1

Issues in Monetary & Financial Cooperation & Integration in Asia & Trans-Pacific Partnership Agreement

Dr. Mah-Hui LIM

Senior Visiting Fellow

Penang Institute

limmahhui@gmail.com

CIER, Taipei

January 24, 2014

International Context

G20 has not shown leadership in restructuring international economic and financial architecture

Makes regional cooperation all the more necessary and urgent

2

Areas for Financial Cooperation

1. Liquidity Support and Management – Chiangmai Initiative (CMIM) & AMF

2. Trade Financing & Facilitation

3. Asian Reserves for Development

4. Regulatory Cooperation/Coordination

5. Trans Pacific Partnership Agreement

3

I- Liquidity Support & Management – Chiangmai Initiative & SAARC Swap Arrgt

CMIM has expanded since inception in 2001. As of May 2012 -

$240 billion fund

Multi-lateralized

40% not subject to IMF conditionality

AMRO established Apr 2011

4

CMIM Swap Lines in Dec 2009

5

Short-comings

Why has never been used despite Korea and Indonesia liquidity problems in 2008 financial crisis?

Still a self-managed pool of reserves, i.e., the request process is multi-lateralized but not the contribution

Size not adequate

60% borrowing quota still linked to IMF conditionality

6

Korean Experience Oct 2008

Korea strong macro economic fundamentals but high ST external debt, free capital flows, high level of foreign equity & bond holdings

Had $260 billion reserves – 6th largest in the world

Spent $60 bn to defend won but couldn’t stop self-reinforcing vicious downward spiral with decline in reserves 7

Korean Experience

Only $30 bn US swap line stemmed the confidence crisis

Plus also had $30 bn bilateral swap lines each with PBOC and BOJ

Why didn’t access CMIM?

Why swap line with PRC and Japan outside of CMIM framework?

8

Suggestions

Increase size of fund and draw-down quota

Reduce conditionality quota

Multi-lateralize approval process

Strengthening AMRO critical

Adequate duration of swap

Diversify away from US$ swap line

Adequate space for counter-cyclical

Expand participating countries 9

Swap lines in local currencies for trading purpose

Set up regional export-import banks

Provide back up lines of credit for trade during crisis period

10

II - Trade Financing & Facilitation

III- Utilization of Asian Foreign Reserves – Bond Markets

Some costs of developing bond markets to recycle regional savings for regional investments

Trade-off btw liquidity of cap mkts & financial & economic stability

Vulnerability to sudden inflow & outflow

Unable to regulate capital flows & exchange rates

11

Std View - Financial Integration = Dev of Bond Mkts

AFC crisis – over dependence on bank finance –double mismatch

Maturity mismatch

Currency mismatch

Bond Mkt supposed to over come this problem

Bond Mkt to mobilize & recycle Asian reserves for regional invsts

12

Bond Markets Performance – 8 East Asian countries 2000-2010

13

2 issues - Bond Mkts :(a) efficient allocator; (b) liquidity

Tobin-4 Meanings of Mkt Efficiency

Information-Arbitrage Efficiency

Arrow-Dubreau’s full insurance efficiency

Fundamental valuation efficiency (DCF)

Functional or social efficiency

14

Social Efficiency

UNCTAD (2009) – Financial mkts do decent job at processing transactions efficiently & low costs but do not contribute to long run growth.

From regulators’ perspective, the most relevant criterion is social efficiency – contribution to stable, long-term economic growth, with minimal increase in fin fragility

15

Social Efficiency

Asian Financial Crisis and Great Financial Crisis question the claims of mkt efficiency in terms of financial stability and long term growth

Experience in financing in Indonesia

Minsky thesis – financial markets becoming inherently more fragile and unstable moving from hedge > speculative > Ponzi financing

16

International Financial Flows & World Fixed Invsts 1970-2009

17

Tobin’s conclusion

Market efficient only in first sense – not possible to gain from trading on basis of available public information

Fail in 2nd, 3rd,most miserably in 4th

18

(2) Liquidity–Stability Trade Off

Raison d’etre of cap mkts – liquidity

ADB- common trading stds make it cheaper and faster for investors to dip in and out of markets

Keynes – no such thing as liquidity for market as a whole. Liquidity is an individual investor concept not a system concept

19

Keynes

“With the development of organized investment markets, a new factor of great importance has entered in, which sometimes facilitates investment but sometimes add greatly to the instability of the system”

20

Liquidity vs Stability

Problem is exacerbated where investments are from foreign sources and recipient economies are small

Divergence btw benefits of liquidity to investors but macro-economic costs to recipient countries i/t of financial and economic instability as evidenced in AFC and in recent GFC

21

Regional Long Term Credit and Development (LTCD)Banks

Set aside small percentage of reserves to fund regional LTCD Banks

Avoid problem of currency & maturity mismatch better, without volatility & instability of bond markets

Take long term view and adopt anti-cyclical policies e.g. build up reserves in good time and lending in difficult time

22

Principles of LTCD Bank

More inclusive lending to small economies and SMEs unlike bond markets that just cater to big corporations

Promote long-term stable growth

Government equity but professional and hands-off approach in operation, credit evaluation & loan allocation

23

IV - Regional Coordination in Capital Controls

Volatile capital flows from excessive international liquidity a major concern to emerging economies

Individual countries, like Malaysia & Thailand, taking capital control measures faced tremendous market pressures

Such measures more effective if they are coordinated

24

V- TPPA (Trans Pacific Partnership Agreement)

Participants in TPPA – 13

Covers 29 chapters – ranging fr intellectual property rights, labor, environment, services, investments, state owned enterprises, govt procurement, trade, SMEs etc

Only 6 of 29 chapters on trade

Trade benefits limited; outweighed by other factors

25

Trade Benefits ?

