Per
Mr. Yam gives a broadbrush picture of Asian monetary co-operation
Jacobsson Lecture given by Mr. Joseph Yam J.P., Chief Executive of the Hong Kong Monetary
Authority in Hong Kong, on 21/9/97.
Introduction
1. Good afternoon. On behalf of the people of Hong Kong, particularly those of us at
the Hong Kong Monetary Authority, let me extend my warmest welcome to all of you to Hong Kong.
For those of you who have visited Hong Kong before, perhaps many times, I hope you are pleased to
see that Hong Kong, as a Special Administrative Region of the People's Republic of China, remains
as vibrant and dynamic as you have known in the past, retaining much of its free market
characteristics, under the principle of "one country, two systems".
2. It is a great honour and privilege for me to be invited to give this year's Per
Jacobsson Lecture. As a Managing Director of the International Monetary Fund (IMF), Mr Per
Jacobsson led a life that was dedicated to the promotion of both European and later international
monetary co-operation. It is only befitting that a lecture held in Asia in memory of this great man
should address the topic of Asian monetary co-operation. This is also a subject that has been brought
to sharp focus in the light of the recent turmoil in the currency markets of Asia.
3. What I intend to do this afternoon is first to define what international monetary
co-operation is about, and in this connection, survey the attitudes of the parties that should have an
interest in such co-operation and discuss the form of this co-operation. I wish to point out that these
attitudes have, perhaps unintentionally, led to international monetary co-operation being regionalized.
I shall then focus specifically on Asian monetary co-operation, covering the history, or the lack of it,
and the monetary problems, current and potential ones, that Asian economies face. I shall then make
a case for much greater monetary co-operation in Asia. I shall also suggest a way forward for Asian
monetary co-operation, with a strategy and a list of issues to be addressed in such co-operation.
Monetary Co-operation
4. Let me start now by attempting a definition on what monetary co-operation is
about. The Oxford Dictionary defines "co-operation" as "working together to the same end". So I
suppose monetary co-operation can simply be defined as working together to the same monetary end.
This then leads to the questions as to what that same monetary end should be, who should be working
together and the form in which they should best work together, particularly when one is talking about
monetary co-operation across monetary systems on a global or regional dimension.
5. The Articles of Agreement of the IMF provide some guidance on what that same
monetary end should be. In defining the purposes of the IMF in Article I to be, among other things,
"to promote international monetary co-operation", the term "consultation and collaboration on
international monetary problems" is used. So it would be appropriate to describe that same monetary
end as the prevention and cure of monetary problems. Indeed, the rapid pace of financial
liberalization and the associated globalization of financial markets have meant that monetary
problems, when they arise, can be highly contagious on the global and particularly on a regional
dimension. And if they are to be properly handled, by way of prevention or cure, there is a clear need
for international monetary co-operation.
6. As to who should be working together, it is quite obvious that the interested parties
would necessarily include the monetary authorities of economies facing or potentially exposed to
monetary problems. The increasing realization of this need to work together has led to the formation
of various, mostly regional, forums where monetary authorities gather to discuss issues of common
interest.
7. Insofar as the Asian region is concerned, these forums are proving to be quite
useful, but there is regrettably also some resistance in making further and the much needed progress
because of, believe it or not, turf issues between ministries of finance and central banks, or perceived
excessive rivalry on the part of individual economies in vying for the lead and influence in the
co-operative effort. But these are facts of life that hopefully should not stand too much in the way of
progress for the benefit of all in the longer term. It is also a fact of life regrettably that minds do not
normally become adequately focused until they are jostled by damaging crises.
8. There are of course the multilateral institutions like the IMF and the Bank for
International Settlements (BIS), and a number of international groupings of experts, who have a clear
mandate or a keen interest in, among other things, promoting international monetary co-operation.
They have been invaluable in providing the necessary support and guidance to monetary co-operation
in Asia.
9. Nevertheless, some in this region have felt that such support and guidance,
particularly from the multilateral institutions, have been less forthcoming than they would have liked,
comparing for example the support given to Thailand with Mexico. They also feel that the special
circumstances and interests of economies in the region have not been adequately taken into account.
Nor do their voices count for enough.
