Global Economic Uncertainties and Southeast Asian Economies 9789814519373

Table of contents :
CONTENTS
PREFACE
CONTRIBUTORS
1. Challenges Facing a Globally Connected ASEAN
2. Fragile Balance of Payment in Indonesia under Global Economic Uncertainties
3. Malaysia in the Midst of Global Economic Uncertainties
4. Singapore: Reinventing Itself amid Global Economic Uncertainties
5. Thailand: Dependency or Diversification?
6. Vietnam’s Economic Experience since WTO Accession
7. Global Economic Imbalances and Reform Policy: Evidence from Asian Economies
8. Foreign Exchange Rate Adjustment Policies in Asia
9. Monetary and Financial Architectures for ASEAN+
10. Global Uncertainties: Implications for the ASEAN Community
INDEX

Citation preview

GLOBAL ECONOMIC UNCERTAINTIES AND SOUTHEAST ASIAN ECONOMIES

The Institute of Southeast Asian Studies (ISEAS) was established as an autonomous organization in 1968. It is a regional centre dedicated to the study of socio-political, security and economic trends and developments in Southeast Asia and its wider geostrategic and economic environment. The Institute’s research programmes are the Regional Economic Studies (RES, including ASEAN and APEC), Regional Strategic and Political Studies (RSPS), and Regional Social and Cultural Studies (RSCS). ISEAS Publishing, an established academic press, has issued more than 2,000 books and journals. It is the largest scholarly publisher of research about Southeast Asia from within the region. ISEAS Publishing works with many other academic and trade publishers and distributors to disseminate important research and analyses from and about Southeast Asia to the rest of the world.

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GLOBAL ECONOMIC UNCERTAINTIES AND SOUTHEAST ASIAN ECONOMIES EDITED

SUTHIPHAND CHAYDDDM AEKAPDL

BY

CHIRATHIVAT SABHASRI

CHDNGVILAIVAN

I5ER5 INSTITUTE OF SOUTHEAST ASIAN STUDIES Singapore

First published in Singapore in 2015 by ISEAS Publishing Institute of Southeast Asian Studies 30 Heng Mui Keng Terrace Pasir Panjang Singapore 119614 E-mail: [email protected] Website: All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of the Institute of Southeast Asian Studies. © 2015 Institute of Southeast Asian Studies The responsibility for facts and opinions in this publication rests exclusively with the author and his interpretations do not necessarily reflect the views or the policy of the publishers or their supporters. ISEAS Library Cataloguing-in-Publication Data Global Economic Uncertainties and Southeast Asian Economies / edited by Suthiphand Chirathivat, Chayodom Sabhasri and Aekapol Chongvilaivan. 1. Southeast Asia—Economic policy. 2. Southeast Asia--Commercial policy. 3. Southeast Asia--Economic conditions—21st century. 4. Financial crises—European Union countries. I. Suthiphand Chirathivat. II. Chayodom Sabhasri. III. Aekapol Chongvilaivan. HC441 G563 2015 ISBN 978-981-4519-36-6 (soft cover) ISBN 978-981-4519-37-3 (e-book, PDF) Typeset by Superskill Graphics Pte Ltd Printed in Singapore by Markono Print Media Pte Ltd

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CONTENTS Preface vii Contributors xi   1. Challenges Facing a Globally Connected ASEAN Jayant Menon and Thiam Hee Ng   2. Fragile Balance of Payment in Indonesia under Global Economic Uncertainties Reza Y. Siregar and Maria Monica Wihardja   3. Malaysia in the Midst of Global Economic Uncertainties Tham Siew Yean   4. Singapore: Reinventing Itself amid Global Economic Uncertainties Sanchita Basu Das and Catherine Rose James

1

22 56

77

  5. Thailand: Dependency or Diversification? Somprawin Manprasert

106

  6. Vietnam’s Economic Experience since WTO Accession Vo Tri Thanh

123

  7. Global Economic Imbalances and Reform Policy: Evidence from Asian Economies Aekapol Chongvilaivan

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vi

Contents

  8. Foreign Exchange Rate Adjustment Policies in Asia Paitoon Wiboonchutikula, Bangorn Tubtimtong, and Nuchit Pruektanakul

174

  9. Monetary and Financial Architectures for ASEAN+ Chayodom Sabhasri

218

10. Global Uncertainties: Implications for the ASEAN Community 242 Piti Srisangnam, Sineenat Sermcheep, and Nuanpan Thamanovanish Index

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PREFACE Southeast Asia entered its worst post-1997 recession against the backdrop of the global economic breakdown in 2008–9. Southeast Asian countries were able to decouple themselves from the ripple effects of the global financial shocks and bounced back strongly in 2009–10, thanks to their growing domestic markets, limited financial exposure to the crisis epicentres, and timely stimulus packages. The major Southeast Asian countries like Singapore, Malaysia and Thailand in 2010 exhibited a V-shaped recovery with staggering GDP growth of 15.0, 6.5 and 6.2 per cent, respectively, from a sharp contraction in 2009, while Indonesia, the Philippines and CLMV (Cambodia, Laos, Myanmar, Vietnam) countries demonstrated exceptional resilience. More recently, however, Europe’s worsening financial and banking crisis and a sluggish recovery of the United States have dampened Southeast Asia’s growth prospects. According to the latest estimates by the Asian Development Bank (ADB), the escalating global economic uncertainties have seen Southeast Asia’s growth forecast revised downwards to 6.6 per cent in 2012 and 7.1 per cent in 2013, from the earlier estimates of 6.9 per cent and 7.3 per cent, respectively. The current global economic circumstances underscore the risks of disproportionate dependence on exports as a crux engine of growth and the unsustainable features of overproduction in developing Asia, upheld by undue consumption in the United States and the European Union. There is a need, therefore, for Southeast Asia to bolster domestic demand and to put greater emphasis on intra-regional sources of economic potentials. For the time being, the region is in dire need of an optimal mix of macroeconomic and trade policy measures that differ by country, underpin domestic demand, and revive the domestic economies. More importantly, a new phase of Southeast Asia’s economic policy needs to address several socio-economic issues which constitute a root cause of

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Preface

the imbalances — including a lack of social security, underdeveloped and incomplete intra-regional financial markets, rapidly increasing income inequality, and limited competition among service products, and put in place a shield against emerging challenges such as a shift of demands towards East Asia, managing capital flows, escalating intra-regional trade linkages, and the mounting significance of intra-industry trade and trade in differentiated products. Nevertheless, the quest for concrete regional actions and coordination has been plagued by the complication of individual economies and the diverse levels of economic and cultural development, on top of the widely varied states of statistical accuracy and, not least, secrecy. For the time being, Southeast Asia is at a critical juncture where a regional panacea for tackling the challenges necessitates in-depth, region-specific economic policy discourse. This book illuminates how a policy push is at work in the region and sheds light on room for strengthening regional cooperation. Against this backdrop, the Institute of Southeast Asian Studies (ISEAS), the Faculty of Economics and the ASEAN Studies Center at Chulalongkorn University jointly organized an international conference on “Global Economic Uncertainties and Southeast Asian Economies” on 22–23 August 2013, at the Faculty of Economics, Chulalongkorn University. Drawing on the research findings and brainstorming from among experts at this conference, this edited book marks the first collaborative effort by the three institutions and aims to deliver the theses on the implications of the global economic uncertainties on Southeast Asian economic agendas. More specific objectives of this book are to: (1) discuss the developments of macroeconomic and trade-policy mix against the backdrop of the eurozone sovereign debt crisis and economic prospects for major countries in Southeast Asia (i.e., Singapore, Thailand, Malaysia, Indonesia, and Vietnam); (2) assess the effectiveness of policy responses to the global economic unrest; (3) identify opportunities and challenges facing Southeast Asia in the midst of the global economic slump when developing Southeast Asia leverages on an ever-expanding role in the global business environment; (4) rethink the East Asian model of growth where enormous gains were driven principally by export demands from advanced economies; and (5) pioneer the key areas of regional cooperation and macroeconomic and trade policy reforms that may potentially strengthen regional economies.

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Preface

ix

In convening this conference, grateful recognition is due to Ambassador Tan Chin Tiong, ISEAS Director, and Dr Ooi Kee Beng, ISEAS Deputy Director, for their continued support and encouragement. Our sincere thanks go to the conference speakers and participants for insightful inputs, the ISEAS Publications Unit for their efforts in publishing this book, and, last but not least, Ms Wanwadee Wongmongkol and Ms Sansanee Somboonsin for excellent assistance. Suthiphand Chirathivat Chayodom Sabhasri Aekapol Chongvilaiva

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CONTRIBUTORS Aekapol Chongvilaivan is Economist, Pacific Department, Asian Development Bank (ADB). Bangorn Tubtimtong is former Assistant Professor, Faculty of Economics, Chulalongkorn University, Thailand. Sanchita Basu Das is ISEAS Fellow and Lead Researcher (Economic Affairs), ASEAN Studies Centre, Institute of Southeast Asian Studies (ISEAS), Singapore. She is also the Coordinator of the Singapore APEC Study Centre, ISEAS. Chayodom Sabhasri is Dean, Faculty of Economics, Chulalongkorn University, Thailand. Catherine Rose James is Research Officer, ASEAN Studies Centre, Institute of Southeast Asian Studies (ISEAS), Singapore. Somprawin Manprasert is Assistant Professor, Faculty of Economics, Chulalongkorn University, Thailand. Jayant Menon is Lead Economist (Trade and Regional Cooperation), Office of Regional Economic Integration, Asian Development Bank (ADB). Nuchit Pruektanakul is a former graduate student at the Faculty of Economics, Chulalongkorn University, Thailand. Thiam Hee Ng is Senior Economist at the Office of Regional Economic Integration, Asian Development Bank (ADB).

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Contributors

Paitoon Wiboonchutikula is Professor at the Faculty of Economics, Chulalongkorn University, Thailand. Sineenart Sermcheep is Lecturer at the Faculty of Economics, Chulalongkorn University, Thailand. Reza Siregar is Group Head and Lead Economist at ASEAN+3 Macroeconomic Research Office (AMRO). Piti Srisangnam is Lecturer at the Faculty of Economics, Chulalongkorn University, Thailand. Suthiphand Chirathivat is Executive Director, ASEAN Studies Center, Chulalongkorn University, Thailand. Nuanpan Thamanovanish is a former graduate student at the Faculty of Economics, Chulalongkorn University, Thailand. Vo Tri Thanh is Vice President, Central Institute of Economic Management, Ministry of Planning and Investment, Vietnam. Maria Monica Wihardja is Researcher at the Centre for Strategic and International Studies (CSIS), Indonesia. Tham Siew Yean is Deputy Director, Institute of Malaysia & International Studies (IKMAS), Universiti Kebangsaan, Malaysia.

