Economic Risk and Resilience in East Asia What’S Changed Since the Asian Financial Crisis? What More Can Be Done to Improve Crisis Preparedness?
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GLOBAL ECONOMY & DEVELOPMENT WORKING PAPER 109 | OCTOBER 2017 ECONOMIC RISK AND RESILIENCE IN EAST ASIA WHAT’S CHANGED SINCE THE ASIAN FINANCIAL CRISIS? WHAT MORE CAN BE DONE TO IMPROVE CRISIS PREPAREDNESS? Barry Sterland Barry Sterland is a visiting fellow at the Global Economy and Development program at the Brookings Institution. Acknowledgments: The author would like to thank Sebastian Strauss for research assistance and Amar Bhattacharya, Randall Henning, and Adam Triggs for comments. The project also benefited from the generous input from many re- searchers and policymakers in the East Asian region and in Washington, D.C. All errors and omissions are solely the authors’ responsibility. The author is a visiting fellow at the Brookings Institution, on secondment from the Australian Treasury. The government of Australia provides other, unrelated financial support to Brookings’s work on global development, economic trends, and digital trade. Brookings recognizes that the value it provides is in its absolute commitment to quality, independence and impact. Activities supported by its donors reflect this commitment and the analysis and recommendations are not determined or influenced by any donation. Any conclusions and recommenda- tions are solely those of the author, and do not represent the views of the Brookings Institution or the Australian government. The Brookings Institution is a nonprofit organization devoted to independent research and policy solutions. Its mission is to conduct high-quality, independent research and, based on that research, to provide innovative, practical recommendations for policymakers and the public. A full list of contributors to the Brookings Institution can be found in the Annual Report at https://www.brook- ings.edu/about-us/annual-report/. CONTENTS Executive summary .....................................................................1 Introduction .......................................................................... 6 Hypothetical scenario ................................................................. 6 Creating better policy options .......................................................... 6 Economic risk in the region. 9 Strengthened frameworks in the emerging economies, but risks remain ...................... 9 Risks concentrated in the large systemic economies in North Asia ...........................13 Regional connectedness adds opportunity and risk co-variance ..............................14 Risks external to the region ............................................................15 Managing and mitigating regional economic risk ............................................18 Global institutions for surveillance dialogue and capacity building ...........................18 Standard-setting bodies ..............................................................20 Regional surveillance dialogue ........................................................ 22 Conclusion on institutions for managing risks ........................................... 24 Crisis mitigation mechanisms in the region ............................................... 25 Institutions to coordinate crisis responses ............................................... 25 Financial safety net resources for the Asian region .........................................28 Elements of the current regional safety net ..............................................28 Assessing the safety net in East Asia .................................................... 33 Strong policies: Does the safety net give sufficient incentives for good ....................... 33 macroeconomic policies and sound lending? Speed: Will crisis resources be delivered fast enough?. 34 Synergy: Will elements of the safety net work smoothly together? ........................... 35 Scale: Are available resources sufficient? ................................................ 37 Conclusion on the strengths and weaknesses of the regional safety net ....................... 39 Ensuring the IMF is an early resort, maintaining strong lending capacity ......................40 Regional financing arrangements: CMIM and beyond ....................................... 43 Bilateral engagement between regional donors ............................................ 46 Conclusion ...........................................................................48 LIST OF BOXES Box 1 The Asian Financial Crisis ...................................................... 8 Box 2 Vulnerabilities then and now. ...................................................12 Box 3 International mechanisms to manage risk .........................................19 Box 4 U.S. Federal Reserve swaps ....................................................30 Box 5 Pros and cons of different layers of the safety net .................................. 36 Box 6 Political economy of the global financial safety nets. ............................... 38 LIST OF FIGURES Figure 1 Public finances ............................................................... 10 Figure 2 Risk indicators. 10 Figure 3 Fast credit growth and past major crises ..........................................13 Figure 4 Links to China ................................................................15 Figure 5 U.S. financial cycle vs. capital flows ..............................................16 Figure 6 IMF lending resources to 2022 ................................................. 42 LIST OF TABLES Table 1 Institutions for macro-financial surveillance and policy dialogue in Asia ...............21 Table 2 Crisis resources available to some key East Asian economies ........................ 29 Table 3 Bilateral swap arrangements in East Asia ........................................ 32 ECONOMIC RISK AND RESILIENCE IN EAST ASIA WHAT’S CHANGED SINCE THE ASIAN FINANCIAL CRISIS? WHAT MORE CAN BE DONE TO IMPROVE CRISIS PREPAREDNESS? Barry Sterland EXECUTIVE SUMMARY ent risks in the credit intermediation process, particularly in times of extended growth. wenty years on from the Asian Financial Crisis T(AFC) it is timely to assess how the East Asian • Regional risks are elevated and concentrated in region is placed to manage and mitigate risks of eco- the core systemic economies of North Asia. The nomic crises. We imagine a scenario where one of the key risk now relates to credit growth and levels emerging economies of Southeast Asia faces risks of in China, though the complex transitions that financial crisis from internal and external sources. Giv- economy needs to make over the medium term en gaps in the global and regional safety net such a sce- will bring new challenges. Japan also has very nario would raise difficult choices for the country, its limited macroeconomic space to react to new neighbors and key regional donors. This paper is about shocks, and geopolitical risks in North Asia also widening available choices so there can be more confi- bring macroeconomic risks. dence that an emerging crisis will be nipped in the bud. • Economic interlinkages within the region have The region’s evolving risk profile grown, bringing significant benefits but also co- variant risks. There are several developments in economic risk in the East Asian region that are salient for later discussion: • The region also faces risks from volatile capital flows particularly related to U.S. dollar financial • All countries in the region have improved their markets. economic frameworks significantly since the AFC. Economic and financial risks appear well • The region as a whole, and China specifically, has contained in Southeast Asia. Like all economies become systemic to the global economy. Hence with significant financial sectors there are inher- regional risks will have strong implications for ECONOMIC RISK AND RESILIENCE IN EAST ASIA 1 the global economy, and conversely respond- which are important tools for mitigating risk. More- ing to any regional crisis will involve global re- over, the region is well represented in these institu- sponses. The lack of macroeconomic space in all tions, although there is still considerable way to go to systemic economies, both inside and outside the ensure their voting influence matches their economic region, throws more policy weight onto financial weight. In the realm of ideas, the dominant interna- regulatory and safety net arrangements to man- tional policy paradigm and regional policy approaches age risk. have converged, due to movement on both sides, mak- ing for a more productive dialogue between the region This growth in systemic and shared risks in the core of and global institutions. There are some indications of the region is a key difference in context from that of the growing traction of IMF advice on regional risk issues. situation ahead of the AFC where risks were asymmet- The region can however approach these institutions in ric and concentrated in small to medium sized econo- a disjointed manner, and therefore not make the most mies. This has important implications for the regional effective use of its common voice to manage shared policy cooperation structures. risks. Assessment of regional risk Regional institutions for policy dialogue are an im- management and crisis response portant complement to global arrangements. The institutions ASEAN+3 institutions are developing stronger sur- veillance and peer review capabilities through the The paper takes a standard risk management approach ASEAN+3 Macroeconomic Research Office (AMRO) to assessing regional arrangements. First, how well are in Singapore. It will understandably