10. Whether or not this feeling is justified, one consequence is for regional initiatives
to surface. This is no bad thing and perhaps the pragmatic way forward, given the need realistically to
address regional disparities in financial markets, infrastructure and degrees of financial liberalization.
But the down side risk which all of us should be aware of is the possibility that the global financial
market may then become segmented into regional blocs which may result in more competition and
friction, rather than co-operation.
11. On the form of monetary co-operation, there is a wide spectrum of experience on
the basis of current practice. There is on the one extreme the simple exchange of information and
expertise amongst monetary authorities helpful to the management of the domestic monetary system
generally, covering the whole range of central banking functions in the management of the currency,
the supervision of financial institutions, the development of the financial infrastructure, the
management of foreign reserves, etc. On the other extreme, there is monetary co-operation to the
extent of achieving monetary union or integration.
12. In between the two extremes there are arrangements for policy co-ordination at the
macro level initiated on the realization of increasing international, particularly regional, economic
interdependence. There are also the more focused schemes for mutual assistance in the provision of
liquidity to facilitate effective monetary management, which may or may not involve the assumption
of credit risks between governments. There have also been considerable efforts spent in supervisory
co-operation towards the standardization of supervisory practices in order to promote international
financial stability, again in recognition of the possibility of the damaging contagion effect of financial
crises across financial systems. Then there are the more forward-looking arrangements for the
development and linkages of elements of the financial infrastructure to facilitate the efficient and safe
financial intermediation across monetary systems.
13. Obviously no one point on this wide spectrum of international monetary
co-operation can be considered as the ideal situation. Much depends on the needs arising from the
circumstances, and the circumstances are changing all the time. But along with financial liberalization
and the globalization of financial markets, the trend, to the extent that one can be ascertained, seems
clearly to be one of increasing monetary co-operation. As is well known, European monetary
co-operation is aiming for monetary integration by 1999, having moved in the past 50 years from
information exchange to policy co-ordination. Whether this could be achieved on time or not, and
whether monetary integration should necessarily then be considered as the final goal of monetary
co-operation in other regions, we shall have to wait and see. But one has to admire the vision of the
pioneer thinkers. I understand that the French economist Jacques Rueff actually declared way back in
the 1950s that "Europe will be created via a currency or not at all".
14. By contrast, Asian monetary co-operation is considerably less well structured.
There is traditionally some exchange of information, mostly on a bilateral basis, through meetings
conducted annually, and largely prior to a game of golf or even on the golf course. There is little, if
any, policy co-ordination amongst Asian economies, not to mention any interest in monetary
integration. It is not clear whether this is a reflection of reluctance to subject domestic policy
decisions to external influence. Indeed, until recently the majority of the economies in the region
seemed happy to concede their sovereign right over monetary policy to the central banks of their
major trading partners, notably the United States, through maintaining a stable exchange rate against
the US dollar by varying degrees. But whatever the reason for the relative lack of monetary
co-operation in the past, there have been significant changes recently, spurred by the events
surrounding Mexico which affected the region and those of Thailand which is right in the middle of
our region. There is serious and continuing discussion on the subject of Asian monetary co-operation.
Hong Kong stands ready to contribute to this discussion and I very much hope that a long term
strategy could come out of this.
History of Asian Monetary Co-operation
15. Let me now describe briefly to you the history of Asian monetary co-operation. In
the post-war period, many Asian central banks evolved from colonial currency boards, which
practised the virtue of stable money fixed to an international reserve currency. As a result of this
monetary discipline, supported by sound fiscal discipline, Asia has enjoyed stable growth with low
inflation. As Asian economies gradually opened their markets to international trade and competition,
with Hong Kong setting a good example of how free markets work, the existence of stable exchange
rates, largely linked to the US dollar, formed the anchor of Asian growth. The need for monetary
co-operation amongst Asian economies, therefore, did not matter much as long as each traded mainly
with Europe or America using the US dollar as the main currency of trade.
16. This was the reason why the work of the principal forum for central bank
discussions in the late 1950s called SEANZA (South East Asia, New Zealand and Australia) focused
mainly at providing training for central bankers. The 18 members of this group cover a geographical
area that spans the whole of Asia-Pacific from India to New Zealand. Training and research was also
the primary focus of another central bank forum founded in 1966. This is SEACEN (Southeast Asian
Central Banks), comprising ten central bank members with a research and training centre in Kuala
Lumpur.