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1 CHALLENGES FACING A GLOBALLY CONNECTED ASEAN Jayant Menon and Thiam Hee Ng

1. INTRODUCTION The countries of the Association of Southeast Asian Nations (ASEAN) are more regionally integrated and globally connected today than ever before. These features continue to grow, and have delivered significant benefits, but they also carry risks. Increased vulnerability to external shocks, as well as contagion that spreads rapidly across the region, are the main concerns. Five years after the global financial crisis (GFC), the economies of the United States and the eurozone continue to struggle, with the eurozone recovery lagging behind that of the United States. Monetary authorities have responded by sharply easing monetary policy. This has brought policy interest rates down to close to zero. Having quickly reached the interest rate floor, both the US Federal Reserve and the European Central Bank (ECB) have resorted to unconventional monetary policy through episodes of quantitative easing. The Bank of Japan, under new leadership, has recently followed suit. This has further increased liquidity in the banking system.

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However, these policy moves have yet to produce the desired effect in the home countries, as private lending has failed to increase as expected. Banks are facing pressure to beef up their capital, making them hesitant to lend. Consumers and businesses are also reluctant to borrow as uncertainty remains high and confidence in the recovery remains low. All of this suggests that the problems in the eurozone are unlikely to end anytime soon. It also points to the very real possibility that the situation could indeed worsen. This remains true despite official figures showing that, technically, the recession in the eurozone came to an end in the second quarter of 2013. Nevertheless, the eurozone economy is still expected to shrink in 2013. It is against this global backdrop that this chapter pays attention to the situation in Southeast Asia. How has the global financial turmoil affected ASEAN economies? Is there a real risk that this crisis could spread to the region? Given the fragility of the financial system, what are the possible effects of a shock to the eurozone financial system on the economies of Southeast Asia? This is a real possibility, given that vulnerability in the region has increased following massive inflows of capital and the buildup of debt related to successive bouts of quantitative easing, initially in the United States and now in Japan. Given that East Asia is now more integrated than it has ever been, how will this affect the depth and spread of the crisis? If East Asia succumbs, is it ready to deal with the fallout, or will it again have to seek support from the International Monetary Fund (IMF), as it did during the 1997/98 Asian financial crisis (AFC), but at a time when global resources are even more stretched? These are the key questions examined in this chapter. The chapter is organized in six further parts. To provide the backdrop, Section 2 traces the process of regional integration in ASEAN, from its beginnings to its current situation and near-term aspirations. Section 3 considers how increased regional integration will affect the ASEAN economies should a crisis hit the region. Section 4 focuses on the impact of monetary policy easing in advanced economies on capital flows in Southeast Asia. Section 5 explores the possible spillovers of a financial shock in Europe on the region’s financial sector, examining both direct and indirect effects. Section 6 looks at the readiness of the region to deal with any possible fallout by examining the adequacy of regional financial safety nets. A final section concludes.

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3

2. ASEAN INTEGRATION: TOWARDS THE AEC AND BEYOND The push towards regional economic integration was not a major part of the agenda of ASEAN during the first decade its existence. In the period between its inception in 1967 up until the mid-1970s, ASEAN’s primary focus was on creating harmony and cohesion within the region. ASEAN’s tentative steps towards economic cooperation only began in earnest in 1976, with the launch of the ASEAN Preferential Trading Agreement (APTA). The APTA was the first major attempt to promote intra-ASEAN trade through institutional integration and regional trade preferences. Over the succeeding decades, pursuing regional economic integration has gained prominence in ASEAN affairs. From the initial focus on trade liberalization, through APTA and eventually the ASEAN Free Trade Agreement (AFTA), ASEAN’s regional economic integration agenda has broadened to include services trade, investment, labour migration, and even macroeconomic policy (Hill and Menon 2012a). ASEAN’s regional economic integration efforts are meant to culminate in the creation of an ASEAN Economic Community, one of the three pillars of the ASEAN Community espoused in ASEAN’s Vision 2020 (the other two pillars are the Security Community and Socio-Cultural Community). The ASEAN Leaders had originally intended to create the ASEAN Economic Community (AEC) by 2020, but in early 2007 they advanced the deadline to 2015. Three factors prompted ASEAN countries to advance the time frame to achieve the AEC. First was the need to maintain the centrality of ASEAN’s role despite the proliferation of free trade agreements (FTAs) between ASEAN and its dialogue partner countries. Many of ASEAN’s free trade agreements aim at full liberalization of the markets before or by 2015; if the ASEAN market is not fully integrated before the realization of ASEAN free trade agreements, ASEAN’s central role faces the risk of being eroded. Second was the political desire of ASEAN leaders to expedite ASEAN economic integration and thereby take it to the next level. Third was the growing concern over the erosion of ASEAN’s competitiveness vis-à-vis its key competitors, such as the People’s Republic of China and India. At the 13th ASEAN Summit held in Singapore on 20 November 2007, the ASEAN Leaders adopted the ASEAN Economic Blueprint for the AEC. The Blueprint defines the four pillars of the AEC and contains seventeen

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Jayant Menon and Thiam Hee Ng

“core elements” and 176 priority actions to serve as a guide for achieving the four pillars. It also contains agreed goals and specific commitments to be carried out within definite timelines, with a “Strategic Schedule” in the form of a matrix specifying “Priority Actions” to be undertaken over four two-year periods from 2008 to 2015. Progress towards the achievement of the AEC is measured through the AEC Scorecard mechanism established in 2008. The AEC Scorecard is a self-assessment tool that monitors the achievement of milestones indicated in the Economic Blueprint’s Strategic Schedule. It also tracks the specific actions that must be undertaken by ASEAN Member Countries, both individually and collectively, to establish the AEC (Das et al. 2013). The fulfilment of these commitments would promote predictability in ASEAN, as well as strengthen its credibility. But with only two years remaining before the 31 December 2015 deadline, many are still wondering whether the AEC will become a reality in 2015, or whether it will remain essentially a vision statement? The latest AEC Scorecard released in March 2012 records progress towards the AEC at about 68 per cent of the targets during 2008–11. The biggest strides have been made in integrating into the world economy (Pillar 4, 86 per cent). Progress in other areas of the AEC has been more muted, with ASEAN as a whole achieving just a little over two-thirds of its targets in the other three pillars. One thing is clear; ASEAN would have moved further down the track towards increased integration. Even if specific targets are not met, the journey towards closer and greater integration would have progressed. As evidenced by the integration indicators in Table 1.1, ASEAN has emerged to become one of the most integrated sub-regions in Asia, both in terms of intra-regional trade and investments. Macroeconomic linkages also seem to be stronger in ASEAN, as evinced by the higher output correlation between economies in the sub-region.

3. RISKS FROM INCREASED REGIONAL INTEGRATION The discussion on regional economic integration has tended to focus more on the benefits than costs. These include, for example, the creation of larger markets to stimulate demand, positive spillover effects of infrastructure connectivity projects, initiatives to share risk, better resource allocation by liberalizing cross-border flows of factors of production, and so on. Much less is heard about the risks of integration. The cascading effect of the ongoing eurozone crisis is a vivid reminder of the contagion risk of highly integrated systems.

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Challenges Facing a Globally Connected ASEAN TABLE 1.1 Progress in Regional Integration, 2008–11 Production Network and Trade

Capital Markets

Macroeconomic Links: Intraregional Output Correlations

Intraregional FDI

Intraregional Trade

Intraregional Equity Holdings

Intraregional Bond Holdings

50.08

55.02

24.98

6.36

0.02

5.33

41.81

36.17

17.6

2.84

0.59

Southeast Asia

6.32

24.61

9.54

9.49

0.7

South Asia

0.03

4.61

0.04

The Pacific and Oceania

1.91

8.05

0.46

Asia Central Asia East Asia

0.36 0.35

Notes: Data calculated for Asia unless otherwise noted. Foreign direct investment (FDI): Average share of intraregional foreign direct investment inflows in 2008–9. Data unavailable for Afghanistan; Bhutan; the Cook Islands; Kiribati; Republic of the Maldives; the Marshall Islands; the Federated States of Micronesia; Mongolia; Nauru; Nepal; Palau; Samoa; Solomon Islands; Sri Lanka; Taipei, China; Tajikistan; Timor-Leste; Tonga; Turkmenistan; Tuvalu; Uzbekistan; and Vietnam. Trade: Average share of intraregional trade. Reporter data unavailable for Bhutan, Kiribati, Nauru, Palau, Timor-Leste, and Tuvalu. Reporter and partner data unavailable for the Cook Islands, the Marshall Islands, and the Federated States of Micronesia. Equity holdings: Average share of intraregional equity investment in 2008–10 based on investments from Hong Kong, China; India; Indonesia; Japan; Kazakhstan; the Republic of Korea; Malaysia; Pakistan; the Philippines; Singapore; Thailand; and Vanuatu. Excludes Oceania. Recipient data unavailable for Azerbaijan, Bhutan, the Federated States of Micronesia, Palau, Samoa, Tonga, Turkmenistan, and Tuvalu as investment destinations. Bond holdings: Average share of intraregional investment in bonds in 2008–10 based on investments from Hong Kong, China; India; Indonesia; Japan; Kazakhstan; the Republic of Korea; Malaysia; Pakistan; the Philippines; Singapore; Thailand; and Vanuatu. Excludes Oceania. Recipient data unavailable for Azerbaijan, Bhutan, the Federated States of Micronesia, Palau, Samoa, Tonga, Turkmenistan, and Tuvalu as investment destinations. Output correlations: Based on simple averages of three-year rolling bilateral correlations of annual growth rates (difference of natural logarithms) of detrended GDP series (2005 base year). Data unavailable for Afghanistan, the Cook Islands, the Marshall Islands, the Federated States of Micronesia, Myanmar, Nauru, Palau, Timor-Leste, and Tuvalu. Source: ADB Asian Economic Integration Monitor, July 2012.

