A Regional Bond Market for East Asia? The Evolving Political Dynamics of Regional Financial Cooperation Jennifer Amyx Department of Political Science University of Pennsylvania Presentation at The Australian National University 9 March 2004

Project motivations Under what conditions will regional financial cooperation emerge in East Asia? Under what conditions will regional financial cooperation emerge in East Asia? Variation in degrees of progress made to date across financial cooperation issues tackled thus far: what explains variation in pace of progress? Variation in degrees of progress made to date across financial cooperation issues tackled thus far: what explains variation in pace of progress? Are regional cooperation outcomes affected by Are regional cooperation outcomes affected by Japan-China competitive dynamics? Japan-China competitive dynamics? Influence of the U.S. in the region? (esp. US-Japan relationship) Influence of the U.S. in the region? (esp. US-Japan relationship)

Differential progress across 3 areas of financial cooperation Area Outcome to date Short-term liquidity support in time of crisis (Chiang Mai Initiative) Mixed success Network of bilateral currency swaps in place (after 3 yrs of negotiation) but amounts involved small and release of 90% of funds tied to IMF program being in place Common currency arrangement Little progress No initiative emerges beyond commitment to “ study ” the issues Asian bond market Rapid developments But, a long way to go

Explanations for and implications of these patterns of progress How much explanatory value does an analysis of political factors provide in accounting for variation in outcomes? How much explanatory value does an analysis of political factors provide in accounting for variation in outcomes? What do these political factors and the results thus far suggest about how the process compares to the European experience and the prospects for attainment of eventual monetary integration in East Asia? What do these political factors and the results thus far suggest about how the process compares to the European experience and the prospects for attainment of eventual monetary integration in East Asia?

Talk Outline Emergence of the ‘ ASEAN+3 ’ Emergence of the ‘ ASEAN+3 ’ Examination of 3 areas of financial cooperation focused on thus far Examination of 3 areas of financial cooperation focused on thus far Explanation for greater and more rapid progress on bond issue Explanation for greater and more rapid progress on bond issue Assessment of political dynamics in East Asia compared to those in Europe on issues of financial cooperation Assessment of political dynamics in East Asia compared to those in Europe on issues of financial cooperation

Situation prior to the Asian financial crisis Increasing economic interdependence through trade, direct investment and finance in region Increasing economic interdependence through trade, direct investment and finance in region But, unmatched by development of mechanisms and institutions for regional financial cooperation But, unmatched by development of mechanisms and institutions for regional financial cooperation Most cooperation focused on trade and conducted at sub-regional and supra-regional level (ASEAN and APEC) Most cooperation focused on trade and conducted at sub-regional and supra-regional level (ASEAN and APEC)

Motivations for the rise of the “ ASEAN + 3 ” Most proximate: Asian financial crisis Most proximate: Asian financial crisis Rise of regionalism elsewhere Rise of regionalism elsewhere (European Union, NAFTA, etc.) (European Union, NAFTA, etc.) Frustration with U.S. dominance of multilateral institutions and a “ hubs and spokes ” model in region Frustration with U.S. dominance of multilateral institutions and a “ hubs and spokes ” model in region For ASEAN, important opportunity to get the “ plus three ” (particularly China and Japan) to talk For ASEAN, important opportunity to get the “ plus three ” (particularly China and Japan) to talk

Differences with past regional institution-building efforts Participants: more exclusively “ Asia ” -- > exclusion of U.S. Participants: more exclusively “ Asia ” -- > exclusion of U.S. * Does excluding the U.S. mean that the grouping assumes a competitive stance vis- à -vis the U.S. or U.S. dominated multilateral organizations? This is a key question for U.S. policymakers * Does excluding the U.S. mean that the grouping assumes a competitive stance vis- à -vis the U.S. or U.S. dominated multilateral organizations? This is a key question for U.S. policymakers Role of ‘ rise of China ’ factor Role of ‘ rise of China ’ factor

3 financial sector initiatives Asian monetary fund-> currency swap network for short-term liquidity support Asian monetary fund-> currency swap network for short-term liquidity support Mixed success Mixed success Common currency arrangement Common currency arrangement Little progress (and certainly nothing concrete) Little progress (and certainly nothing concrete) Asian bond market Asian bond market Rapid developments forward in short period of time (over past year and a half) Rapid developments forward in short period of time (over past year and a half)