17. In the 1990s, the number of Asia Pacific groupings increased, partly as a result of
accelerating intra-regional trade. The establishment of APEC (Asia Pacific Economic Co-operation)
in 1989 promoted trade and investment amongst the 18 member economies, but there were only
ancillary discussions on monetary co-operation. In February 1991, nevertheless, Asian monetary
co-operation took a quiet but significant step forward with the creation of EMEAP (Executives'
Meeting of East Asia Pacific Central Banks). This 11-member group of central banks was initiated by
the Bank of Japan. At the beginning, EMEAP concentrated on the exchange of information on market
developments in the economies of members and was the forum for the Bank of Japan to brief others
on G-7 discussions. But it has since evolved into quite a productive, and certainly the most active,
forum for central banking discussions in the region to date through its biannual meetings of deputy
governors and an annual meeting of governors.
18. The discussion in EMEAP now has a sharp focus on Asian monetary
co-operation. This need was perhaps crystallized by the Mexican crisis, which rippled to Asian
currencies in January 1995. In its wake, I convened an informal meeting of several EMEAP central
banks that experienced speculative activity. There was immediate agreement that it would be useful
to exchange market intelligence and to share knowledge and techniques on monetary operations
helpful to the maintenance of monetary stability. Out of this meeting also evolved the package of
bilateral repurchase agreements of US Treasuries signed by five central banks in Hong Kong on 20
November 1995 and aimed at the enhancement of the liquidity of the foreign reserves that they hold
-- a historic landmark in Asian monetary co-operation that eventually expanded to cover all the
eleven EMEAP members.
19. In this connection, I should pay tribute to the foresight of Bernie Fraser, then
Governor of the Reserve Bank of Australia, who called for the establishment of a new regional
institution -- for want of a better name, an Asian BIS -- to promote Asian monetary co-operation.
Bernie saw quite rightly that "globalisation is elevating the international dimension of monetary
co-operation". In response to his call, EMEAP convened a working group to study the proposals and,
at its first Governors' Meeting in Tokyo in July 1996, further established two working groups and a
study group to share knowledge and expertise on financial market development, central bank
operations and banking supervision issues respectively. Although the question on the establishment
of a regional institution to further Asian monetary co-operation has been put aside for the time being,
the progress achieved by the various groups was commendable, with ambitious plans to produce the
Asian equivalent of the Green Book on banking supervision, the Red Book on payment systems and
a Gold Book on reserve management practices.
20. Meanwhile, greater international monetary co-operation involving the Asian
economies was also advanced when the BIS admitted the People's Bank of China, the Reserve Bank
of India, the Hong Kong Monetary Authority, the Monetary Authority of Singapore and the Bank of
Korea, among others, to its membership in 1996, the first new Asian members after the Bank of
Japan.
21. All these initiatives were unfortunately overshadowed by the advent of the Thai
crisis, which erupted in May this year. But it was still to EMEAP's credit that in the second
Governors' meeting in Shanghai in July, the group called for the creation of an Asian facility to
supplement the IMF in providing assistance to member economies in Asia to make structural
adjustments. That historic decision paved the way for the smooth meeting organized by the Fund in
Tokyo two weeks later in August when more than US$10 billion out of a total package of
US$17 billion facility to Thailand was amassed from EMEAP members with almost no fuss.
Meanwhile, the call for an Asian facility is still being considered. Discussions are continuing
amongst the interested parties, whenever opportunities present themselves.
Asian Monetary Problems
22. It is perhaps one of the ironies of the post-Bretton Woods era that the modern
world is no longer generally short of liquidity, and indeed is arguably at present overflush with
liquidity. Yet amidst all this liquidity and prosperity, liquidity crunches can even test the solvency of
nations. The currency turbulence in Asia has prompted a realization of this irony and consequently
much soul searching on the appropriateness of exchange rate and other monetary arrangements,
macroeconomic and structural adjustment policies, the adequacy of financial market regulation and
banking supervision, the pace of financial liberalization, etc. Many words of wisdom are being
offered. While some are critical of the wisdom of fixed exchange rate systems, others blame volatile
capital flows and currency speculators for the currency crises in rather strong and emotive terms. Still
others fault inappropriate government policies and perhaps complacency in not taking early action.