The main concern relating to increased integration or interdependence is that it exacerbates contagion in times of crisis. Examples abound of financial crises rapidly spreading from one country to another, especially

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when integration is deeper due to either geographical proximity or a regional arrangement. While a shock may originate in the financial sector of one country, it can rapidly infect others across a region, affecting entire economies and damaging people’s welfare. For Asia, the damage caused by the 1997/98 Asian financial crisis is a powerful reminder of the danger of contagion. An idiosyncratic shock occurring in Thailand leaped across boundaries, devastating other economies. And yet, despite some policy convergence, the scale of integration in Asia at the time was more limited than now. One can only imagine how much worse the crisis would have been, had intra-Asian cross-border financial holdings been larger than they were. As noted earlier, regional integration and global connectedness are progressing hand in hand in ASEAN, as it is in many parts of the world. Goods and services are traded and increasingly produced globally and regionally; labour and capital are becoming more mobile. It is clear that regional integration is progressing in Asia, and this has strengthened further after the recent global financial crisis (ADB 2013). However, unlike Europe, Asian regional integration, especially in ASEAN, has been more market-driven, institution-light and bottom-up. To the extent that greater integration can also elevate the probability of contagion, there is a need to better manage the market process of integration to reap the benefits while minimizing potential costs. In many cases, Asia needs to cooperate more and better — not just in trade and finance, but also in macroeconomic policy, infrastructure, energy, and on the environment. In some of these areas, greater cooperation will not necessarily lead to greater integration. Cooperation in providing financial safety nets is an example in point; it can mitigate the risks of contagion-driven crises with no direct impact on integration (Azis 2012). On the other hand, cooperation in infrastructure connectivity will almost automatically increase the cross-border flows of goods, services and people. With the current uncertainties over the global economy, any country is vulnerable to a contagion-driven crisis through real sector, trade and financial channels. The contagion through the financial channel is perhaps the most difficult to detect, yet its impact can be devastating. While domestic macroeconomic policy can help mitigate the impact, sufficient foreign exchange reserves are usually the first line of defence against financial contagion. But a domestic safety net alone may be inadequate, even for a resilient Asia. If contagion effects are severe, markets may react

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indiscriminately. To the extent that an interconnected financial system raises the probability of spillover effects — and that the global nature of most crises calls for a coordinated policy response — a regional safety net can complement the domestic and global financial reforms needed to respond to systemic shocks. An effective financial safety net is thus necessary (see Section 6).

4. SOUTHEAST ASIA AFTER THE GLOBAL FINANCIAL CRISIS The initial impact of the 2007/8 Global Financial Crisis was the most evident in the real economy. A huge decline in exports led to a sharp slowdown in the region’s economic growth. However, this impact was short-lived; the rebound was swift and sharp (see Figures 1.1 and 1.2). This was aided by a partial shift of the region’s exports away from the United States and eurozone towards other countries in the region and other developing regions. On the financial side, there was also an initial outflow of foreign capital from the region’s economies. However, inflows of funds resumed quickly. The region’s financial system has become more resilient following the reforms carried out after the 1997/98 AFC. Furthermore, prudent management minimized the financial system’s exposure to the toxic financial assets that caused heavy losses for American and European banks. The initial outflows from the region likely reflect a flight to safety amid huge uncertainties following Lehman Brothers’ collapse. As global financial markets became calmer, fund inflows to the region soon resumed (see Figure 1.3). Nevertheless, capital inflows to the region have remained volatile. While the Federal Reserve’s announcement in September 2012 to increase quantitative easing spurred capital flows to the region, the more recent decision to begin winding back quantitative easing, combined with further uncertainty in the eurozone, is likely to mean that investors’ confidence remains fragile. The sentiment could easily change and capital inflows could suddenly reverse and become outflows. Since sudden reversals in capital flows could disrupt financial systems and lead to macroeconomic instability, there is a need to carefully weigh the benefits and costs of greater capital inflows to the region. Caution is necessary, as the region has experienced volatile capital flows in the past, particularly during the 1997/98 AFC and more recently during the 2008/9 GFC. Large inflows

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Jayant Menon and Thiam Hee Ng FIGURE 1.1 Merchandise Export Growth (%, year-on-year, 3-month moving average) Merchandise Exports Growth (Annual growth %, 3 month moving average) 40.00

35.00

30.00

25.00

20.00

15.00

10.00

5.00

Philippines

Jul-13

Jan-13

Mar-13

May-13

Jul-12

Sep-12

Nov-12

Jan-12

Mar-12

May-12

Jul-11

Sep-11

Singapore

Nov-11

Jan-11

Mar-11

May-11

Jul-10

Sep-10

Nov-10

Jan-10

Mar-10

May-10

Jul-09

Sep-09

Malaysia

Nov-09

Jan-09

Mar-09

May-09

Jul-08

Sep-08

Indonesia

Nov-08

Jan-08

Mar-08

May-08

Jul-07

Sep-07

Nov-07

Jan-07

Mar-07

May-07

0.00

Thailand

Source: ADB’s Asia Regional Integration Centre.

FIGURE 1.2 Current Account of ASEAN-4, 2011–13 (quarterly, as share of GDP) Current Account Balance of ASEAN-4, 2011- 2013 25

20

15

10

Indonesia

5

Thailand

Malaysia

% of GDP

Philippines

0 2007 - Q1

2008 - Q1

2009 - Q1

2010 - Q1

2011 - Q1

2012 - Q1

2013 - Q1

-5

-10

Source: ADB’s Asia Regional Integration Centre.

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Challenges Facing a Globally Connected ASEAN FIGURE 1.3 Composition of Capital Inflows in Emerging Asia Gross Capital Inflows into Emerging East Asia

US$ billion 1,200

1,000

800

600 Other Investment Portfolio Investment 400

Foreign Direct Investment Gross Inflows

200

0

-200

-400 2005

2006

2007

2008

2009

2010

2011

2012

Notes: Gross Inflows = Foreign Direct Investment + Portfolio Investment + Other Investment. Emerging East Asia comprises the People’s Republic of China (PRC); Hong Kong, China; Indonesia; the Republic of Korea; Malaysia; the Philippines; Singapore; and Thailand. Data for 2011 is incomplete. Data for the PRC, Singapore, and Thailand is not available from data source. Data for Malaysia only included Foreign Direct Investment and Gross Inflows. Source: ADB staff calculations based on balance of payments data (BPM5) from International Financial Statistics, IMF.

to the region before the AFC suddenly reversed, becoming outflows that precipitated currency and banking crises in several countries in Southeast Asia and plunged the most affected countries into deep recession. The swift resumption of capital inflows in 2009 is seen as a sign of confidence in the region’s economies, underscoring economic resilience in the face of the GFC. However, as the size of capital inflows continued to grow, especially in 2010, concerns about a repeat of the 1997/98 AFC also grew. A rapid surge in short-term capital inflows makes it increasingly difficult to manage risks. An attempt to sterilize inflows will only create excess liquidity in domestic financial markets, resulting in exchange rate misalignments, and ultimately derailing economic stability and growth. Fears that the surge in capital flows could lead to asset bubbles and exert upward pressure on the exchange rate have been realized, to varying

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degrees, across ASEAN countries. For instance, easy credit combined with strong demand driven by speculative motives have raised property prices in many Southeast ASEAN cities — including Bangkok, Ho Chi Minh, Phnom Penh, Kuala Lumpur and Singapore — in some cases surpassing peaks reached in 2007. This increases the risk of price bubbles that could lead to drastic losses in terms of both real output and price levels (Menon and Chongvilaivan 2011). There are also concerns about sudden reversals of capital inflows destabilizing asset and financial markets. Ng (2011) has shown that capital inflows to the region are strongly affected by global risk perception. Concerns relating to future growth prospects of Asia’s giant economies of the People’s Republic of China (PRC) and India, coupled with the looming deadline of the Fed’s unwinding of its quantitative easing, have already seen significant volatility in the region in August 2013, with significant amounts of portfolio capital exiting the region. As can be seen from the severe recession following the AFC, the cost of the volatility of capital flows can be very high indeed. Given the threat to the region’s economies, governments reacted quickly to the 2008/9 GFC by implementing fiscal and monetary stimulus measures. Higher initial policy rates, compared with those in the United States and Europe, provided ample room for the region’s monetary authorities to reduce interest rates. As a result, the region’s policy rates have fallen considerably (see Figure 1.4). Despite recent improvements in economic performance, policy rates in many countries have remained well below pre-crisis levels. Given the uncertain state of the global recovery, many of the region’s governments have been hesitant to raise interest rates quickly. Monetary policy easing has had the desired impact of increasing bank lending in the ASEAN economies (see Figure 1.5). This likely reflects the region’s stronger macroeconomic fundamentals, and possibly a more optimistic outlook among the region’s consumers and businesses. The resilience of the region’s financial system in the aftermath of the GFC has also likely helped shore up confidence. As Figure 1.4 shows, while bank lending slowed considerably after the GFC, the easing of monetary policy has since led to an increase in bank lending. Consequently, although Asia had relatively low levels of debt at the beginning of the GFC, it is now more highly leveraged. Domestic bank lending has soared, particularly in Thailand, Malaysia and Singapore (see Figure 1.6). At the same time, given the weakness in global financial institutions, we have seen a considerable decline in loans by European

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Challenges Facing a Globally Connected ASEAN FIGURE 1.4 Policy Rates in the ASEAN-4 Policy Rates in ASEAN 4 10

9

8

7

6 Indonesia Malaysia

% 5

Philippines Thailand

4

3

2

1

0 2007 - Jan

2008 - Jan

2009 - Jan

2010 - Jan

2011 - Jan

2012 - Jan

2013 - Jan

2014 - Jan

Source: ADB’s Asian Regional Integration Centre.

FIGURE 1.5 Growth in Bank Lending (%, year-on-year) Growth in Bank Lending 45%

40%

35%

30%

25%

Indonesia Malaysia Philippines

Y-o-Y change 20%

Singapore Thailand

15%

10%

5%

0% Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Jan-13

-5%

Source: International Financial Statistics.

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Jayant Menon and Thiam Hee Ng FIGURE 1.6 Domestic Credit Provided by Banking Sector (% of GDP) Domesc credit provided by banking sector 180

160

140

120

100 % of GDP 80

60

40

20

0 2007

2008 Indonesia

2009 Malaysia

Philippines

2010 Singapore

2011

2012

Thailand

Source: International Financial Statistics.

banks to the region. This has particularly affected the use of trade finance in the region. Basel III regulations aim to increase the capital cushion that banks will have to carry. This means that European banks will have to raise more capital in a difficult environment. Alternatively, the banks may opt to reduce their asset base by reducing lending, which is a major concern for the region. Another cause for concern is non-core liabilities (usually consisting of interbank borrowings), which have been increasing significantly even prior to the 2007/8 GFC. There are concerns that with European banks deleveraging, the banking system in Southeast Asia will find it more difficult to continue borrowing funds from abroad. The share of other investment flows has declined in the region. Given the importance of the banking system in the region, the trend in non-core liabilities, which is on the rise, is a cause for concern (Menon and Ng 2013).