The Chiang Mai Initiative (CMI) of May 2000 Network of bilateral currency swaps among countries Network of bilateral currency swaps among countries Seen by some as functional equivalent to an “ Asian Monetary Fund ” Seen by some as functional equivalent to an “ Asian Monetary Fund ” Japan ’ s role as leader and arbitrator of intra- regional interests Japan ’ s role as leader and arbitrator of intra- regional interests Outcome: 90% linkage to IMF program in place; review planned this year Outcome: 90% linkage to IMF program in place; review planned this year Key factor limiting greater regional independence: “ surveillance ” capacity Key factor limiting greater regional independence: “ surveillance ” capacity

Basic Elements of Bilateral Swaps Under Chiang Mai Initiative Modality:U.S. dollar and local currencies Maturity:90 days, renewable for up to 2 years Drawing conditions:Activation linked to IMF programs but up to 10 percent may be disbursed without linkage to IMF programs. Interest rate:Market interest rate + premium Other:Guarantee or collateral provided by the Government of country requesting the swap. Source: Ministry of Finance, Japan

Exchange rate / currency coordination Championed by Japan ’ s Ministry of Finance Championed by Japan ’ s Ministry of Finance Seen as route for internationalizing the yen Seen as route for internationalizing the yen Study groups formed but little progress Study groups formed but little progress Construct basket of regional currencies as an Asian currency unit (like European currency unit in place )? Construct basket of regional currencies as an Asian currency unit (like European currency unit in place )? Little enthusiasm among actors, even in Japan Little enthusiasm among actors, even in Japan Common currency arrangement seen to disproportionately benefit some members over others Common currency arrangement seen to disproportionately benefit some members over others View from outside the region? Disinterest View from outside the region? Disinterest

Underdeveloped bond markets in Asia (Hong Kong Institute for Monetary Research) Effective but underusedHong Kong Singapore Effective but inefficientKorea Malaysia Taiwan Semi-effective or blockedIndonesia Philippines Thailand UnderdevelopedChina

Why the relative lack of depth or activity in Asia ’ s bond markets? No shared singular explanation; constraints differ across economies. No shared singular explanation; constraints differ across economies. Historically, private sector lobbying (often non-Asian banks) has driven financial sector reforms in these economies Historically, private sector lobbying (often non-Asian banks) has driven financial sector reforms in these economies

Arguments for expanding Asia ’ s bond markets Region may become less prone to contagion from economic shocks and shifts in sentiment if lessen financial system reliance on banking sector and improve the efficiency with which savings is mobilized. Region may become less prone to contagion from economic shocks and shifts in sentiment if lessen financial system reliance on banking sector and improve the efficiency with which savings is mobilized. If bonds issued in local currencies or as an ‘ Asian bond ’, then also decreases currency mismatch problem If bonds issued in local currencies or as an ‘ Asian bond ’, then also decreases currency mismatch problem US dollar ’ s weakness suggests to Asian investor that capital preservation may not be compatible with a passive accumulation of U.S. gov ’ t bonds US dollar ’ s weakness suggests to Asian investor that capital preservation may not be compatible with a passive accumulation of U.S. gov ’ t bonds

Shared goal: better dvlpt of local bond markets But, getting there is politically difficult for many governments and requires passage of much legislation and high level of policy coordination But, getting there is politically difficult for many governments and requires passage of much legislation and high level of policy coordination Thus, regional cooperation efforts being viewed by many individual country actors as drivers for domestic reforms Thus, regional cooperation efforts being viewed by many individual country actors as drivers for domestic reforms

Developments to date Market evolving through a series of relatively low-profile and interlinked initiatives rather than through a single ‘big bang’ Rush of initiatives moving ahead of creation fo infrastructure to trade these instruments

Developments to date Establishment of on “Asian Bond Fund” in June 2003 (for investing in dollar-denominated bonds) by EMEAP (managed by BIS) Second and larger “Asian Bond Fund” (for investment in local currency bonds) to be launched in months by central bankers

