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Paper: Regional Currency Unit (RCU) and Exchange Rate Policy Cooperation in East Asia

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Paper: Regional Currency Unit (RCU) and Exchange Rate Policy Cooperation in East Asia November 2007 Regional Currency Unit (RCU) and Exchange Rate Policy Cooperation in East Asia∗ Yung Chul Park Graduate School of International Studies, Seoul National University Comments on the paper "The Influence of the Renminbi on Exchange Rate Policy in Other Economies" presented by Takatoshi Ito at the Conference on China’s Exchange Rate Policy, Peterson Institute for International Economics, Washington, DC, October 19, 2007. 1. ACU Arithmetic As part of their efforts at promoting cooperation for financial and monetary integration, policymakers from ASEAN+3(China, Japan, Korea) agreed to explore steps to create regional monetary units (RCU) as a sequel to the two other regional initiatives- Chiang Mai Initiative and Asian Bond Market Initiative- in 2006. This agreement was preceded by a proposal for the creation of an Asian Currency Unit (ACU) by the Asian Development Bank and a number of Japanese economists, among them Mori, Kinukawa, Nukaya and Hashimoto (2002), Ogawa (2006), and Ogawa and Shimizu(2006). Both the ADB and Ogawa (2006) define the ACU or Asian Monetary Unit (AMU) as a basket of the thirteen currencies of the ASEAN+3 member countries weighted by their relative importance in terms of GDP, trade volume, population, and the degree of capital account liberalization1 ∗ This note draws on Park(2007) 1 In Ogawa (2006)’s construction, the 13 ASEAN+3 currencies are weighted by their relative GDPs valued in terms of purchasing power parity (PPP) and total trade volumes (the sum of exports and imports). In order to reflect the most recent trade relationships and economic trends, Ogawa uses the averages of these variables for the most recent three years for which data are available. The value of the AMU is then quoted in terms of a weighted average of the two major international currencies-the US dollar and the euro. The weights of the two currencies are the shares of the US and the Euro area in total trade of the ASEAN+3 countries and set at 65% and 35%, respectively. The benchmark period of the AMU exchange rate of the dollar-euro , for which the AMU exchange rate is set at unity, is chosen for a period (2000-2001) when the total trade balance of the thirteen countries with the rest of the world and the total trade balance of ASEAN+2(excluding Japan) with Japan are relatively close to zero. 1 If the ACU is an Asian version of the ECU, it is an accounting unit. However, it is suggested that (i) the unit could assist ASEAN+3 policy authorities in their conduct of exchange rate policy and serve as a surveillance indicator for regional coordination of exchange rate policy in East Asia (Kuroda 2006A and B); (ii) the ACU could be adopted as an internal common currency basket to which the ASEAN +3 members except Japan could link their currencies (Ogawa and Shimizu 2006)1 (iii) it could facilitate the creation of a regional market for basket bonds denominated in the ACU (Kuroda 2006C); and (iv) it could be an intermediate step toward making the yen as the anchor currency for the member states of ASEAN + 3(Ogawa and Shimizu 2006). These additional functions make the ACU more than a simple numeraire, and have understandably generated a certain amount of confusion on its role. 2. The ACU as a Regional Accounting Unit How would the creation of the ACU contribute to exchange rate policy coordination and monetary integration in East Asia? The experience of the EU with the European Currency Unit (ECU) may provide both lessons as well as answers. The ECU was a political gesture towards monetary union. The unit of account was symbolic, just as the SDR is a symbol for a future world currency. It was used as an internal accounting unit for all official transactions and accounts of the EU, although the member central banks did not use it in their transactions. As seen from the management of the EMS, the ECU played no particular role in stabilizing the intra-member exchange rates of the 2 constituent currencies, although it was one of the four elements of the EMS in addition to the grid, mutual support, and a commitment to joint decision of realignments (Baldwin and Wyplosz 2004 chapter 12). Initially, the ECU was expected to impose a symmetric burden on both weak and strong currencies to intervene. In reality, market interventions were made by the weak currencies well before the limits of the system were reached so that the burden was largely asymmetric. The only real lasting effect of the ECU is that when the euro became the