NEAT Working Group on East Asian Financial Cooperation

ReportBeijing
July 10, 2006

Introduction
The NEAT Working Group Meeting on East Asian Financial Cooperation was held inShanghai, China, on May 26 and 27, 2006. The participants included scholars andexperts from twelve of the ASEAN+3 countries (Cambodia was absent). The
discussions, candid, lively, fruitful, and down to earth, focused on three major themes,
namely, Changes in the Backdrop of East Asian Financial Cooperation, Assessment ofthe Latest Development of East Asian Financial Cooperation, and Prospects andPolicy Recommendations.

I. Progress in East Asian Financial Cooperation
1. Expansion of Chiang Mai Swap Arrangements
Agreements were made at ASEAN+3 Finance Ministers’ Meeting in Istanbul in May
2005 to further develop the Chiang Mai Swap Mechanism. As of early May 2006, themechanism had increased by 90% in size from US$39.5 billion to US$75 billion.
Moreover, the percentage of automatic drawing has risen from 10% to 20%. The latest
ASEAN+3 Finance Ministers’ Meeting clearly stated that the CMI should be
multilateralized and efforts should be made to establish a Post-CMI cooperation
framework.
2. Intensified Efforts to Build the Asian Bond Market
The domestic bond markets of East Asian economies are growing rapidly. In 2005, theoverall size of the bond markets in East Asian economies (excluding Japan) expanded
by 14%. The share of local currency bonds increased from 13% to more than 19% asvarious international financial institutions have increased their issuance of East Asian
local currency-denominated bonds. Asian Bond Fund II officially started operation inMay 2005, with a capacity of US$2 billion.
3. Growing Government Attention on a Regional Monetary Unit
The Asian Development Bank is continuing its effort to create an Asian Currency Unit
(ACU). If the ACU were created, it would be a significant advancement in regionalmonetary cooperation. The recent ASEAN+3 Finance Ministers’ Meeting clearlyrecognized for the first time the importance of research on the creation of a regionalmonetary unit. A similar view was also expressed at the latest Ministerial Meeting
among China, Japan, and ROK.

II. Changes in the Backdrop of East Asian Financial Cooperation
1. An Even More Urgent Need for East Asian Financial Cooperation
1) Regional trade and investment integration, as well as the flow of capital, has been
greatly accelerated. Financial and monetary cooperation is required to provide a stable1

financial environment and necessary financial support.
2) Global imbalances in economy and finance have intensified. The U.S. twin deficits
have reached another record high. One of the risks caused by this is depreciation ofthe U.S. dollar, resulting in the appreciation of East Asian currencies. Foreignexchange reserves in East Asia continue to grow, amounting to US$2.6 trillion andmore than 60% of them are held in U.S. dollars.
3) The US Federal Reserve Board has increased the interest rates successively for as
many as 16 times in the past two years and is continuing to do so, causing a newround of interest rate increases worldwide. Together with it is the surge in global oil
prices and real estate bubbles which pose new problems for the East Asian economic
development and financial stability.
2. A More Favorable Environment for East Asian Financial Cooperation
1) A growing economy provides a solid foundation for East Asian financial
cooperation. East Asia is still the fastest growing region in the world. Its growth rate
in 2005 was 2.5% higher than the world average. The recovery of the Japan’s
economy helps the region continue to grow.
2) Multi-level and multi-dimensional East Asian cooperation provides a favorable
overall environment. Examples include the first East Asia Summit in 2005; thegrowing possibility of the untied FTA in this region with the separate FTAs processing
fluently and the active roles of related parties in promoting East Asian investment
cooperation.
3) The rapid growth of trade, large inflow of international capital, and especially thedramatic increase in foreign reserves provide the region with an environment forregional cooperation. The increase in the proportion of intra-regional trade andinvestment may create additional dynamics for financial cooperation.
4) Reforms and improvements in the foreign financing policies of East Asian
economies provide an institutional environment for the financial cooperation. Amongthem, the most important include the adjustment of the Chinese RMB exchange ratemechanism and progress in opening capital accounts in East Asia.

III. Prospect and Policy Recommendations
1. Launch a Study on the East Asian Monetary System
1) East Asian financial cooperation is making progress in the following three aspects:
A. Promotion of the regional monetary units;
B. Improvement of coordination and dialogue mechanisms on exchange rates at
all levels; andC. Upgrading of the Chiang Mai swap mechanism from a bilateral system to a2multilateral system.
2) A corresponding mechanism for coordination and interaction among the threeaspects is yet to take shape. It is desirable that studies on the East Asian monetarysystem be launched in a more comprehensive way and be incorporated into theframework of NEAT with reference to the study by the ASEAN+3 Research Group.
The following are important for such studies:A. Make further studies on the East Asian currency units. At present, discussion
should be focused on the countries that the East Asian currency unit should coverand on the share of each currency in the regional currency basket. Starting withthe 13 currencies of ASEAN 10, China, Japan, and the ROK, the studies may also
include the currency basket system for the stabilization of East Asian currencies,
and the possibility of having an Asian dollar market.
B. Study coordination mechanisms on exchange rates. Discussions should beconducted first of all on the relationship between the currencies of the member
states and the proposed East Asian currency unit. Then a study should be made on
how to coordinate exchange rates and carry out market intervention in terms ofsuch relationship. Before an East Asian currency unit is put into effect, further
in-depth studies should be conducted on the existing coordination and dialoguemechanism for policy coordination and economic surveillance.
C. Make careful studies on an East Asian monetary fund. The purpose is topromote the multilateralization of the Chiang Mai mechanism. Studies should becarried out on how CMI can best serve as the key initiative and the firstfoundation for regional integration. Studies should also be carried out on thepossibility and the roadmap of the CMI being upgraded fully into being a regionalmonetary fund.
D. Explore interactions between regional economic processes and economic
globalization, including major international financial institutions and other actors
outside the region, and study what positive and negative impacts such interactions
may have on regional financial cooperation.
E. Pay attention to the gap between economies in the region. Narrowing thedevelopment gap should be an important goal of regional cooperation.
2. Further Develop the Asian Bond Market
The Asian bond market has obvious weaknesses, which include its insignificant size,
the uneven development of the individual domestic bond markets, the low level ofmarket liquidity, and the low degree of market integration. All these problems reflect
the insufficiency in capacity building of the East Asian bond market and theinadequacy in infrastructure, supervision systems, and market players.

