FPRI’s Research for the Fiscal Policy Research Institute ASEAN+3 Research Group Draft Report The Role of Regional Financial Safety Nets in the Global Architecture Fiscal Policy Research Institute (FPRI), Thailand Contents Page Introduction 3 1. Objectives of the study 4 2. Scope of the study 5 3. Conceptual framework of the study 7 4. Output 8 Chapter 1 Development of Regional Financial Safety Nets 9 Chapter 2 Current Regional Financial Safety Net Arrangements 13 2.1 Chiang Mai Initiatives Multilateralization (CMIM) 13 2.2 European Financial Assistance Mechanism 17 2.3 Arab Monetary Fund (AMF) 21 2.4 North American Framework Agreement (NAFA) 26 2.5 Latin American Reserve Fund (FLAR) 28 Chapter 3 Financial Safety Net Elements 31 3.1 Elements of regional funds/FSNs 31 3.1.1 Fund size 31 3.1.2 Speed of decision making 31 3.1.3 Linkage with the IMF 31 3.1.4 Surveillance and monitoring 32 3.2 FSNs characteristics and funding adequacy 35 3.3 Challenges for the development of regional FSNs 38 Chapter 4 An Analysis of CMIM Enhancement and Implementation 39 4.1 Policy measures to enhance FSNs’ efficiency, effectiveness, 39 complementarities and sustainability 4.2 A scenario analysis of an enhanced ASEAN+3 financial cooperation 41 Chapter 5 Conclusion 51 5.1 Measures that leverage on countries’ resource and financial markets 52 5.2 Measures that complement the global FSN and other regional FSNs 53 References 55 Fiscal Policy Research Institute (FPRI), Thailand 1 Table Page Table 1.1: ASEAN+3 Total Reserves (includes gold) 9 Table 2.1: CMIM contributions, purchasing multiples and 16 voting-power distribution Table 2.2: EFSF Guarantee Commitment Contribution 19 Table 2.3: Funding for Greece, Ireland and Portugal assistance packages 20 Table 2.4: ESM’s shareholder contribution key 21 Table 2.5: AMF contributions, quotas and voting power distributions 25 Table 2.6: Available NAFA Funding 27 Table 2.7: FLAR lines of credit 30 Table 2.8: FLAR contributions, quotas, voting power, and key indicators 30 Table 3.1: FSNs Comparison 33 Table 3.2: Member Accessible Funds, Short-Term External Debt and 36 Foreign Reserves Table 3.3: Member Accessible Funds, Short-Term Debt and 37 Foreign Reserves (cont.) Table 4.1: External Debt-Imports Coverage 42 Table 4.2: Portfolio Liabilities-Imports Coverage 44 Table 4.3: CMIM External Debt-Imports Coverage 47 Table 4.4: CMIM Portfolio Liabilities-Imports Coverage 48 Figure Page Figure 4.1: ASEAN Funding Adequacy 45 Fiscal Policy Research Institute (FPRI), Thailand 2 Introduction Ten years since the Asian crisis in 1997-1998 and the Russian debt default in 1998, the global economy is in a period of uncertainty again as a result of another financial and economic crisis in 2008 that originated in the United States, spread through Europe and impacted Asia and the rest of the world. Since the global capital market became increasingly more liberalized and world economies became more integrated, financial crisis in a single economy, due to a balance of payment difficulty or a private or sovereign debt event, may have adverse consequences for both advanced and emerging/developing countries throughout the region and the rest of the world. There is an increasing need for financial safety nets (FSNs), institutional arrangements that can provide emergency funding for vulnerable countries in order to alleviate the impacts and prevent shocks from affecting “innocent bystanders.” FSNs can be arranged at the national, regional or global level. At the national level, each country accumulates its own foreign reserves in order to self- insure against a sudden capital outflow. Large amounts reserves of Asian economies (US$ 4.9 trillion in 2010) (ADB, 2010), for example, came as a result of interventions to prevent the domestic currency from appreciating too much due to capital inflows. However it may be too costly in terms of the loss in value, due to the depreciation of the reserve currency, for a country to provide sufficient liquidity on its own for the purpose of crisis prevention. Regional FSNs help to leverage the reserve of the individual member countries in order to provide the needed liquidity more efficiently and effectively. A country can also manage to keep the amount of its short-term external debt at a low level in order to reduce its vulnerability. Global crises often require global responses, however, and a global institution like the IMF provides a channel for which a substantial emergency loan package can be provided to the affected countries. The IMF’s Flexible Credit Line (FCL) and Precautionary and Liquidity Line (PLL) constitute a global FSN that aims to prevent countries from being affected by crises in advance. In addition, bilateral swap lines for currency exchanges with central banks of major economies are often setup at an early stage. Since these kinds of assistance may not be forthcoming or would require individual nation to comply with stringent conditions to ensure fund repayment and seem to portray the nation as being in deep trouble (stigma), a regional FSN provides an alternative where emergency funding may be more