Developments to date ASEAN+3 Finance ministers expected to announce market-enabling initiatives in May (following up on 2002 “Asian Bond Fund Initiative” and establishment of working groups in summer 2003) Thailand and South Korea plan unilateral initiatives Multilateral entities plan to issue local currency bonds in China and Thailand

Division of labor in working toward creation of regional bond market TaskForum Supply side ASEAN+3 (ABMI), APEC Demand side EMEAP (ABF-1, ABF-2) Political support ACD

A division of labor EMEAP (central bankers group) EMEAP (central bankers group) Focus on demand side through establishing Asian bond fund (US$1 bil) with plans for 2nd fund now underway Focus on demand side through establishing Asian bond fund (US$1 bil) with plans for 2nd fund now underway Idea initiated by Hong Kong Monetary Authority Idea initiated by Hong Kong Monetary Authority Goal: help alleviate exchange rate risk and buoy investor interest in Asian bonds Goal: help alleviate exchange rate risk and buoy investor interest in Asian bonds Politically, relatively easy to do because involves investing small amounts in EXISTING bonds and US dollar- denominated foreign assets commonly held by all EMEAP central banks so can draw on these. Politically, relatively easy to do because involves investing small amounts in EXISTING bonds and US dollar- denominated foreign assets commonly held by all EMEAP central banks so can draw on these. Political sensitivities anticipated, esp. in Japan, if move toward buying up large amts of assets with lower credit ratings than US Treasury bonds Political sensitivities anticipated, esp. in Japan, if move toward buying up large amts of assets with lower credit ratings than US Treasury bonds

A division of labor ASEAN + 3 Finance Ministers ASEAN + 3 Finance Ministers Focus on supply side Focus on supply side Considering creation of an Asian credit guarantee institution and an Asian credit rating agency Considering creation of an Asian credit guarantee institution and an Asian credit rating agency Discussion of Japan Bank for International Cooperation acting as guarantee institution Discussion of Japan Bank for International Cooperation acting as guarantee institution

Role of other regional groups: APEC (led by HK, Korea and Thailand) APEC (led by HK, Korea and Thailand) Focus on securitization issues Focus on securitization issues ACD ACD Includes India Includes India Provides political support for ideas Provides political support for ideas

Supplemented by individual country efforts Ex: Japan ’ s METI plans to set up a structure that provides guarantees for bonds issued in local currencies by Japanese companies operating abroad in Asia Ex: Japan ’ s METI plans to set up a structure that provides guarantees for bonds issued in local currencies by Japanese companies operating abroad in Asia

Explaining the rapid progress on the bond issue Feasibility Feasibility Domestic politics Domestic politics Makes use of a number of issue-specific capabilities (which differ from overall national capabilities) Makes use of a number of issue-specific capabilities (which differ from overall national capabilities) More potential for positive sum aspect to cooperation More potential for positive sum aspect to cooperation Supportive or passive response by actors outside the region Supportive or passive response by actors outside the region

Feasibility Asian bond fund less ambitious and more easily implemented than currency cooperation pact -- draws on existing foreign exchange reserves and amounts involved not very large Asian bond fund less ambitious and more easily implemented than currency cooperation pact -- draws on existing foreign exchange reserves and amounts involved not very large Issuing bonds in local currencies will be more difficult Issuing bonds in local currencies will be more difficult

Foreign Currency Sovereign Debt Long Term Ratings (Source: Bloomberg Database; as of 27 Feb, 2004)

Foreign Currency Sovereign Debt Short-term Ratings (Source: Bloomberg Database; as of 27 Feb, 2004)

Role of domestic politics/ political leadership THAILAND THAILAND PM Thaksin a key proponent; creation of Asian bond market leads to nat ’ l press conference PM Thaksin a key proponent; creation of Asian bond market leads to nat ’ l press conference Motivation: silence domestic critics and emerge as new leader within ASEAN? Motivation: silence domestic critics and emerge as new leader within ASEAN? Importance of political leadership in bringing Bank of Thailand on board Importance of political leadership in bringing Bank of Thailand on board

Role of domestic politics/ political leadership JAPAN: JAPAN: Typically, very little involvement on these types of issues Typically, very little involvement on these types of issues But, (then) Finance Minister Shiokawa strongly supportive of EMEAP Asian Bond Fun idea because pushing BOJ liability structure in direction desired by gov ’ t (toward inflation targeting measures) But, (then) Finance Minister Shiokawa strongly supportive of EMEAP Asian Bond Fun idea because pushing BOJ liability structure in direction desired by gov ’ t (toward inflation targeting measures) Even so, political involvement very low compared to Thailand, Malaysia, etc. Even so, political involvement very low compared to Thailand, Malaysia, etc.