5. ESTIMATING THE IMPACT OF SPILLOVERS FROM A EUROZONE FINANCIAL CRISIS While aggressive actions from the European Central Bank have helped to improve market confidence and stabilize bond yields, the risks in

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the eurozone’s financial system have not faded completely. Financial institutions in the eurozone, particularly banks, are still struggling to regain profitability amidst a weak macroeconomic environment. While there are recent signs of improvement in the eurozone economies, it is still expected to end 2013 mired in recession. As a result of the weak growth, banks are still finding it difficult to lend, with borrowers preferring to remain on the sidelines for now. With eurozone banks pulling back from overseas markets, they have also become more dependent on the slow-growing eurozone market. So while the financial conditions in the eurozone are calmer now, the continued fragility of the financial system means that they remain susceptible to sudden shifts in investor confidence. The reaction of the region’s financial markets to the news of the Federal Reserve potentially tapering its quantitative easing operations demonstrates that the region remains vulnerable to external shocks. A financial crisis in the eurozone will almost certainly have an impact on the region’s financial markets — the only question relates to the magnitude of the spillover. To estimate the potential impact of spillovers from a financial crisis in the eurozone, we employ the global vector autoregression (GVAR) model originally introduced by Pesaran et al. (2004) and further developed by Dees et al. (2007). The advantage of the GVAR model is that it not only incorporates the economic structures and global interdependencies of the world economy into a VAR model, it also avoids the identification problem found in VAR models. Furthermore, there are major differences in the cross-country correlations of various real variables. For instance, equity returns are much more closely correlated across countries than real gross domestic product (GDP) growth and inflation. This suggests that different channels of transmission should be considered. The GVAR approach allows us to model these different types of links directly, using trade-weighted observable macroeconomic aggregates and financial variables. The advantage of performing a quantitative assessment of this type is that it allows us to identify which economies are likely to be the most vulnerable in the event of a crisis, as well as providing an estimate of the magnitude of the impact on individual economies. These estimates can provide policymakers with a quantitative assessment of the extent of their vulnerability, and can serve as an important incentive to implement timely remedial policy actions. The GVAR approach has been used by several researchers to examine spillover effects of this type. Galessi and Sgherri (2009), for instance, analysed the transmission of shocks across financial sectors in Europe. They used bilateral bank lending as the weights in their model. Chen et al.

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(2010), on the other hand, used the GVAR model to examine how banks’ and nonfinancial private companies’ default risk could spread among countries. In their case, a combination of trade and financial variables were used as the weights in conducting the estimation. To estimate the spillovers from an external financial shock, we construct a GVAR model for thirteen economies: the United States, United Kingdom and eurozone, plus ten Asian economies — the East Asian economies of the PRC, Hong Kong, Japan and the Republic of Korea; the five original members of ASEAN, which are Indonesia, Malaysia, the Philippines, Thailand and Singapore; and India. The variables included in the model are real GDP growth, equity prices, lending to the private sector, and interbank rates. It is estimated using monthly data over the period 1999–2011. As GDP growth data are only available quarterly, we used interpolation methods to convert quarterly GDP growth into monthly figures, following Smith and Galessi (2011). Since we are interested in examining the impact of financial linkages across countries, we use the share of portfolio investment in the economy — obtained from the Coordinated Portfolio Investment Survey — as the weights for the GVAR model. In order to examine the impact of a shock from the European financial markets, we estimate generalized impulse response functions (GIRFs). Within the GVAR framework, GIRFs are widely used as they are not affected by the ordering of the variables and countries. In a large model with many countries and variables, there is no obvious way to identify the ordering of countries. Furthermore, the focus of our analysis is to examine the spillover effects from the eurozone on Asian economies, rather than to identify the effects of a specific shock. Figure 1.7 presents the GIRFs of a negative-one standard deviation shock on eurozone equity markets on ASEAN stock markets. Our dynamic analysis shows that the equity market shocks from the eurozone are transmitted quickly to the region through stock prices. There are substantial co-movements in ASEAN stock markets following a negative shock in eurozone equities. The transmission is rapid, with the peak effect occurring about five to seven months after the onset of a shock. Next, we examine the impact of a eurozone financial shock on ASEAN’s economic growth. We find that the responses of the region’s economies are mostly similar (see Figure 1.8). However, the impact of the shock on economic growth, as opposed to equity markets, is transmitted over a longer period, taking seven to nine months to reach its trough. Economic growth rates in Malaysia and Singapore are the most affected by a eurozone equity shock. In contrast, the economies of Indonesia and

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Challenges Facing a Globally Connected ASEAN FIGURE 1.7 Response of ASEAN Equity Returns to a Negative Eurozone Equity Shock Impact on ASEAN equity markets from a eurozone shock 1

0 0

1

2

3

4

5

6

7

8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40

-1

Indonesia

-2

Malaysia Philippines Singapore -3

Thailand

-4

-5

-6

Source: Authors’ calculations.

FIGURE 1.8 Response of Output Growth to a Eurozone Equity Shock Impact on ASEAN growth of Eurozone equity shock 0.6

0.4

0.2

0 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 Indonesia -0.2

Malaysia Philippines

-0.4

Singapore Thailand

-0.6

-0.8

-1

-1.2

Source: Authors’ calculations.

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Jayant Menon and Thiam Hee Ng

the Philippines — with their relatively large domestic sectors — appear to be better insulated against a financial shock from Europe. Our empirical results show that a eurozone financial crisis would have a small but non-negligible impact on the region’s stock markets and economic growth. Such a crisis would affect countries in the region to varying degrees, with Singapore and Malaysia the most affected in terms of real economic impact given their greater exposure to global markets. These are the effects that we can directly attribute to a further shock in the eurozone. What we cannot quantify are the indirect effects that may flow from adjustments that take place via changes in value assessments as a result of heightened risk perception. Since the region’s asset prices — both real and financial — have increased significantly due to large capital inflows driven by quantitative easing in the advanced economies, there could be an underlying perception among global investors of overheating that has resulted in an artificial asset bubble. Although difficult to quantify, the possibility of such indirect effects is real, and could accumulate to produce a much greater negative impact on the region. Given the potential for shocks in eurozone financial markets to affect Asia both directly and indirectly, policymakers need to ensure that they respond quickly to bolster financial stability and avoid deterioration in market confidence. This need is even more pressing now, given the extent of integration in the region and the increased risk of contagion. Policymakers should also continue to carefully monitor banks’ portfolios, especially in countries where lending has risen sharply, to ensure that there has not been excessive risk-taking. A further real-side contraction driven by a trade slowdown could compound the debt situation in many ASEAN countries.

6. IS EAST ASIA READY FOR ANY FALLOUT? How prepared is the region to deal with a shock in the eurozone that translates into a liquidity crisis in East Asia? Although our analysis points to a small but non-negligible direct impact from a further shock to the eurozone economy, this can easily be amplified into a significant one through indirect channels. In this section, we look at whether the region is ready to deal with such fallout. The importance of the region’s ability to fend for itself is heightened if such a contagious crisis sees a significant share of the world competing for scarce global resources. The current situation in Europe has already seen the troika — the IMF, European Commission

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and European Central Bank — expend €303 billion in bailout funds for Greece (€130 billion total with an IMF share of €28 billion); Portugal (€78 billion total with an IMF share of 27.5 billion); Ireland (€85 billion with an IMF share of €22.5 billion); and Cyprus (€10 billion with an IMF share of €1 billion). Given the sheer size of the amounts involved, it is easy to see how a worsening situation in Europe could constrain the IMF’s ability to serve as lender of last resort, should Asia also require emergency support. When the Asian financial crisis hit, the ASEAN Swap Arrangement (ASA) proved sorely inadequate, given its small size, in providing the liquidity needed by its members. As a result, there was little choice but to resort to the IMF. Amid widespread disenchantment with the way in which the IMF dealt with the AFC, the region has since been working on bolstering its own financial safety nets. The first step towards establishing such a scheme was taken in May 2000 with the launch of the Chiang Mai Initiative (CMI) as part of the ASEAN+3 process. The CMI grew from just US$1 billion at inception to US$84 billion at the onset of the GFC. If the Asian financial crisis crystallized the need to transform the ASA into the CMI, then the GFC of 2008/9 highlighted the continued shortcomings of that transformation. Despite the CMI having grown rapidly in size, it was still too small to be effective during the GFC, and the absence of rapid-response mechanisms forced affected countries to turn to bilateral swaps with the United States, PRC and Japan, and to regional agencies (Hill and Menon 2012b). What followed was a radical transformation of the CMI. First, it was multilateralized so that the revamped CMIM would be a self-managed reserve-pooling arrangement governed by a single contract, reducing costly and wasteful duplication. Second, the size of the pool was increased to US$120 billion in May 2009. A decision was taken to establish an ancillary institution in the form of an independent regional surveillance unit, the ASEAN+3 Macroeconomic Research Office (AMRO), which came into being in May 2011. The continuing problems in the eurozone and risks of further deterioration have highlighted the need to strengthen the CMIM’s capacity to act as a regional financial safety net (Azis 2012). To address this need, the 15th Meeting of ASEAN+3 Finance Ministers in May 2012 agreed to (1) double the total size of the CMIM to US$240 billion; (2) increase the IMF de-linked portion to 30 per cent in 2012, with a view to increasing it to 40 per cent in 2014, subject to review should conditions warrant; and (3) introduce a crisis prevention facility.

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These are impressive developments over a relatively short period of time. However, the critical question that needs to be answered is whether these reforms are sufficient to provide the region with a working alternative in the event of a crisis. Is it likely that the CMIM will be called upon when the next crisis strikes? Unfortunately, the CMIM still appears unusable, whether as a co-financing facility in tandem with the IMF or as a standalone alternative. There are a number of reasons for this, and therefore an equal number of issues that need to be addressed to make it viable. First, as a reserve-pooling arrangement, there is no actual fund, but rather a series of promises (Hill and Menon 2012b). This is not a problem per se, except when there are no rapid-response procedures to handle a fastdeveloping financial emergency. Unless these procedures are streamlined, the CMIM is unlikely ever to be called upon, even as a co-financing facility. Yet, if the IMF’s resources are already committed elsewhere, especially if conditions in Europe were to deteriorate thus requiring further bailouts, then the role of the CMIM becomes critical. If the CMIM is to be a real substitute for the IMF and serve as a true regional alternative, then the size of the fund, or the portion de-linked from an IMF programme, needs to be increased substantially. During the AFC, Thailand received over US$17 billion in emergency liquidity. Yet Thailand (and the four other original ASEAN members) can access only a fraction of this amount, about US$7 billion in 2012 US dollars, from the CMIM without an IMF programme. Indonesia received almost six times (US$40 billion) the amount of its de-linked portion of the CMIM, or an even greater multiple if converted into today’s dollars. The Republic of Korea was the other crisis-hit country that availed of an IMF-led programme and bilateral support that totalled US$57 billion, while today its full quota with the CMIM is only about US$38 billion (Hill and Menon, 2012b). Unlike with the IMF, the CMIM does not have an exceptional access clause that allows a country to borrow amounts above their quota in exceptional circumstances provided that the country satisfies a predetermined set of conditions. If there were to be a full-blown systemic crisis in East Asia that spread across several members, then this clause would not be of much value either. This is another reason why membership also needs to expand beyond ASEAN+3, not just to bolster the size of the fund, but also to diversify it. Without these changes, ASEAN+3 is unlikely to turn to the CMIM as a co-financier or a substitute for the IMF, which explains why countries

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continue to take the high-cost mercantilist route of self-insurance through excessive holdings of foreign exchange reserves, or why they continue to pursue bilateral swaps separately, often with other CMIM members. Furthermore, Japan is also looking to strengthen bilateral relations with ASEAN directly, bypassing the ASEAN+3 process, and is expected to revive bilateral currency swap agreements with Malaysia, Singapore and Thailand, and to strengthen existing bilateral arrangements with Indonesia and the Philippines. Some see this as an early warning sign of an unravelling of the CMIM, as a result of rising tensions involving territorial disputes and competition among the “+3” countries to gain influence in Southeast Asia. If this process continues or spreads, we could see a return of the so-called “noodle bowl” of bilateral swap agreements that the CMIM’s single agreement was designed to replace. In fact, bilateral swaps are quickly becoming the main instrument in Asia’s financial safety net, although on a somewhat ad hoc basis. However, shifting national reserves to a regional fund that is unlikely to be used could actually be counterproductive, as it weakens a country’s first line of defence. Although ASEAN+3 may appear to have a co-financing facility with the IMF in the CMIM, it is not a useable one. If it wants its own regional safety net, then it has a long way to go. How far is still unclear, but hopefully it can be made workable before, rather than because of, the next crisis.