European Monetary Union’s new unit of account, its conversion rate was €1 = ECU 1, an obscure stipulation of the Maastricht Treaty2 3. The ACU as the Nuneraire for Asian basket bonds In the past a few attempts at issuing bonds denominated in a basket of currencies in Europe have not been successful. It is true that debt instruments denominated in the ECU were issued in Europe, but Dammers and McCauley (2006) show that these instruments owed their limited success in the 1980s and 1990s to the restrictions on internationalization of the Deutsche Mark and speculative investments. Certainly the EU did not encourage or render any institutional support for developing a market for bonds denominated in the ECU. Notwithstanding the European experience, the advocates of Asian basket bonds, however denominated, should be able to spell out justification for the involvement of the public sector in creating a market for such an instrument. It is not clear what the advantages of holding basket bonds over bond portfolios consisting of bonds in different currencies. Market participants may prefer bond portfolios diversified in terms of currency to basket bonds as they give greater flexibility in managing return and risk profiles of their investments. If there is demand for basket bonds, it is reasonable to argue that private 2 The author owes this point to Charles Wyplosz 3 institutions would not leave the market opportunity unexploited. That is, investment banks and securities firms would be prepared to create and market bonds denominated in many different baskets of different currencies they choose as long as there is demand for them. The absence of a regional accounting unit does not stand in the way of developing markets for basket bonds. There may be failures of the market, regulatory controls, or the insufficiency of market infrastructure that have prevented development of markets for basket bonds in Asia. If that is the case, the advocates of Asian basket bonds should identify what these impediments are and how they could be mitigated before proposing the public sector involvement in fostering basket bond markets in Asia. 4. The ACU as a Surveillance Indicator for Exchange rate Policy Coordination The role of the ECU in monetary unification of the EU makes it clear that the creation of the AMU in and by itself will not strengthen exchange policy coordination in East Asia. What is needed for the coordination in East Asia is a collective regional exchange rate regime such as the exchange rate mechanism (ERM) adopted by the EC as part of the EMS or a common basket pegging. This can be seen from recent movements of some of the key East Asian currencies vis-à-vis the US dollar, the Euro, and the AMU. Figure 1 depicts changes in the AMU exchange rate in terms of the US dollar and euro. It has appreciated slightly against the dollar while depreciating a great deal vis-à-vis the euro since the mid 2002 largely because of the weakening of the yen and inflexibility of the dollar-renminbi exchange rate. Since ASEAN+3 as a group has been running sizable amounts of surplus in their trade with both the US, and EU, which have become the major sources of the global imbalance, it may be in the interest of ASEAN+3 to let the AMU 4 appreciate against the dollar and euro. What could then these countries do collectively to bring about such an adjustment? The yen is a component currency of the AMU. But since it is a free floating currency, Japanese authorities are not likely to intervene in the dollar-yen Figure 1 AMU in terms of the US$-euro (benchmark year=2000/2001) 1.2 1.15 1.1 1.05 1 0.95 0.9 0.85 0.8 0.75 0.7 Jul-00 Jul-01 Jul-02 Jul-03 Jul-04 Jul-05 Jul-06 Jul-07 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 U.S.$-euro/AMU U.S.$/AMU euro/AMU Source : Ogawa (2006) market. This means that other members of ASEAN +3 will have to adjust their exchange rates, although the yen is largely responsible for the weakening of the AMU vis-à-vis the dollar and the euro. Except for Japan and Singapore the other member countries of ASEAN+3 do not have a domestic currency-yen market and their currencies are largely non-convertible. As a result the only way they can engineer an appreciation of the ACU vis-à-vis the dollar or the euro is to intervene in their local currency- dollar markets to induce an appreciation of their currencies against the dollar. If they do, then their currencies will strengthen further against 5 the yen while Japan is running a surplus with them. percent and the renminbi by 9.3 percent while Japanese yen depreciated by 12 percent As shown in Figure 2 the Korean won appreciated against the dollar by 11.6 between the early 2005 and September 2007.
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