Role of domestic politics/ political leadership KOREA: KOREA: Leadership under Kim Dae-Jung but currently political leadership lacking Leadership under Kim Dae-Jung but currently political leadership lacking BUT, other quasi-governmental actors (such as KAMCO) enthusiastically pushing forward bond market issues BUT, other quasi-governmental actors (such as KAMCO) enthusiastically pushing forward bond market issues

A number of countries possess capabilities to contribute Japan weak in domestic credit rating agents, experience with secondary debt markets, etc. Japan weak in domestic credit rating agents, experience with secondary debt markets, etc. But, Korea, Malaysia, and Thailand have more experience here. But, Korea, Malaysia, and Thailand have more experience here. -> Issue-specific capacities differ sigificantly from aggregate economic capabilities -> Issue-specific capacities differ sigificantly from aggregate economic capabilities

Infrastructure requirements Component Best positioned to lead Credible system of governance (esp.strong and indep. regulator) Unclear Guaranteeing agency Japan ? (Japan Bank for Int‘l Coop) Credible rating agency Korea and Thailand? Strong legal system w/ well- functioning bankruptcy procedures Unclear Developed base of natural buyers of long-term securities Japan

Reactions outside the region? IMF IMF Supportive Supportive Europe Europe Supportive Supportive U.S. U.S. Passive stance Passive stance But, potential for concern? But, potential for concern? Detrimental impact on demand for US Treasury bonds unlikely until currency pegs eliminated Detrimental impact on demand for US Treasury bonds unlikely until currency pegs eliminated

Why relatively more progress? Summing up Relatively easy to take small steps toward longer term goals Relatively easy to take small steps toward longer term goals Supportive or passive reactions by external actors Supportive or passive reactions by external actors Neither Japan nor China is natural leader on all aspects of infrastructure-building; potentially large contributions by smaller economies Neither Japan nor China is natural leader on all aspects of infrastructure-building; potentially large contributions by smaller economies Coincidence with domestic political ambitions (esp. in Thailand) Coincidence with domestic political ambitions (esp. in Thailand)

Comparing the East Asian and European Experiences Diversity and heterogeneity of economies in region Diversity and heterogeneity of economies in region Substantial economic convergence a prerequisite to jt action at regional level Substantial economic convergence a prerequisite to jt action at regional level Political leadership Political leadership Differences in political systems and weak trust Differences in political systems and weak trust No dominant power like U.S. in western hemisphere; nor, a stable bipolar relationship like Franco-German alliance in Western Europe. No dominant power like U.S. in western hemisphere; nor, a stable bipolar relationship like Franco-German alliance in Western Europe.

Comparing the East Asian and European Experiences In Europe, Maastricht conditions for convergence required relevant differences be eliminated as precondition for participation in monetary union; to offset consequences of diversity, compensation mechanisms envisaged and financed. In Europe, Maastricht conditions for convergence required relevant differences be eliminated as precondition for participation in monetary union; to offset consequences of diversity, compensation mechanisms envisaged and financed. East Asia: efforts to proceed at regional level first, hoping for regional developments to provide pressure for convergence on domestic actors; little discussion of compensation mechanisms East Asia: efforts to proceed at regional level first, hoping for regional developments to provide pressure for convergence on domestic actors; little discussion of compensation mechanisms

Comparing the East Asian and European Experiences The desire for monetary union and establishment of euro served as focal pt in Europe The desire for monetary union and establishment of euro served as focal pt in Europe Private sector played a KEY role in European monetary integration/union but relatively silent in East Asia Private sector played a KEY role in European monetary integration/union but relatively silent in East Asia Political integration was a clear goal in the European process Political integration was a clear goal in the European process