7. CONCLUSION ASEAN countries, even its newer members, have made impressive progress in regional economic integration and cooperation. The region’s diversity, development pattern and global links have generated a unique Asian model of regionalism — dynamic, open and market driven — which enhances prosperity not only in the region but also in the rest of the world. Asia’s open regionalism underscores the importance of strengthening trade, investment and capital flows within the region while maintaining strong ties with and remaining open to the rest of the world. It aims to build a regionally integrated and globally connected Asia. But while increasing regional integration with rising global engagement brings obvious benefits, it also carries substantial risks. While ASEAN entered the GFC with relatively low levels of debt, it is now more highly leveraged following large inflows of capital resulting from successive rounds of quantitative easing in the advanced economies of

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Europe and the United States. The decision by the Bank of Japan in 2013 to also aggressively pursue monetary easing is likely to lead to further flows into the region. At the same time, given the weakness of global financial institutions, we have seen considerable cutbacks in loans by European banks to the region. The recent decision by the Federal Reserve to begin winding back quantitative easing is already being felt in the region. Trade finance is also being affected. If there is a worsening of the eurozone debt crisis, and there are signs of this with yields beginning to increase again starting June 2013, it could result in a rise in global investor risk aversion that would have an impact on ASEAN economies. And with ASEAN more integrated today than it has ever been, the risk of contagion spreading rapidly across the region and beyond is also higher than ever before. Estimates from a GVAR model suggest that while the overall impact of a worsening in the eurozone crisis is likely to be quite limited, the larger impact would be on equity markets in the region. There is also the possibility that such spillovers, while relatively small in the aggregate, could lead to a second round of adjustments involving re-evaluation of other asset prices. In other words, even a muted direct impact could result in a magnified overall impact through indirect means, involving adjustments to asset prices viewed to be at inflated levels. In light of this, there is a pressing need to ensure that crisis management frameworks are strengthened and ready for use. Despite significant progress over a relatively short period of time, East Asia’s regional financial safety net still appears unusable. Further reforms are necessary in order to make the CMIM workable should a crisis hit the region, especially if resources are scarce in the event of a global meltdown. With the IMF’s resources already stretched in bailing out Europe, a further shock there would leave a lot less available for countries in Asia should contagion hit.

References Asian Development Bank. Asian Economic Integration Monitor. Manila: Asian Development Bank, 2013. Azis, I. “Regional Financial Arrangement”. In Crisis, Complexity and Conflict, edited by I. Azis. London: Emerald, 2009. ———. “Asian Regional Financial Safety Nets? Don’t Hold Your Breath”. Public Policy Review 8, no. 3 (2012): 357–76. Chen, Q., D.F. Gray, P. N’Diaye, H. Oura, and N.T. Tamirisa. “International Transmission of Bank and Corporate Distress”. IMF Working Paper, No. 124. Washington DC: International Monetary Fund, 2010.

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Das, S., J. Menon, R. Severino, and O. Shrestha. The ASEAN Economic Community: A Work in Progress. Singapore: Asian Development Bank and Institute of Southeast Asian Studies, 2013. Dees, S., F. di Mauro, M.H. Pesaran, and L.V. Smith. “Exploring the International Linkages in the Euro Area: A Global VAR Analysis”. Journal of Applied Econometrics 22, no. 1 (2007): 1–38. Galessi, A. and S. Sgherri. “Regional Financial Spillovers across Europe: A Global VAR Analysis”. IMF Working Paper No. 23. Washington DC: International Monetary Fund, 2009. Hill, H. and J. Menon. “ASEAN Economic Integration: Driven by Markets, Bureaucrats, or Both?” In Handbook of International Commercial Policy, edited by Mordechai E. Kreinin and Michael Plummer. Oxford: Oxford University Press, 2012a. ———. “Financial Safety Nets in Asia: Genesis, Evolution, Adequacy, and Way Forward”. ADBI Working Paper No. 395. Tokyo: Asian Development Bank Institute, 2012b. Menon J. and T.H. Ng. “Impact of Eurozone Financial Shocks on Southeast Asian Economies”. Journal of Southeast Asian Economies, forthcoming. Menon, J. and A. Chongvilaivan. “Southeast Asia beyond the Global Financial Crisis: Managing Capital Flows”. ASEAN Economic Bulletin 28, no. 2 (2011): 107–14. Milesi-Ferretti, G.M. and C. Tille. “The Great Retrenchment: International Capital Flows during the Global Financial Crisis”. Graduate Institute of International and Development Studies Working Paper No. 18, Geneva: Graduate Institute of International and Development Studies, 2010. Ng, T.H. “Is Capital being Pushed or Pulled into Southeast Asia?” ASEAN Economic Bulletin 28, no. 2 (2011): 203–20. Pesaran, M.H., T. Schuermann, and S.M. Weiner. “Modeling Regional Interdependencies Using a Global Error-Correcting Macroeconometric Model”. Journal of Business and Economic Statistics 22, no. 2 (2004): 129–62. Smith, L.V. and A. Galessi. “GVAR Toolbox 1.1”, 2011 (accessed 22 August 2013).

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2 FRAGILE BALANCE OF PAYMENT IN INDONESIA UNDER GLOBAL ECONOMIC UNCERTAINTIES Reza Y. Siregar and Maria Monica Wihardja

1. INTRODUCTION Amid the global financial turbulence, the economy of Indonesia posted an annual average growth of above 6 per cent between 2008 and 2012, except in 2009. This was arguably among the most stable growth performance among the regional economies of East and Southeast Asia. The strength of domestic demand has indeed been a primary driver of the stable growth performance. In contrast to the major ASEAN (Association of Southeast Asian Nations) economies, exports of Indonesia amounted to less than 25 per cent of its GDP, compared to Malaysia at more than 80 per cent and Thailand at more than 60 per cent in recent years. Private consumption contributed between 44 and 49 per cent of the quarterly year-on-year GDP growth in 2012 (see Figure 2.1). Indonesia has also seen investment pick up in recent years, and the country’s resilient growth in 2008–12 can also be attributed to high commodity prices and capital inflow surges.

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23

Source: National Bureau of Statistics.

FIGURE 2.1 Domestic Demand-driven Economy

Fragile Balance of Payments in Indonesia

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Reza Y. Siregar and Maria Monica Wihardja

Despite the large domestic demand base, the uncertainties with the advanced economies, particularly the United States and the European Union, had negatively affected and exposed a number of apparent weaknesses with the Indonesian economy. A couple of these vulnerabilities are worth highlighting as they are arguably structural in nature. First is the country’s banking sector’s exposure to cross-border bank-lending activities. Like the rest of the ASEAN economies, the banking sector assumes a vital role in overall financing activity in the local economy. Among the major ASEAN economies, Indonesia arguably adopts the most open banking sector regulation. Majority foreign ownership, as high as 100 per cent, has long been adopted following the 1997 East Asian crisis. Furthermore, foreign banks are allowed to enter the local industry both as a branch or a subsidiary. The high interconnectedness of the local banking sector to the global banks exposed the local economy to increasingly volatile cross-border bank-lending flows as evident during the deleveraging of the European banks in 2011. The second is current account weaknesses. The persistent current account deficits in recent years have raised concerns over macroeconomic stability, causing depreciation pressures on the local currency. The root cause of the current account deficit has been attributed to costly long-standing energy subsidies and the heavy reliance on commodity exports. On the back of weak external demand, especially from the advanced economies, and volatile commodity prices, especially oil prices, subsidy measures have not only amplified fiscal burden, but also contributed to the recent robust import and weakening trade balance. With the above issues as the central themes, the overview of this chapter is as follows: The next section will introduce key challenges facing the management of balance of payments for the country during the turbulent period of 2008 and 2012. Section 3 reviews issues surrounding the persistent current account deficit reported in recent years. In particular, the focus will be on highlighting the root causes of the deficit and the possible links to the counry’s overall fiscal management. Section 4 tables a number of issues facing the globally and regionally integrated banking sector in Indonesia during recent years. A brief concluding remarks section, focusing on the economic outlook for the country and major policy issues, completes the chapter.

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Fragile Balance of Payments in Indonesia

25

2. NAVIGATING THE TURBULENCE: BALANCE OF PAYMENT PERFORMANCE As in many parts of East and Southeast Asia, the balance of payment position of Indonesia improved significantly following the Lehman Brothers collapse in late 2008 (see Figure 2.2). Moreover, the balance of payment performance until the end of 2012 had been the story of two opposite forces of strong capital and financial account coupled with a weak current account position. Strong economic growth, a stable macroeconomic environment, and high yields in the country attracted abundant global liquidity on the back of quantitative easing measures by major advanced economies. Capital and financial account surplus was in persistent surplus from the third quarter of 2009 to the second quarter of 2011. These quarterly surpluses coincided with the significant amount of liquidity injection to the global economies via quantitative measures by the US Fed, Bank of England and Bank of Japan (see Table 2.1 and Table A.1 in the appendix). The return of high uncertainties in the eurozone area at the beginning of 2012 triggered another round of capital and financial account surplus until the end of 2012. In a sharp contrast, we have seen a relatively weak current account position with mild surpluses in 2010 turned into deficits since the third quarter of 2011. At the end of the first quarter of 2013, Indonesia experienced the first capital and financial account deficit since the third quarter of 2011, and the largest balance of payment deficit in the past decade (see Table 2.2).

