (i) Substantially liberalize foreign portfolio investment by institutional investors and collective investment vehicles by progressively raising prudential limits; (ii) liberalize purchases abroad of securities by residents, subject to mutual recognition principle; (iii) allow nonresidents to issue securities in the domestic market, subject to mutual recognition principle

(i) Substantially liberalize purchases abroad of securities by residents; (ii) substantially allow nonresidents to issue securities in the domestic market

Other flows (i) Substantially liberalize external borrowing, especially for nonfinancial entities; (ii) liberalize external ringgit lending within the context of ASEAN financial services liberalization; (iii) substantially allow residents without own foreign funds to open deposit accounts with banks located in other ASEAN member states

Substantially liberalize external ringgit lending, including for activities outside Malaysia

Other measures

Malaysia (66)

2011-15 2016-20Current account and FDI related Accept obligations under Article IV of the IMF

Articles of Agreement(i) Eliminate payment formalities; (ii) substantially liberalize FDI outflows

Portfolio inflows Establish a legal framework Continue to ease

Portfolio outflows Establish a legal framework Continue to ease

Other flows Ease in the context of ASEAN financial services liberalization, including through bank deposits

Continue to ease

Other measures Allow some personal transactions to take place

Myanmar (2)

2011-15 2016-20Current account and FDI related (i) Eliminate payment formalities for invisibles; (ii)

eliminate repatriation requirements for FDI inflows; (iii) fully liberalize FDI outflows

Portfolio inflows

Portfolio outflows (i) Allow nonresidents to issue securities in the domestic market, (in the case of equities) subject to mutual recognition principle; (ii) allow residents to purchase foreign securities, including through collective investment vehicles, (in the case of equities) subject to mutual recognition principle

(i) Substantially allow nonresidents to issue securities in the domestic market; (ii) substantially allow residents to purchase foreign securities, including through collective investment vehicles

Other flows Liberalize external lending in the context of ASEAN financial services liberalization, including by progressively allowing residents to open deposit accounts with banks located in other ASEAN member states

Substantially liberalize external lending

Other measures (i) allow some personal transactions to be conducted freely; (ii) rationalize withholding tax for foreign investors, subject to mutual tax arrangement

(i) Fully rationalize withholding tax for foreign investors; (ii) substantially allow offshore use of peso

The Philippines (60)

2011-15 2016-20Current account and FDI related

Portfolio inflows

Portfolio outflows Take measures to promote capital outflows with ASEAN

Other flows Eliminate the foreign exchange conversion requirement for external lending in Singapore dollar

Other measures Promote offshore use of Singapore dollar in neighboring countries

Singapore (94)

2011-15 2016-20Current account and FDI related (i) Eliminate surrender/repatriation requirements for export

proceeds; (ii) eliminate payment formalities for invisibles; (iii) eliminate surrender requirements for FDI inflows: (iv) substantially liberalize FDI outflows

Portfolio inflows (i) Eliminate repatriation requirements for portfolio inflows; (ii) substantially allow residents to issue securities abroad; (iii) substantially allow nonresidents to purchase domestic debt and money market instruments

Portfolio outflows (i) Substantially liberalize foreign portfolio investment by banks and institutional investors; (ii) allow nonresidents to issue securities in the domestic market, subject to mutual recognition principle; (iii) liberalize purchases of foreign securities by residents, including through collective investment vehicles, subject to mutual recognition principle

(i) Substantially allow nonresidents to issue securities in the domestic market; (ii) substantially liberalize purchases by residents of foreign securities including through collective investment vehicles

Other flows (i) Substantially liberalize external borrowing; (ii) liberalize external lending in the context of ASEAN financial services liberalization

Substantially liberalize external lending

Other measures Rationalize withholding tax on all securities for foreign investors, subject to mutual tax arrangement

(i) Fully rationalize withholding tax on all securities for foreign investors; (ii) substantially allow offshore use of baht

Thailand (45)

2011-15 2016-20Current account and FDI related Eliminate repatriation requirements for export proceeds Substantially liberalize FDI outflows (by 2016)

Portfolio inflows (i) Eliminate repatriation requirements for portfolio inflows; (ii) substantially allow residents to issue securities abroad

Portfolio outflows (i) Substantially ease restrictions on foreign portfolio investment by institutional investors; (ii) liberalize purchases by residents of foreign securities, including through collective investment vehicles, (in the case of equities) subject to mutual recognition principle; (iii) allow nonresidents to issue securities in the domestic market, (in the case of equities) subject to mutual recognition principle

Continue to ease

Other flows (i) Substantially liberalize external borrowing; (ii) liberalize external lending in the context of ASEAN financial services liberalization

Continue to ease

Other measures Allow some personal transactions to take place

Vietnam (33)

Safeguard Measures

Three Types of Safeguard Measures

1. Sound and consistent macroeconomic policies

2. Administrative mechanisms3. Capital controls

1. Sound and Consistent Macroeconomic Policies

• Sound policies characterized by price stability and fiscal discipline

• Choice between exchange rate stability and monetary independence, given the working of the impossible trinity under high capital mobility

2. Administrative Measures

• Restrictions on cross-border trading in forwards and derivatives, offshore currency use

• Mutual recognition• Routine ex post reporting requirements• Authorized domestic intermediaries• Registration requirements• Others

3. Capital Controls

• Need to build institutional capacity• Regional cooperation to define an

emergency during which such controls can be introduced

• Regional cooperation to remove stigma attached to such controls

Conclusion• The diversity across the region calls for a gradual and

judicious approach to sequencing the needed reforms• The approach to CAL must be realistic, giving due respect

for the level of economic and financial sector development of individual members

• Even so, the aim of the AEC to create an integrated financial market can substantially be achieved by 2015—and certainly by 2020—with determined efforts and political will