E.g. Msia – avg tariff rates 23% vs US tariff rate of 3.4%, Msia has to cut much higher tariff compared to US

Zero tariffs threaten many local industry & agr. US agr producers rec subsidies > lower prodn cost

E.g. US rice 27c/kilo or 34% below cost; Msia rice tariff, without protection will be destroyed

26

Trade Balance pre & post FTA with U.S.

Export Import Trade to US from US Balance Peru 2008 6.2 bil 5.8 bil + 400m 2012 6.4 9.3 - 2.9 bil Chile 2003 3.7 bil 2.7 b + 1 bil 2012 9.4 18.8 - 9.4 bil Spore 2003 15.1 bil 16.6 b - 1.4 bil 2012 20.2 30.5 - 10.3 bil

Investment issues

Liberalization of ownership

Protection of investors rights

Investor-state disputes

Free capital flows

28

Definition of investment – very broad

Includes FDI, portfolio invst, financial derivatives, intellectual property, future profits

Committed to open entry to foreign investors to many sectors incldg services; may go up to 100% ownership

Negative rather than positive list

29

Excessive Protection rights

National treatment – foreign investors same rights as local investors

Fair & Equitable treatment-stable, predictable invst environt, i.e.no new policies that affect revenue of investor

Expropriation-not only confiscation of property but also changes in contracts, and reduction of revenues due to new policies and regulations.

30

Investor-State Dispute Chapter

Private investor can sue governments for losses incldg potential losses resulting fr govt policies

Compromise state sovereignty – ability to enact policies to protect public interest

In last 13 years, number of private suits against govts rose 500% fr 69 to 370

31

Examples of Investor-State Disputes

Philip Morris sue Australia & Thailand for billions -requiring plain packaging

Renco sue Peru for $800m for environmental requirements

U.K. co.Churchill sue Indonesia for $2b for revoking mining rights

Disputes must be settled in international arbitration tribunals

Often conflict of interests – lawyers for corps also act as arbitrators

32

Awards Made Against Some Countries (excl. interest/costs)

Ecuador -- US$1,928 mil.

Argentina -- $ 1,140 mil

Libya -- $948 mil

Slovakia -- 896 mil

Mexico – 242 mil

Czech Republic - 483 mil

Lebanon – 266 mil

Sri Lanka – 60.8 mil

Capital Transfer Provision in Investment Chapter

“Each Party shall permit all transfers relating to a covered investment to be made freely and without delay into and out of its territory”

i.e. NO Capital Controls over inflow and outflow of capital

This is more restrictive than IMF conditions

34

Proposed Balance of Payment Safeguards

If free capital flows threaten or cause serious balance of payment difficulties and/or

In exceptional cases, macro-economic difficulties for monetary and exchange rate policies

then

Temporary measures of capital controls may be adopted

35

However, series of limiting conditions are stipulated

Non-discriminatory

Consistent with IMF articles

Avoid unnecessary damage to commercial, financial interests

Temporary & be phased out as situation improves

36

Comments on Free Capital Flows

Who defines temporary and for how long? Same for serious & exceptional

The country affected should judge for itself when it is prudent to phase out the controls, i.e. self judging and not imposed from outside

The limitation clauses are too restrictive and defeat the purpose & effectiveness of control measures

37

Relation btw Fin Crises & Cap & Fin Deregulation-1880s to 2009

38

Reinhart & Roghoff – This Time is

Different: Eight Centuries of Financial Folly (2009)

“Periods of high international capital mobility have repeatedly produced international banking crises, not only in the 1990s but historically”

“In 18 out of 26 banking crises, the financial sector had been liberalized within the preceding 5 years” (p.155)

39

Two Recent Financial Crises

Asian Financial Crisis of 1997 and Global Financial Crisis of 2007 both a result of excessive financial deregulation and liberalization

In Asia, 2 countries that escaped the Asian Financial Crisis – China and India had kept capital controls ability

40

BIS 71st Annual Report June 2001

“When financial systems were heavily regulated … the scope for damaging financial cycles were constrained…Such regulated environments…were less proned to large cyclical swings seen in today’s more liberalized environment”

41

Costs of Financial Crises

Countries Fiscal Costs

% GDP

Output Loss %

GDP

Indonesia 55 40

Thailand 35 40

Malaysia 16 33

Philippines 13 10

US Subprime $ 1 trillion 8%

US GDP

Reinhart & Roghoff

At least 5 years output loss and employment loss after financial crisis

Government debt increase by average of 86% after 3 years

43

Due to Dangers of Financial Crisis -Govts Need Policy Space To:

Prevent and Avoid financial crisis -regulate capital inflows

To Manage and Overcome financial crisis – regulate capital outflows

To do Sovereign Debt Restructuring

44

Two Examples where Capital Controls Had Positive Results

Malaysia imposed temporary capital controls during the Asian Financial Crisis. Result it recovered faster from the crisis than Indonesia & Thailand.

Even the IMF admits today that capital controls helped Malaysia’s recovery

45

U.S. Use of Capital Controls (Moffitt, The World’s Money 1983:pp41-47)

1963 – US imposed Interest Equalization Tax (IET) on USD bonds issued by foreign companies to stem capital outflows & balance of payment problem. Result -

International bonds issued in the USD in US dropped from 72% (1963) to 55% (1964) and 28% (1968)

46

Even IMF Concerned Over Constraints on Capital Account Restrictions

“The limited flexibility afforded by some bilateral and regional agreements in respect to liberalization obligations may create challenges for the management of capital flows” (IMF, Liberalizing Capital Flows & Managing Outflows. 2012).

47

THANK YOU

48