3Therefore, the following measures should be taken to further develop the Asian bondmarket.
1) Promote the use of credit guarantee and investment mechanism. Under theASEAN+3 Finance Ministers’ Process, the study should be launched to look intobusiness model of the mechanism and feasibility of the preferred organizational
options. The Asian Development Bank may be an alterative for the time being. A newEast Asian Bank concentrating on credit guarantee and investment may be taken into
account in the later study and discussion. Comprehensive dialogue and consensus
building are expected among all the member countries regarding the future directionof the possible mechanism. No matter what the new credit guarantee and investment
mechanism is, successful experiences of private international investment banks should
be applied.
2) Provide the business circumstances where the private sector activates its sales ofsimilar products as ABF and ABF 2. Explore some further possibilities where similar
trials such as ABF and ABF 2 make sense in terms of improving the infrastructure offinancial markets. It is proposed that the Fund expand its size suitably, increase its
frequency of issuances, optimize its investment targets, and strengthen its guarantee
function in order to make advantage of the Fund’s leading role to the private sector
participants.
3) Enhance the capacity building of the Asian bond market. The infrastructure of thefinancial market should be strengthened. The member states, in particular, the lessdeveloped members, should make vigorous effort to seek technical assistance fromvarious resources and build up their capacities in the following aspects: theinfrastructure of bond markets, transaction platforms, and settlement systems; tax
reduction and other preferential policies; credit rating institutions and otherintermediary organizations in the bond market; laws, regulations, and supervision
mechanisms.
4) Integrate bond markets in Asia. It is proposed that member states should step up
their cooperation on settlement and transaction systems and supervision standards.
They should work out relatively consistent market standards and enhance theircooperation on taxation and foreign exchange regulations so as to facilitate theinvestment by East Asian countries in each other’s bond markets. Asian bonds
denominated by the East Asian currency basket should be issued as soon as possible.
Cooperation can be expanded from bond market to stock market with an aim tointegrate the capital market in this region.
3. Establish an East Asian Finance Association to Promote Financial Cooperationand Exchange
The proposed East Asian Finance Association should be a joint organization made upof the representatives from the central banks, financial supervision institutions, andprivate financial institutions of the economies in the region. East Asian countries shall4

designate their leading organizations and representatives and hold an annual meeting(the proposed name is “East Asian Financial Conference”) to discuss and exchange
views on major issues concerning the development of East Asian financial integration.
Policy consensus and action plans are expected to be reached at the conference. Dueto the wide domain of the financial sector, sub-associations can be set up, such as a
“East Asian Banking Association,” “East Asian Securities Association,” and “EastAsian Insurance Association.”
The East Asian Finance Association and its sub-associations should focus on thefollowing tasks:1) Promote cooperation among financial supervision institutions. The financial
supervision institutions in East Asia should take the lead in building the cooperation
mechanism. They should better exchange and share their expertise and information on
financial products and financial technology, enhance cooperation on supervision
technology, and unify financial supervision standards. They should also gather todiscuss the timetable for the opening financial sector to each other.
2) Encourage cooperation among banks and other financial institutions on trade,financing, syndicate credit, bond issuance, guarantees, and insurance. Restrictions thathinder banks from opening branches in other countries of this region should beremoved or reduced. Multilateral institutions, finance policy-making institutions andother official institutions should offer more credit guarantees and insurance for tradeand investment in this region, thus diminishing the risks of private financialinstitutions.
3) Build a regional settlement system. In the context of increased intra-regional trade,the use of local currencies in this region should be encouraged in intra-regional trade,so as to reduce the transaction cost and shrink exchange rate risks. Since some of the13 currencies in East Asia are not freely convertible, a multilateral settlement andpayment system should be set up in this region on the basis of the existing bilateral
settlement agreements. When the East Asian currency unit is mature, it can be taken
as the pricing currency or basic pricing measure.

Conclusion
The NEAT Working Group on East Asian Financial Cooperation agrees that financial
cooperation is a crucial part of the regional integration process. Although the overall
environment for financial cooperation has grown more and more favorable, risks are
not low and obstacles are by no means slight. East Asian financial cooperation should
be carried out further in the spirit of consensus and consultation so as to make great
headway and bring practical benefits to the people of this region.

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