2.1 Capital and Financial Account The dynamics of foreign direct investment (FDI) and other investment have dominated the performance of capital and the financial account of Indonesia in recent years. FDI has become a key driver of the economic growth and balance of payment position of the country. The primary and secondary sectors have recorded annual surges of investment since 2009 (see Table 2.3). In the primary sector, the food crops and plantation and mining industries received the largest increases in FDI in 2011 and 2012. For the secondary sector, a wider range of industries have been targeted by foreign investors, from food to chemicals and machinery. FDI contributed more than 70 per

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26

Source: CEIC database.

FIGURE 2.2 Balance of Payments

Reza Y. Siregar and Maria Monica Wihardja

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27

Fragile Balance of Payments in Indonesia TABLE 2.1 Consolidated QE Amounts for Selected Periods (US$ billion)

US$ bn U.S. Fed (changes in securities held)

Pre-QE: Mar ’09 Nov ’09 Nov ’10 Jul ’11 Sep ’12 Sep ’08 to to to to to to Oct ’09(a) Oct ’10(b) Jun ’11(c) Aug ’12(d) Apr ’13(e) Feb ’09 102.1

1,108.5

354.1

604.1

–72.4

474.1

0.0

274.4

25.1

–0.5

235.1

42.7

0.0

0.0

255.7

203.2

284.2

162.1

102.1

1,382.9

634.8

806.7

446.9

678.9

BOE (changes in Gilts)

BOJ (changes in JGBs & Others) Total

Notes: (a) Period refers to US Fed QE1 and start of BOE Asset Purchase Facility. (b) October 2010 is the start of BOJ’s Asset Purchase Program. (c) Period refers to US Fed QE2. (d) Re-launch of the BOE Asset Purchase Facility. (e) Period refers to US Fed QE3. QE3 is still continuing; however, the period is up to April 2013 only due to data availability. Source: US Fed, BOE and BOJ.

TABLE 2.2 Worsening Balance of Payments Position US$ bn CA  Goods  Services  Income  Transfer Capital Financial  FDI  Portfolio  Other BoP

2013 1Q

4Q

3Q

2012

2Q

1Q

4Q

3Q

2011

2Q

1Q

–5.27 –7.65 –5.33 –7.99 –3.11 –2.30 0.77 0.27 2.95 1.64 0.80 3.19 0.82 3.81 6.60 9.70 9.22 9.26 –2.31 –3.32 –2.48 –2.91 –2.07 –3.11 –2.56 –3.13 –1.82 –5.69 –6.34 –6.91 –6.80 –5.90 –6.96 –7.42 –6.78 –5.52 1.10 1.21 0.86 0.90 1.06 1.18 1.05 0.96 1.03 0.00 0.02 0.01 0.00 0.01 0.02 0.01 0.00 0.00 –1.37 11.83 5.88 5.10 2.10 0.19 –3.11 11.62 4.83 3.39 4.45 4.54 3.76 1.56 3.12 2.12 2.51 3.78 2.91 0.18 2.52 3.87 2.63 0.24 –4.57 5.21 2.92 –7.67 7.20 –1.18 –2.54 –2.09 –3.17 –0.66 3.90 –1.87 –6.61

3.23

0.83 –2.81 –1.03 –3.73 –3.96

11.88

7.67

Source: CEIC database.

02 GlobalEco_Uncertainties.indd 27

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02 GlobalEco_Uncertainties.indd 28

137 383.1%

83.6%

28

1,466 371 253.5%

16

105

798

258 456.5%

18.3%

6,780 101.9% 1,098 7.0% 498 221.9% 250 73.3%

46

5

Growth (yoy)

4,870 60.1% 1,236 64.6% 2 –55.3% 14 –64.0% 10 –44.4% 3,608 61.8%

Value

51

3,357 1,026 155 144

Secondary Sector Food Industry Textile Industry Leather Goods &   Footwear Industry Wood Industry Paper and Printing  Industry Chemical and   Pharmaceutical Industry Rubber and Plastic  Industry Non Metallic Mineral  Industry

12

18

Rank

2011

43

3,042 751 5 39 18 2,229

Value

2010

Primary Food crops & plantation Livestock Forestry Fishery Mining

US$ million

15

17 10

12

16

Rank

49.6%

660

2,770

6.2%

77.9%

88.9%

1,307 406.0%

76

11,770 73.6% 1,783 62.4% 473 –5.1% 159 –36.4%

0.6

2.7

11.3

5.3

0.3

47.9 7.3 1.9 0.6

24.2 6.5 0.1 0.1 0.1 17.3

Growth Share (yoy)

5,933 21.8% 1,602 29.6% 20 843.9% 27 89.7% 29 189.9% 4,255 17.9%

Value

2012

TABLE 2.3 Steady Surge of Investment across Sectors

13

19

16

11

17

Rank

30 –28.2%

122 –44.0%

1,228 228.5%

579 509.0%

1 –91.1%

4,552 96.8% 405 5.4% 234 44.7% 25 –63.3%

0.4

1.7

17.4

8.2

0.0

64.6 5.8 3.3 0.4

24.0 4.5 0.0 0.0 0.0 19.5

Growth Share (yoy)

1,695 4.7% 314 –39.% 2 –87.6% 1 737.9% 1 –78.3% 1,376 27.1%

Value

Q1 2013

12

15

6 8

11

17

Rank

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02 GlobalEco_Uncertainties.indd 29

266 –74.7% 485 –15.5%

14

1,050 574 16,215

Total

Source: CEIC database and Board of Investment of Indonesia database.

20.1%

3,866 –23.4%

11

5,046

19,475

1,865 30.5% 283 –54.4% 821 4.6% 240 –23.0%

13 19 17

7,825 –20.3%

1,428 620 785 312

9,815

770 95.6% 65 146.2%

394 26

1,773 200.8% 42 2892.9%

10

1

590

Tertiary Sector Electricity, Gas & Water  Supply Construction Trade and Repair Hotel and Restaurant Transport, Storage &  Communication Real Estate, Ind. Estate &   Business Activities Other Services

Metal, Machinery &   Electronics Industry Medical Preci & Optical   Instru. Watches & Clock  Industry Motor Vehicles & Other   Transport Equip. Industry Other Industry

1

11

13 1 18

19

14 38.3%

–18.8% –15.2% –41.1% 219.5%

24,565

402 646

26.1%

51.2% 33.2%

2,808 –27.4%

1,515 240 484 768

6,862 –12.3%

1,840 138.9% 100 55.3%

3 –91.9%

2,453

100%

1.6 2.6

11.4

6.2 1.0 2.0 3.1

27.9

7.5 0.4

0.0

10.0

12

10

18

15

14

7,048

23.1%

117 61.8% 137 –66.9%

52 –93.2%

218 30.4% 31 72.7% 216 36.9% 31 –84.6%

801 –55.4%

866 93.0% 18 105.6%

0

1,042 108.3%

100%

1.7 1.9

0.7

3.1 0.4 3.1 0.4

11.4

12.3 0.3

0.0

14.8

19

10

14

13

Fragile Balance of Payments in Indonesia

29

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30

Reza Y. Siregar and Maria Monica Wihardja

cent of total investment in recent years. In 2010 the quarterly average of net direct investment to the country was more than triple the number in 2009, and the rising trend continued in 2011 and 2012. Accordingly, gross fixed capital formation (proxy of investment) — reaching well above 30 per cent of GDP since 2009 — has finally reached the level it held prior to the 1997 East Asian economic crisis. In recent years it has been among the highest in Southeast Asia. In contrast, portfolio and other investments have been sources of volatility and weakness for the financial account position. While volatility has long been associated with portfolio capital, the recent intermittent sharp surges and pull-outs of investment have increasingly been sources of policy concern. Other investments consist predominantly of international bank lending. The substantial sharp pull-out of other investments was the primary source of financial and capital account deficit in the first quarter of 2013. Understanding some of the root causes of the fluctuations, in particular outflows, of international bank lending will be the primary objective of Section 4. It is sufficient to note that Indonesia, amid the massive capital inflows in recent years, has seen a significant rise in gross external debt from about US$141 billion at the end of 2007 to more than US$251 billion by the end of 2012 (Table 2.4). A marked increase in the level of short-term external debts has largely been attributed to banks and non-bank financial institutions (corporates) issuing bonds to generate funding amid the low cost of funding.

2.2 Sustained Current Account Deficits As reported in Table 2.2, deficits accumulated in both service and income accounts contributed to the current account performance of Indonesia. Given the dependency of the economy on external service sectors, such as freight transportation services, the deficit in the service account is to be expected, and has in fact been largely stable over the last few years. Similarly, the large participation of foreign firms and FDI in the local economy has for years led to negative income of the current account balance. Looking at the trend of the income balance, the deficit has largely been steadily fluctuating within the range of US$5.5 billion to US$7 billion over the past two to three years. Observing closer the breakdowns of the current account balance, the deterioration in recent quarters can arguably be attributed to the worsening performance of the goods trade account. From 2009 to 2011 the goods

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31

Fragile Balance of Payments in Indonesia TABLE 2.4 Gross External Debt End-Period (US$ billion) Gross external debt (by sectors) • General government and Monetary Authorities • Banks • Non-bank Institutions Gross external debt (by maturity) • Long term debt Of which – General government and Monetary Authorities – Banks – Non-bank Institutions • Short term debt Of which – General government and Monetary Authorities – Banks – Non-bank Institutions Short term debt/international reserves ratio (%) Short term debt/GDP ratio (%) Short term debt/long term debt ratio (%)

Q4

141.2

2007

% share

Q4

2012

% share

100.0

251.2

100.0

80.6 9.9 50.6 141.2 122.5

57.1 7.0 35.9 100.0 86.8

126.1 22.9 102.1 251.2 206.4

50.2 9.1 40.7 100.0 82.2

77.6 2.6 42.3 18.7

55.0 1.8 30.0 13.2

118.7 6.2 81.5 44.8

47.3 2.5 32.5 17.8

3.0 7.4 8.3

2.1 5.2 5.9

7.4 16.7 20.6

3.0 6.7 8.2

32.7 3.6 14.2

— — —

39.7 5.1 21.7

— — —

Source: Authors’ compilation.

account recorded steady surpluses of around US$30.9 billion in 2009, US$30.6 billion in 2010, and US$34.8 billion in 2011. These healthy trade surpluses kept the overall current account payment positive until the end of 2011. However, in 2012 the net surplus dropped to only US$8.6 billion, with a mere 0.8 billion trade surplus reported in the final quarter of 2012. The next section will look into the primary causes for the deterioration of the goods trade in recent years.

