INTERVIEW/ Masahiro Kawai: Asia currency swap should reach $120 billion

Amid despondency over the global economy, the leaders of Japan, China and South Korea recently held their first trilateral summit meeting in Fukuoka. As ASEAN Plus Three members, they agreed to work more closely to tackle the global financial meltdown.

Masahiro Kawai, Dean of the Asian Development Bank Institute, told IHT/The Asahi Shimbun in an interview that he thought the meeting was significant. He said the group should expand its currency swap agreement called the Chiang Mai Initiative (CMI) to $120 billion from the currently agreed $80 billion to combat a currency crisis. He said the group should also adopt a currency adjustment mechanism similar to the "Snake" system established before the emergency of the European Monetary System.

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Question: In Fukuoka, Japan, China and South Korea agreed to strengthen their cooperation. In your mind, what was the significance of this?

Answer: Initially, the 14th Southeast Asian Nations (ASEAN) summit, the ASEAN Plus Three summit and the East Asia summit were to be held in Chiang Mai, Thailand, during the week following the Fukuoka trilateral meeting. Unfortunately the summit meetings were pushed back to 2009 due to political turmoil in Thailand.

However, the fact that Japan, China and South Korea got together before the summits next year and reached a tripartite recognition of the need to strengthen financial cooperation among themselves is particularly significant. ASEAN members have been strengthening their economic and financial cooperation--including the formation of an ASEAN Economic Community by 2015--but that has not necessarily been the case for Japan, China and South Korea.

The lack of solid trilateral cooperation has not been helpful in strengthening their collective partnership with ASEAN. Japan and China have always been keen on strengthening ties with ASEAN, while South Korea has been slow in doing so. Furthermore, among the numerous bilateral ties that have been formed so far, the one between Japan and China has been the weakest. In that sense, it is quite significant that the Plus Three leaders came together to issue a statement to promote trilateral financial cooperation, as this can reinforce ASEAN Plus Three cooperation.

Q: Aside from the expanded bilateral foreign currency swap arrangements between Japan and China and China and South Korea, the Fukuoka meeting agreed to bolster the capital of the Asian Development Bank. Why are these steps needed right now?

A: South Korea pushed for expanding the foreign currency swap deals. Its economy has been experiencing a major capital outflow since the financial contagion that began on Sept. 15 with the collapse of Lehman Brothers.

The nation has accumulated large short-term foreign currency debts and was borrowing capital from overseas which could easily turn into outflows. Capital outflows began depressing the won rapidly as well as draining South Korea's foreign exchange reserves.

In the face of such vulnerability, South Korea must have realized it needed to secure its foreign currency reserves in order to ensure financial stability. So South Korea established a currency swap deal with the U.S. Federal Reserve System in October. Yet, downward pressure on the currency continued. South Korea appears to feel that obtaining a bailout loan from the IMF would be a bad political move.

Opposition toward the IMF is strong among Koreans who believe the organization treated the country harshly 10 years ago during its currency and financial crisis, when lending conditions required by the IMF were too strict and overbearing.

The Asian Development Bank's primary task is to provide medium- to long-term loans to its developing member countries to help promote economic development. Ever since Sept. 15, many Asian countries have experienced capital outflows, similar to what is happening in South Korea.

U.S. banks and financial institutions trying to deleverage and consolidate their balance sheets have been busy securing U.S. dollars from all over the world. Some Asian countries are now facing extreme difficulties in issuing bonds in the international capital market to raise funds. Their economic growth will be hurt by the economic crisis and their fiscal revenues will decrease.

Since the countries cannot take out loans from overseas private banks, they must rely on loans from multilateral development finance institutions like the ADB, or bilateral development finance institutions like the Japan Bank for International Cooperation. Since the current global financial crisis emerged, the need for loans from developing member countries has soared.

Nevertheless, the ADB faces a capital constraint under the current arrangement. Unless there is a capital increase, it is quite difficult to extend more loans.

Q: Do you foresee any threat of an Asian currency crisis?

A: Generally speaking, I would say there is a possibility. Capital outflows from emerging markets are taking place all over the world. The impact of the global financial crisis on emerging economies with large trade deficits or large short-term foreign currency debts could be serious as rapid capital outflows can result in currency crises. In the case of South Korea, the country now has adequate foreign reserves, though its currency value depreciated alarmingly.

The Korean won is now at about half of its peak. Some smaller countries in Asia with vulnerable capital account positions face the highest risk, but I believe they will manage to avoid future crises. Since U.S. banks are still trying to secure U.S. dollars, the dollar market itself is extremely tight. Asian exporters and importers are experiencing difficulties in securing trade credit. Commercial banks are now overly sensitive to risk-taking and thus wary of extending credit.

If the ASEAN Plus Three summit had taken place, I expect a statement would have been released with regard to strengthening the Chiang Mai Initiative. The process to move from bilateral swap arrangements to multilateral arrangements is now under way. However I believe we need at least 1.5 times the current $80 billion fund that has been decided upon.

Q: How should Asian countries implement financial cooperation?

A: Sooner or later, when U.S. banks become stable, there will be a need to get back to business again. Then I think capital will flow back into Asia as the region shows the highest growth potential globally. Ultimately, that will bring about a weak dollar and strong Asian currencies. Asian countries must cope with this.

Until now, these nations were intent on intervening to prevent appreciation of their respective currencies. If this takes place in excess once again, it will lead to creating a domestic economic bubble and inflation. This was what was happening in 2006 through 2007. In the future, countries should not resist currency appreciation against the U.S. dollar.

Unless they accept this, they will end up harming their own macroeconomic and financial sector conditions. If all Asian nations allow appreciation of their currencies together, it will not have much effect on their individual competitive edge. Asia is a comparatively high-growth region, so it will be able to absorb the negative impact of currencies that are appreciating.

For this to take place, it will be necessary to create some kind of framework for cooperation. Asian countries should aim at adopting a floating exchange rate system against the U.S. dollar, while trying to stabilize their exchange rates in relation to each other's currencies within the region. That kind of framework will be the first step in building a cooperative monetary system in Asia.

This is actually something that the European Community implemented when it saw the breakdown of the Bretton Woods system in the 1970s, which eventually led to the EMS monetary system in 1979. Many European nations attempted to restrain currency fluctuations within the European Community, while allowing them to float against the U.S. dollar. The arrangement was known as the Snake. Asian countries should try to create an Asian Snake similar to the European Snake.

Q: What role should the ADB and Japan play here?

A: The ADB should provide technical assistance to strengthen member countries' financial systems as well as regional financial cooperation. Though this plan has now been shelved, it could create an Asian Currency Unit index or other measures to make strong appeals to countries within the Asian region about the importance of financial and monetary cooperation.

To support the CMI, Asian countries need to conduct effective regional economic surveillance. For this purpose, it would be useful to set up a professional secretariat to give support to the cause. I hope Japan will take the lead and be active in pursuing this sort of effort as well as building a forum that monitors banking and capital market conditions within Asia.

Economic ties among Asian countries are becoming stronger. The dollar will drift into decline and the Euro may not necessarily take over. I think it is necessary that Asians try to build a stable currency block.(IHT/Asahi: December 29,2008)