readily available and accessible. Fiscal Policy Research Institute (FPRI), Thailand 3 As such, the establishment of an effective division of labor between FSNs should be pursued with the following principles in mind. First, to avoid moral hazard and enhance predictability, there should be a clear and measureable guidance about the criteria of crisis and accessibility of the facility. It should be readily known what conditions will allow access to the facility and the extent of resources available. And it must have sufficient capital to meet the countries’ financial need (provider for last resort). Also, it should be able to take preventive actions before a financial turbulence becomes more destructive (surveillance). Lastly, countries should have flexibility to use the facility both for addressing a balance of payments crisis and a budget deficit while minimizing the potential stigma effect. In this connection, among the questions that have been raised rather often in the region is: what would be the best policy for an individual country to participate in regional FSNs? It seems that first best policy solutions from the “old playbook”-such as fiscal discipline and monetary policy focused on controlling inflation-although necessary, are no longer adequate. In order to address the adverse consequences from volatile capital flows and financial interconnections between economies, an effective regional FSN arrangement will be needed along with greater macro prudential regulation and stronger collaboration with national and global FSNs. Such issues are explored in this study from both theoretical and empirical perspectives. Relevant components are addressed in a brief and concise manner in order to derive policy implications for future applications. 1. Objectives of the study The FPRI’s study on “The Role of Regional Financial Safety Nets in the Global Architecture” has the following objectives: (1) To review and compare the available regional mechanisms (fund/FSN): Chiang Mai Initiatives Multi-lateralization, European Financial Assistance Mechanism, Arab Monetary Fund, North American Framework Agreement, FLAR, etc, (2) To review the elements of the regional funds or FSNs: Power/Size of the funds, Surveillance and monitoring, Speed of decision making, Certainty (voting formula, etc.), Linkage with the global FSNs, (3) To identify appropriate policy measures to enhance the effectiveness and complementarities of the regional FSNs. Fiscal Policy Research Institute (FPRI), Thailand 4 2. Scope of the study In order to achieve the above objectives of the research project, the scope of the study can be outlined as follows: (1) The available regional mechanisms (funds/FSNs): Chiang Mai Initiatives Multi-lateralization, European Financial Assistance Mechanism, Arab Monetary Fund, North American Framework Agreement, FLAR Review and compare the available regional mechanisms (funds/FSNs) The study will discuss existing regional safety net arrangements, conducting a survey of the related literature and policy issues in the process. In this regard, we will determine the foundation and types of the arrangements, primarily focusing on the ASEAN+3 and subject to data availability. All in all, the purpose of this section will be to assess the extent of regional safety nets within the context of the recent financial crises. (2) The elements of the regional funds or FSNs: power/size of the funds, surveillance and monitoring, speed of decision making, certainty (voting formula, etc.), linkages with the global FSNs Review and analyze the elements of the regional mechanisms (funds/FSNs) This section will integrate the key findings emerging from the previous section for an examination of the power/size of the funds, surveillance and monitoring, speed of decision making, certainty (voting formula, etc.) of the regional FSNs and linkages with the global FSNs. In addition, we will investigate the implementation and effectiveness of the FSNs. We will try to gain a more in-depth understanding of the regional issues and member-specific information in order to achieve the ultimate goal in strengthening surveillance and the effectiveness of FSNs. (3) Policy measures to enhance the effectiveness and complementarities of the regional FSNs Identify appropriate policy measures to enhance the effectiveness and complementarities of the regional the FSNs. The regional financial safety net – the regional network of crisis financing instruments – can play a useful role in helping national authorities deal with unexpected capital flows that can be both massive and unfavourable in nature. Fiscal Policy Research Institute (FPRI), Thailand 5 In the last decade, after the Asian financial crisis in late 1990s, the ASEAN+3 (China, Japan and Korea) countries made significant progress in financial cooperation by focusing on establishing regional liquidity support mechanisms, developing regional bond markets, and reinforcing economic review and policy dialogues. The development in ASEAN+3 financial cooperation has contributed a lot to the economic and financial stability and integration in the region.