3. STRUCTURAL TRADE BALANCE DEFICIT 3.1 Investment and Commodity Price Factors Strong growth, the sound fiscal position and a healthy financial market led to a sequence of credit and investment rating upgrades by major

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Reza Y. Siregar and Maria Monica Wihardja

rating agencies in 2011 and 2012.1 Robust domestic consumption and an investment surge, especially FDI, have in turn boosted strong import demand in the country since late 2011. Non–oil and gas imports continued to expand robustly on an annual basis, with average monthly year-onyear growth rates of 27 per cent in 2011 and 17 per cent during the first six months of 2012 (see Figure 2.3). Concurrently, weak global demand for the country’s export products has been felt since late 2011. As such, a combination of weak exports and relatively robust import demand raised concerns over the possibility of the country facing a more sustained and structural trade deficit. In addition to strong investment, another root cause of the worsening trade balance lies with the dependency on commodity goods, particularly oil and gas products. Imports of oil and gas made up around 22 per cent of total imports in 2011 and 2012. Similarly, exports of oil and gas contributed to around 20 per cent of total exports for the same years. As also reported elsewhere in the region, commodity exports of Indonesia have performed worse than non-commodity exports in 2012 (see Figures 2.4 and 2.5). Furthermore, oil and gas exports and imports have been volatile, reflecting the swings in the commodity prices in the world market. Cooling demand amid economic growth slowdowns in major global commodity markets, particularly China, has, to a large extent, depressed prices of major commodities. In turn, the fall in commodity prices and the slowdown in global demand for commodities contributed to the fall in Indonesia’s exports since the second half of 2012, of which coal, copper and palm oil make up a large portion. China has also recently announced a restriction on low-quality coal, which accounts for about one third of Indonesia’s coal exports to that country. Although this restriction has not yet been implemented, China’s policy towards more environmentally friendly energy use may pose a threat to Indonesia’s coal exports. Structural changes in the supply of energy fuels, in particular the recent development of shale gas, may have a persistent negative impact on Indonesia’s exports of natural gas and coal.

3.2 Subsidy Policy Distortion to Trade Performance In addition to the strong investment surge and the external challenges discussed above, one of the key and long-standing contributors to robust imports of oil and gas has arguably been the subsidy policy of

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02 GlobalEco_Uncertainties.indd 33

2002

2003

2004

Net Exports of non oil and gas sector

2001

Source: Naonal Bureau of Stascs

Source: National Bureau of Statistics.

45.0 40.0 35.0 30.0 25.0 20.0 15.0 10.0 5.0 0.0 -5.0 -10.0

USD billion

2005

2007

2008

2009

Net Exports of oil and gas sector

2006

FIGURE 2.3 Trade Balances

2011

2012

Overall Trade Balance

2010

Fragile Balance of Payments in Indonesia

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02 GlobalEco_Uncertainties.indd 34

2009

Non–Oil and Gas Exports

2010

2012

Non–Oil and Gas Imports

2011

Jan MarMay Jul Sep Nov Jan MarMay Jul Sep Nov Jan MarMay Jul Sep Nov Jan MarMay Jul Sep Nov

Source: National Bureau of Statistics.

-60.0

-40.0

-20.0

0.0

20.0

40.0

60.0

FIGURE 2.4 Non–Oil and Gas Exports and Imports (% year-on-year change)

34 Reza Y. Siregar and Maria Monica Wihardja

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Jan

Source: CEIC database.

-100.0

-50.0

0.0

50.0

Jul

May 2009

Jul

May

Sep

Mar

Jan

Oil and Gas Exports

2010

Jul

May

Mar Nov

Sep

Oil and Gas Imports

2011

Jan

Mar

Jan

Nov

Nov

Sep

02 GlobalEco_Uncertainties.indd 35

100.0

150.0

FIGURE 2.5 Oil and Gas Exports and Imports (% year-on-year change)

Jul May

2012

Fragile Balance of Payments in Indonesia

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Nov

Sep

Mar

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Reza Y. Siregar and Maria Monica Wihardja

the national budget. The energy subsidy has been a key feature of the central government’s fiscal policy. In 2012 the energy subsidy accounted for over 30 per cent of total central government expenditure; it was more than 40 per cent higher than forecast due to an extra Rp76.1 billion of subsidy, predominantly fuel subsidy (see Table 2.5). Given the fiscal rule that Indonesia has adopted since the Asian financial crisis of 1997–98, in line with the Maastricht Treaty, which regulates less than three per cent of budget deficit and less than 60 per cent of public-debt-to-GDP ratio, the large spending on subsidy means that Indonesia has less for other productive spending, including social and capital spending. It has been well documented that sustained general administered price and subsidy could lead to a number of unwanted distortionary consequences. One of them has to do with the impacts of global price movement on the local demand of the relevant goods. Subsidy and administered price measures have to a large extent shielded domestic demand from the volatility of price. This feature is evident in Indonesia, as shown in Figure 2.6. The rise in the energy price in the world market has either limited or no impact on the domestic price of energy. Consequently, no demand adjustment to the price change took place. Despite the rise in the global energy price, imports of oil and gas products to Indonesia climbed. This often resulted in a further deterioration of the trade balance and a rising cost of subsidy in the country. TABLE 2.5 Subsidy Breakdowns in 2012 Revised Forecast (Rp billions)

% of Forecast Actual % of Forecast Expenditure* (Rp billions of) Expenditure*

Total Subsidies

245.1

22.9

346.4

34.3

Energy

230.4

21.5

306.5

30.4

Fuel

137.4

12.8

211.9

21.0

Electricity

193.1

18.7

194.6

19.4

Non-Energy

140.3

13.8

139.9

14.0

Source: Ministry of Finance. Note: * as % of Central Government total expenditure.

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Jul-09

May-09

Mar-09

Jan-09

Source: Index Mundi and CEIC.

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

Nov-10 Jan-11

Sep-10 Imports

Nov-11 Sep-11 Jul-11

Price (rhs)

Sep-12

Jul-12 May-12

Mar-12 Jan-12

May-11

Mar-11

May-10 Jul-10

Mar-10

Nov-09 Jan-10

Sep-09

02 GlobalEco_Uncertainties.indd 37

4.0

4.5

FIGURE 2.6 Commodity Fuel (Energy) Monthly Price Index and Gas and Oil Imports

0

50

100

150

200

250

Fragile Balance of Payments in Indonesia

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Mar-13 Jan-13

Nov-12

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Reza Y. Siregar and Maria Monica Wihardja

4. GLOBALIZED BANKING SECTOR 4.1 Brief Historical Perspectives To comprehend the openness of the banking sector in Indonesia, one needs to review its situation following the aftermath of the 1997 East Asian financial crisis. On 1 November 1997, the day after the first IMF agreement with Indonesia was signed, the government announced the liquidation of sixteen banks. The banking restructuring was one of two cornerstones of the IMF-led recovery programmes. In addition to the liquidation programme, a number of commercial banks (private and public) received recapitalized bonds, totalling about US$435 billion (Siregar 2005). These banks included four state banks and seven major private banks. Following the restructuring of their balance sheets, most of these recapitalized private banks were eventually taken over by foreign investors. In addition to the vast potential market, with a high share of the population still having limited access to banking services, the friendly foreign ownership policy allowing majority ownership to a single foreign investor became the major pull-factor behind the massive takeovers. Presently, the Indonesian system is arguably the most open banking sector among the Southeast Asian economies. Major private commercial banks are predominantly controlled by global and regional investors, as shown in Table 2.6. Based on a survey conducted by Siregar and Lim (2010), a number of these rescued commercial banks have established themselves among the largest and most influential banks in Indonesia. The alleged advantages of opening the local financial markets to the foreign banks are well-documented. Under the presence of foreign banks, emerging markets have benefitted from efficiency gains manifested in greater variety in financial services and lower prices; transfer and spillover of knowledge and technical know-how; and greater availability of funding, especially to credit-constrained firms and households. Foreign bank lending has also been found to be more stable during the past economic and financial crises originating from the emerging markets. The balance sheets of the Indonesian banks amid the global financial turbulence, particularly the capital adequacy position, non-performing loan level and profitability, continued to be sound and among the best in the region (see Figures 2.7–2.9).

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39

Fragile Balance of Payments in Indonesia TABLE 2.6 Foreign Ownership in Domestic Banks Foreign Share

Total Assets*

Bank

Foreign Owner

(%)

Rp Trillion

(%)

CIMB Niaga

CIMB Group Sdn Bhd, Malaysia

77.0

100.7

4.29

Danamon

Temasek Holdings, Singapore

67.9

98.0

4.17

Panin

ANZ Bank, Australia

35.0

72.2

3.07

Permata

Standard Chartered Bank, UK

44.5

56.8

2.42

Bll

Maybank, Malaysia

54.3

54.5

2.32

Buana

UOB, Singapore

91.0

22.4

0.95

Ekonomi Raharja

HSBC, Hong Kong

99.0

21.2

0.90

BTPN

Texas Pacific, USA

71.6

19.3

0.82

ANK

Commonwealth Bank of Australia

83.0

10.9

0.46

Bumiputera

Che Abdul Daim, Malaysia

58.3

6.5

0.28

Mustika Dharma

RHB Capital Berhad, Malaysia

80.0

5.3

0.23

Nusantara

Tokyo Mitsubishi, Japan

75.4

4.0

0.17

Halim International

ICBC, China

90.0

3.5

0.15

Swadesi

Bank of India

76.0

1.5

0.06

Indomonex

Bank of India

76.0

n/a

n/a

476.8

20.31

Total *Based on 2009 audited reports. “n/a” = not available. Source: Indonesia Stock Exchange and Wie and Negara (2010).

4.2 Headwinds and Recent Debates The sudden interruption to this spectacular rise in international bank lending during the 2007/8 global financial crisis serves as a stark reminder that international bank lending can rapidly transmit adverse shocks from developed markets to emerging markets. Total international bank claims to Indonesia reached over US$92 billion by the third quarter of 2012, more

02 GlobalEco_Uncertainties.indd 39

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02 GlobalEco_Uncertainties.indd 40

Source: IMF database.

0.0

5.0

10.0

15.0

20.0

Indonesia 2008

Malaysia 2009

2010

Philippines

2011

Singapore

FIGURE 2.7 Regulatory Tier 1 Capital to Risk-Weighted Assets

Thailand

40 Reza Y. Siregar and Maria Monica Wihardja

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02 GlobalEco_Uncertainties.indd 41

Source: IMF database.

0.0

1.0

2.0

3.0

4.0

5.0

6.0

Indonesia 2008

Malaysia 2009

2010

Philippines

2011

Singapore

FIGURE 2.8 Ratio of Non-performing Loans to Total Gross Loans

Thailand

Fragile Balance of Payments in Indonesia

41

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02 GlobalEco_Uncertainties.indd 42

Source: IMF database.