All in all a rather confusing picture. At the risk of causing even greater confusion, let me try to
identify and articulate the monetary problems that Asian economies have been facing.
23. Capital inflow must be at the top of the list. At the beginning of the decade, net
capital inflow to emerging markets was less than US$50 billion a year. By 1996, however, this had
increased to US$245 billion. Asia has received roughly half of this capital inflow, thanks to the rather
attractive basic economic fundamentals. These fundamentals, incidentally, have remained attractive
today, notwithstanding the recent turmoil in Asian financial markets. The key factors that contributed
to the surge in capital flows into the region include Japan's willingness to export capital as a result of
sustained and large current account surpluses. The rising costs of production in Japan, associated
with the appreciation of the yen have forced many Japanese firms to relocate their production to the
rest of Asia. Also contributing was the low interest rate policy in the industrial economies,
particularly in Japan in the post-bubble phase, which has flooded the global market with liquidity.
Increasing amounts of mutual funds and pension funds of these economies looked for higher returns
in the emerging markets. Clearly, Asian economies have benefited much from such capital inflows,
but at the same time they have exposed themselves to the threat of a sudden loss of market confidence
and hence large outflows of funds due to policy mistakes or shifts in the international economic
environment. This is particularly true if a large proportion of inflows are volatile portfolio investment
or short-term borrowing.
24. The next monetary problem concerns current account deficits. A number of Asian
economies were able to run larger than normal current account deficits in the balance of payments
because they were easily funded by capital inflows. The bad news about large capital inflows is that
they might allow investment and even consumption to expand without enduring the pain of
overheating or loss of competitiveness. Higher levels of domestic credit, consumption, investment,
growth and even budget revenues can be sustained at the cost of rapid accumulation of foreign debt.
To make matters worse, over 80% of the current account deficits of selected Asian economies was
funded from short-term bank debt. In hindsight, the ready availability of short-term external financing
might have delayed the necessary policy adjustments in face of cyclical and structural changes in the
domestic and international economic environment. In short, we can all easily make the mistake of
taking capital inflows for granted.
25. Then there is asset price inflation which is a rather common consequence of
capital inflows. In an open economic environment, capital inflows may not lead to consumer price
inflation, since imports would alleviate excess demand. However, if the domestic financial system is
underdeveloped and financial institutions are not adequately supervised, as external hot money
increases the deposit base of domestic banks they may be lured into fueling domestic asset price
bubbles. These have two major consequences. First, asset price inflation eventually leads to domestic
inflation and erodes external competitiveness. Second, excessive lending concentration in real estate
exposes financial institutions to large non-performing loans when oversupply of property emerges.
Indeed, banks are absorbing credit risk on top of interest rate and exchange rate risks. In some Asian
economies, weakness of the financial system has constrained the ability of the monetary authorities to
raise interest rates to defend their currencies when the exchange rates are under pressure. Conversely,
to allow the currency to depreciate exposes banks and other borrowers to exchange losses on their
unhedged foreign currency liabilities.
26. At the same time, the external environment has been changing. Whilst Asia was
enjoying an unprecedented boom, the global competitive environment was subtly but surely shifting,
which led to portfolio rebalancing by global asset managers. The adjustments in the US economy,
through fiscal and monetary tightening, and technology and corporate restructuring, had brought
substantial benefits in the form of lower budget deficits, and the lowest levels of unemployment and
inflation for decades. In case anyone forgets, the US equity market has in the last three years
outperformed almost all Asian equity markets with the exception of that of China. Funds have been
attracted back to the US markets which at the same time strengthened the US dollar, adding to the
momentum of that flow. It was a pure case of risk versus return.
27. In addition, growing competition at the low-wage end of industries came from
other Asian and non-Asian economies. In Europe, cheaper production came from the restructuring
economies of Eastern Europe. Competition came from the revival of Latin American economies with
improved access to the US market through NAFTA. In Asia, India and China are emerging as major
exporters. As a result, exports in Asia suffered a downturn, while imports continued to rise, leading
to growing levels of current account deficits.
