Impact of Eurozone Financial Shocks on an Increasingly Integrated and

Globally Connected ASEAN

Jayant Menon Lead Economist (Trade and Regional

Cooperation)Office of Regional Economic Integration

Asian Development Bank

Boustead Annual Globalisation Lecture 2014

University of Nottingham- Kuala Lumpur,

19th February, 2014

The views expressed in this presentation are those of the author and do not necessarily reflect the views and policies of the Asian Development Bank, or its Board of Governors or the governments they represent.

Presentation Outline

• Introduction- more regionally integrated and globally connected; benefits but also risks

• Direct Impacts of Eurozone shock

• Indirect Impacts

• Is the region ready for another crisis?

Progress of Integration – Asia (intraregional as % of

total)

ASEAN – defining characteristicsASEAN – defining characteristics

• ASEAN - the most durable regional association in the developing world.• Four defining characteristics:a)Diversity – greater than any other major regional grouping. History, language, politics, and economics (50:1 GDP/cap), population, resource endowments.b)Generally rapid economic development.

But ASEAN membership no guarantee (Myanmar)

ASEAN – defining characteristicsASEAN – defining characteristics

c) Avoidance of strong supra-national organization; deliberately under-powered secretariat; the ‘ASEAN Way’ – strengths & weaknesses.

d) Unlikely to ever be an EU-style organization; or a customs union with common macroeconomic policies.- No political appetite, nor economic basis

ASEAN – defining characteristicsASEAN – defining characteristics

• ASEAN today is more regionally integrated and globally connected than it has ever been.

• Regional integration has been increasing- trade, FDI, equity and bond holding, and highest output correlation

• Less than East Asia, but more than other Asian subregions.

Progress in Regional Integration, 2008–2011

 

Production Network and Trade

Capital MarketsMacroeconomic

Links: Intraregional

Output Correlations 

Intra-regional

FDI

Intra-regional Trade

Intraregional Equity Holdings

Intraregional Bond Holdings

Asia 50.08 55.02 24.98 6.36 0.36Central Asia 0.02 5.33     0.35East Asia 41.81 36.17 17.6 2.84 0.59Southeast Asia 6.32 24.61 9.54 9.49 0.7

South Asia 0.03 4.61     0.04

The Pacific and Oceania 1.91 8.05     0.46

Intra-ASEAN Holdings of Debt Intra-ASEAN Holdings of Debt Securities Securities

ASEAN – defining characteristicsASEAN – defining characteristics

• As an open, outward-looking region, ASEAN today is more globally connected than it has ever been.

• The level of interdependence is driven not so much by increasing regional integration, but a common dependence on external markets.

• Trade-investment nexus and ‘Factory Asia’

ASEAN – defining characteristicsASEAN – defining characteristics

• A rare example of rising regional integration while at the same time increasing globally connexion

• These features deliver significant benefits, but they also carry risks.

• Increased vulnerability to external shocks, as well as contagion that spreads rapidly across the region

Merchandise Export Growth(y-o-y, %, 3-month moving average)

Current Account of ASEAN4, 2011- 2013 (quarterly, as a

share of GDP)

Growth in Bank Lending (y-o-y, %)

Response of ASEAN Equity Returns to a Negative Eurozone

Equity Shock

Response of Output Growth to a Eurozone Equity Shock

Direct Impacts

• Eurozone financial crisis would have a small but non-negligible impact on the region’s stock markets and economic growth.

• In terms of real impact, Singapore and Malaysia are more exposed

• What we cannot quantify are the indirect effects that may flow from adjustments that take place via changes in value assessments and confidence.

Indirect Impacts

• Since the region’s asset prices—both real and financial—have seen significant increases resulting from the large inflows of capital driven by quantitative easing in the advanced economies, underlying perception among global investors of asset bubble.

• If the direct impact of a Eurozone shock leads to a re-assessment of asset valuations in the region and perceptions of risk, this could lead to further corrections

Indirect Impacts

• Eurozone crisis is one possible trigger; any shock, including tapering, could be an instigator

• Early signs of possible impacts of increased tapering were witnessed in India and Indonesia in particular last year

• Even right now, the volatility of foreign exchange rates and equity markets are clear signs of increased vulnerability that could easily spillover into a crisis

What if crisis strikes?

• Although ASEAN is more resilient cf. AFC, should crisis strike, is the region ready?

• Not quite- regional financial safety net still inadequate

• Size of CMIM is still too small at $240 bil; less than 3% of about $5 trillion in reserves of ASEAN+3

• Even smaller if increased regional integration results in contagion and multiple applications.

• Stigma attached to IMF conditionality for majority (more than 30%) of quota

Now, is it usable? • Although recent reform measures constitute major

progress, but questions on “how” and “who” remain

• On “how”, two options: complement to, or substitute for, IMF

• On “who”, not +3, since they are providers not users. Have their own bilateral swaps

• For original ASEAN, size of quotas too small as substitute, but maybe complement. Maybe new ASEAN more likely, as significant share of their reserves. Eg, Cambodia: non-IMF quota of $360M; reserves in Feb 2012 of $3.6B. But in crisis, may still look beyond the CMIM.

Now, is it usable?

• Regardless of whether complement or substitute to IMF, the speed and efficiency of requests need to be addressed. Uncertainty over procedures, since never tested.

• Decisions lie with a high-level, non-resident body. The CMIM is not a fund, but a reserve pooling system.

• Needs to be demonstrated that CMIM is superior to quick-disbursing bilateral swaps, which appears to be quickly becoming the first line of defense after national reserves.

Now, is it usable?

As an alternative to the IMF, then 3 reforms:a) Further increase in the size of the CMIM:$240B almost certainly inadequate. Eg, the original ASEAN 4 countries have a non-IMF quota of about $7B each, but during the AFC the Thai and Indonesian packages were about $17B and $40B, respectively.So either the size or the non-IMF limit need to be increased.b) Expanding CMIM Membership: Has more to do with diversifying the source of funds than simply expanding its size of the fund. To include countries less directly connected to the East Asian business cycle.

Now, is it usable?

c) Strengthening AMRO’s Credibility: This is crucial for CMIM; perhaps more important than size or diversity of membership, ie, capacity to lead – or be a key partner in – a credible rescue package is the key.Eg., with AFC, IMF lead, but funds also came from regional and bilateral sources

So, CMIM still appears unusable if crisis strikes tomorrow, but progress being made- and hopefully before, rather than because of, the next crisis!

Thank you!Thank you!For inquiry or comments, please contact:

Jayant Menon Lead Economist (Trade and Regional Cooperation)

Office of Regional Economic Integration

Telephone: (63-2) 632-6205Email: jmenon@adb.orgTwitter: @jayantmenon

Menon and Ng (2013), containing detailed results, downloadable from:

http://aric.adb.org/pdf/workingpaper/WP116_Menon_Ng_Eurozone_shocks.pdf