28. Then came problems on the exchange rate front. The volatility of key exchange
rates, particularly that of the yen against the US dollar, has placed the balance of payments of some
Asian economies under considerable stress. For instance, since most Asian currencies are explicitly
or implicitly linked to the US dollar, the appreciation of the US dollar severely squeezed the
exporters, who have to compete with their rivals in Japan and the emerging economies in other parts
of the world. The weakness of the yen revived Japanese exports, placing Japan in direct competition
with its major trading partners in Asia, as the cheaper yen stimulated exports of Japanese durable
goods and capital goods to Asia, while reducing imports from the region. It did not make sense to
export out of the subsidiaries in ASEAN when it was cheaper to buy directly from the plant in Japan.
The weaker yen also has a tendency to slow foreign direct investment from Japan, as it is no longer
so expensive to produce in Japan.
29. As we are all aware, this combination of Asian monetary problems has recently
put tremendous pressure on the financial markets, in particular the foreign exchange markets, in the
region. This was compounded by speculators who took advantage of these market developments to
set up their attacks, resulting in the currency turmoil in Asian currencies that we have seen.
30. Here I cannot possibly resist the temptation to offer a few comments. There is a
common perception that the adoption of more flexible exchange rate regimes by a number of Asian
economies implied a failure of fixed exchange rate systems. This is in my view a mistaken
perception. As all central bankers are aware, there is no one perfect exchange rate regime. One of the
dilemmas of any exchange rate regime is how the exchange rate can reflect the underlying economic
conditions, which are constantly changing, so that external balance can be achieved. A fixed
exchange rate regime can function well if there is strict financial and fiscal discipline, and flexibility
of domestic goods and services markets to adjust for any structural changes in the economy. On the
other hand, a flexible exchange rate regime can also work, provided that the policy package is correct
and there is a well functioning foreign exchange and financial market. But it would be a mistake to
think devaluation can substitute for fundamental policy adjustments to correct a structural external
imbalance. Competitive devaluations are "beggar-thy-neighbour" policies that are self defeating.
31. Indeed, the adoption of more flexible exchange rate systems by some Asian
economies has not meant they can avoid the adjustments that are currently being undertaken. With a
fixed exchange rate under a very strong and disciplined regime in the form of a currency board
system, Hong Kong focused precisely on our underlying productivity, maintaining strict financial and
fiscal discipline, and also prudent banking supervision, in order to enhance the resilience of the linked
exchange rate system, and minimize and manage the downside risks of overheating in the economy.
32. Let me also put the currency adjustments in their proper perspective. In the last
few years, the currencies with the greatest adjustments and volatility have been the G-3 currencies,
rather than the Asian currencies. The yen has depreciated by 50% against the US dollar from its peak
in 1995. The deutschemark has likewise fallen by over 30%. In comparison, the Asian currencies
have until recently remained relatively stable. The Hong Kong dollar has been the most stable of
Asian currencies, moving less than 1% against the US dollar. It is the greater volatility of G-3
currencies that ultimately contributed to, if not caused, the volatility in smaller regional currencies.
33. There is yet another Asian monetary problem and this is one of a different nature.
It concerns the effectiveness of financial intermediation in this region. Asia needs substantial
investments in the economic infrastructure to prevent bottlenecks from hindering sustained growth.
The World Bank has estimated that for East Asia alone, projected infrastructure investments amount
to US$1.5 trillion between 1995-2004. If other forms of capital investment are included, the figure
rises to a staggering $8 trillion. At the same time, Asian economies also have very high savings rates,
some as high as 30% to 50%. The aging population in Northern Asia, for example, will be ploughing
increasing savings into institutionalized retirement funds, which are risk-averse and would need to be
invested in markets generating, other things being equal, higher returns, lower risks and greater
liquidity. Japan, for example, has an estimated ¥1200 trillion outstanding in private savings that must
be invested. When the Hong Kong Mandatory Provident Fund comes into operation by the year
2000, about 4% of Hong Kong's GDP would be added annually to institutional investments. But the
question is why Asian savings do not seem to have been adequately and effectively channeled into
Asian investments in a manner more conducive to ensuring monetary and financial stability.
34. Much of Asian savings, in particular official sector savings and private sector
savings that have been institutionalized, are still invested in assets of OECD countries, although the
trend has been a gradually falling one. I cannot speak for other economies, but insofar as Hong Kong
is concerned, in excess of 95% of our US$85 billion of foreign reserves are invested outside Asia.
Specifically, in the management of our foreign reserves, we work against a preferred neutral position
of about 75% in US dollar assets, mostly in US Treasury securities. I understand also that more than
80% of total Asian foreign exchange reserves amounting to US$600 billion are invested largely in
North America and Europe. At the same time, there has been much foreign direct investment and
foreign portfolio investment from OECD countries in Asia. It can be argued therefore that Asia is
financing much of the budget deficits of developed economies, particularly the United States, but has
to try hard to attract money back into the region through foreign investments. And the volatility of
foreign portfolio investments has been a major cause of disruptions to the monetary and financial
systems of the Asian economies. Some have even gone as far as to say that the Asian economies are
providing the funding to hedge funds in non-Asian centres to play havoc with their currencies and
financial markets.
35. This comment is perhaps a little unkind, given the important role that is being
played by the international financial community in the globalized financial environment. But there
certainly is a problem with the effectiveness of financial intermediation in this region which is
inhibiting the flow of long-term savings into long-term investments. I believe an important factor
behind this is the perceived or actual risks inherent in dealing with the products, the intermediaries
and the market that are part of the process of financial intermediation. I also believe that monetary
authorities have a responsibility, through concerted efforts in prudential regulation and supervision,
and the development of the financial infrastructure, to contain these risks to levels more acceptable to
those concerned, including themselves as managers of official foreign reserves.
The Case for Asian Monetary Co-operation
36. These Asian monetary problems which I have described can seriously undermine
the ability of Asian monetary authorities to deal with shocks, and so when shocks do come they will
cause much agony in terms of economic disruptions and painful adjustments. The problems are also
highly contagious, transmitted through sudden shifts in the same direction in the perception of risks
by international investors, as they looked for worrisome similarities amongst Asian economies, as the
recent turmoil in Asian currency markets has shown. The fall in one market may also lead them to
look for liquidity in other markets, thus contributing further to the contagion.
37. We are living in an ever more interdependent region. Increasing trade and
investment flows, made possible by trade and financial market liberalization, have bound our fates
together. A decade ago, we relied heavily on markets outside Asia for our products, sending over
three-quarters of exports to those markets. That reliance has been reduced sharply. In 1996, around
35% of trade in East Asia was conducted within the region, compared with the share of 28% with
NAFTA countries and 20% with the European Union.
38. On investment and capital flows, the story is similar. As recently as in 1989,
equity flows within the Asian region amounted to only US$24 billion. In 1995, the flows had
increased three-fold to almost US$80 billion. According to the Asian Development Bank (ADB), the
share of foreign direct investment from North America and the European Union in East Asia had
fallen from 40% of the total fifteen years ago to 25% by 1993. Now over 50% of foreign direct
investment comes from within the region. This trend can only grow, as the population giants of China
and India increasingly become more engaged in trade and investment (see Table 5).
39. Much greater interdependence of course means that policies in one economy can
have important implications for others. A more liberalized financial environment also means that
policy mistakes can be punished almost instantaneously by the market and that monetary problems in
one economy can easily spread to others. So, referring again to one of the purposes of the IMF, as
defined in its Articles of Agreement, there is a clear need "to promote international monetary
co-operation" through "consultation and collaboration" on these "international monetary problems"
that we now face in the Asian region.
The Way Forward
40. I would like now to spell out how I think monetary co-operation in this region
should proceed. In order to have effective monetary co-operation, we must have clearly defined and
realistic goals. Over-ambitious goals may not be credible, and may even be counterproductive. In any
case, they may not be politically acceptable to the individual economies. Monetary co-operation, and
indeed any type of co-operation, is meaningless when you do not have common goals.
41. Notwithstanding increasing economic integration, one has to accept reality, and
this is that the economies in Asia are a very diverse group. There are dramatic differences with regard
to political institutions, economic systems, basic infrastructure and any aspect you care to think of. In
terms of economic structure, for example, they range from some of the largest agricultural economies
in the world to the most urban economies. In terms of economic philosophy, they range from some of
the freest economies in the world to economies where there is considerable central planning. In terms
of the stage of economic development, they range from economies with the highest per capita
incomes to t