0.0

5.0

10.0

15.0

20.0

25.0

30.0

Indonesia 2008

Malaysia 2009

2010

Philippines

FIGURE 2.9 Return on Equity

2011

Singapore

Thailand

42 Reza Y. Siregar and Maria Monica Wihardja

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Fragile Balance of Payments in Indonesia

43

than 400 per cent of the level reported in the first quarter of 2005. Since the outbreak of the global financial crisis in 2007, total foreign bank claims contracted in the fourth quarter of 2008 and the first quarter of 2009 by about US$4.9 billion and US$750 million, respectively (see Figure 2.10). Assessing more deeply the major international bank lenders, it is clear that the global financial turbulence has affected the Indonesian banking system through the lending of major global banks from the crisis-affected advanced economies. The claims of the U.S. and eurozone banks were in declining trends from the first half of 2011 and showed mild rebounds in the third quarter of 2012 (see Figure 2.11). Consolidation of the bank balance sheets, particularly among the eurozone banks, resulted in deleveraging from their exposures to Indonesia in two periods. The first of these, from the first quarter of 2008 to the second quarter of 2010, resulted in pull-outs of more than US$5 billion. The second round of deleveraging, taking place between the first quarter of 2011 and the second quarter of 2012, resulted in lending cut by more than US$7.5 billion. In contrast, Japanese and UK banks expanded their lending without marked interruptions. Beyond just the numbers, there are several fundamental challenges highlighted by the withdrawals of claims by the international banks to Indonesia. First is the degree of exposure highlighted by the share of cross-border lending vis-à-vis local lending by these banks to Indonesia. Second is the allocation of these claims in Indonesia, particularly on the sovereign bond markets. These issues will be elaborated here.

4.2.1 Cross-border Lending What has been learnt from the experience of the sudden reversals of international bank lending? Recent studies such as Pontines and Siregar (2013), Kamil and Rai (2010), and de Haas and van Lelyveld (2010) demonstrate that cross-border operations of international banks are more prone to a “sudden stop” and sharp reversal during economic downturns in source economies. By definition, the total claims of international banks can be broken down into (1) lending by the local branch or subsidiary of the foreign bank, often refered to as local lending; and (2) cross-border lending — lending from the headquarters, branch or subsidiary of the bank located in another country. As shown in Figure 2.12, around 50 per cent of the total international bank claims to Indonesia came in the form of crossborder lending. The high shares of cross-border claims of the eurozone

02 GlobalEco_Uncertainties.indd 43

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Source: BIS database.

-

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

100,000

FIGURE 2.10 Total International Bank Claims to Indonesia (in millions of US$)

2005-Q1 2005-Q2 2005-Q3 2005-Q4 2006-Q1 2006-Q2 2006-Q3 2006-Q4 2007-Q1 2007-Q2 2007-Q3 2007-Q4 2008-Q1 2008-Q2 2008-Q3 2008-Q4 2009-Q1 2009-Q2 2009-Q3 2009-Q4 2010-Q1 2010-Q2 2010-Q3 2010-Q4 2011-Q1 2011-Q2 2011-Q3 2011-Q4 2012-Q1 2012-Q2 2012-Q3

44

Reza Y. Siregar and Maria Monica Wihardja

02 GlobalEco_Uncertainties.indd 45

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Source: BIS database.

-

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

20,000

Eurozone USA UK

FIGURE 2.11 Total International Bank Claims across Major Lenders

Japan

2005-Q1 2005-Q2 2005-Q3 2005-Q4 2006-Q1 2006-Q2 2006-Q3 2006-Q4 2007-Q1 2007-Q2 2007-Q3 2007-Q4 2008-Q1 2008-Q2 2008-Q3 2008-Q4 2009-Q1 2009-Q2 2009-Q3 2009-Q4 2010-Q1 2010-Q2 2010-Q3 2010-Q4 2011-Q1 2011-Q2 2011-Q3 2011-Q4 2012-Q1 2012-Q2 2012-Q3

45

Fragile Balance of Payments in Indonesia

02 GlobalEco_Uncertainties.indd 46

%

MY

HK

TH

34

66

SG

33

67

JP

44

56

KR

48

52

BN

45

55

ID

52

48

VN

53

47

Local claims of foreign affiliates in foreign currency (% share)

26

74

22

78

CN

48

52

PH

60

40

MM

98

2

LA

100

0

Cross border claims (% share)

KH

48

52

Note: HK: Hong Kong; MY: Malaysia; TH: Thailand; SG: Singapore; JP: Japan; KR: Korea; BN: Brunei; ID: Indonesia; VN: Vietnam; KH: Cambodia; CN: China; PH: Philippines; MM: Malaysia; LA: Laos.

0

10

20

30

40

50

60

70

80

90

100

FIGURE 2.12 Shares of Cross-border Claims in Total Foreign Claims (as of first quarter of 2011)

46 Reza Y. Siregar and Maria Monica Wihardja

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47

Fragile Balance of Payments in Indonesia

banks in major Asian economies, including Indonesia, have partly explained the relatively marked declines in the total claims of the eurozone banks in the region. Compared to major Latin American economies, claims of the eurozone banks in Indonesia have predominantly been in the form of cross-border claims (see Table 2.7).

4.2.2 Participation in the Bond Market The significance and potential impacts of foreign banks’ activities are not only to be measured by the size of their claims, but also the allocations of their funding. More than 20 per cent of total claims of international banks to East and Southeast Asian economies were invested in sovereign bonds. Similarly, banks in Indonesia have played a major role in foreign investors’ participation in the domestic bond markets, especially sovereign bonds. Considered to be a relatively safer asset, especially following the collapse of the Lehman Brothers, with one of the highest yields in the region and the globe, local currency denominated sovereign bonds issued by the central banks (Bank Indonesia Certificate) and by the government of Indonesia (IDR Bond) had attracted foreign investors during the past few years (Figure 2.13). Following the collapse of Lehman Brothers, the foreign investors’ holdings of Bank Indonesia certificates plunged from TABLE 2.7 Share of Cross-Border Lending of the Eurozone Bank Lending Total Foreign Claims* (in US$ bn) (a)

Cross-Border Claims* (in US$ bn) (b)

Ratio (b/a) in %

1. China 2. Indonesia 3.  Korea

191 114 168

191 114 168

191 114 168

1. Argentina 2. Brazil 3.  Mexico

124 285 179

124 285 179

124 285 179

ASEAN+3

Latin America

*Data as of the second quarter of 2011. Source: BIS database.

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02 GlobalEco_Uncertainties.indd 48

Source: Bank Danamon International, Bank Indonesia and Ministry of Finance, Indonesia.

FIGURE 2.13 Holdings of Sovereign Bond and Bank Indonesia Certificate by Foreign Investors

48 Reza Y. Siregar and Maria Monica Wihardja

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49

Fragile Balance of Payments in Indonesia

Rp54.7 trillion (slightly over US$6 billion) in July 2008 to a mere Rp6.5 trillion (or slightly over US$720 million) in November 2008. Participation rebounded and peaked at Rp87.1 trillion in April 2011. Experiences of the emerging markets, including those in Asia, after the collapse of Lehman Brothers in September 2008, demonstrated that sudden withdrawals by foreign investors from the bond markets could introduce greater bond yield volatility, and in turn complicate open-market operation. These have been the experiences of Indonesia in recent years. To reduce short-term volatility, Bank Indonesia introduced a one-month holding period for certificates purchased in primary and secondary markets in June 2010. Prior to that the central bank has made a concerted effort to shift the maturity structure from one month to a longer-term. The policy has largely been effective in moderating foreign investor participation in its Central Bank Certificates (SBI). By January 2012, the amount of foreign investors holding SBIs was less than 9 per cent of its peak in April 2011. The holding of government bonds by the foreign investors, including banks, however, continued to expand until early 2013. In recent months, particularly since the early second quarter of 2013, bond markets (corporate and sovereign) in Indonesia and the region in general have seen massive sell-outs, largely driven by the anticipation of tapering of quantitative easing measures in the United States. While the rise in foreign demand for government bonds sustained the low cost of financing, as shown in the yield curve of the five-year government bond, the recent sell-outs by foreign investors have raised the yield curve (see Table 2.8). The wide swings TABLE 2.8 5-Year Local Government Bond Yield Curves of Major ASEAN Economies (January 2007–June 2013)

Korea

Singapore Thailand

Malaysia

Indonesia

Level as of midJune 2013

Maximum

Minimum

3.1

15.8

2.5

1.6

13.9

0.8

3.3

17.2

2.6

3.8

15.8

2.7

7.4

10.4

4.4

Source: Nomura (2013) and Bloomberg.

02 GlobalEco_Uncertainties.indd 49

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Reza Y. Siregar and Maria Monica Wihardja

of the sovereign bond yields certainly would complicate and escalate the financing cost of budget deficits. This, in turn, could potentially undermine the level of fiscal space in the country.

5. CONCLUDING REMARKS ON OUTLOOK AND POLICY CHALLENGES Balancing the need to improve fiscal management and the current account position, while at the same time maintaining steady economic growth, will be more challenging in the near future for Indonesian policymakers. Concerns have arisen over Indonesia’s weak external position, with the country posting a staggering US$6.6 billion deficit in its balance of payments in the first quarter of 2013. The deficit was mainly attributed to the weak performance of the country’s current account, with a deficit of US$5.27 billion, or 2.4 per cent of GDP. Continuing pressure on the “bleeding” fiscal budget from fuel subsidies, threats of inflation, and the widening current account deficit led to the outlook revision by S&P from BB+ positive to BB+ stable in May 2013. Pressure on the rupiah from the declining balance of payments led to intervention by Bank Indonesia. As a result, the international reserve declined from the record US$125 billion high in 2011 to less than US$100 billion by July 2013. This was exacerbated by portfolio outflows due to the news of the Fed increasing the interest rate and potentially winding down the quantitative easing measures (QE3). To reduce subsidy pressure on the budget, the government made a revision to the 2013 national budget. The key features of the revised budget, approved by the parliament on 17 June 2013, were a revision of projected spending on fuel subsidies and a package of compensation measures designed to reduce the impact of higher fuel prices on the poor (including direct cash transfer, rice for the poor, and children’s scholarship). The rise in subsidized fuel prices was made effective on 22 June, with the subsidized petrol price rising by 44 per cent to Rp6500 per litre and the subsidized diesel price increasing by 22 per cent to Rp5500 per litre. The 2013 deficit has been revised upwards by 0.7 percentage points to 2.4 per cent of GDP, due to lower projected nominal revenues, in line with weaker anticipated GDP growth and higher total expenditure (including on fuel subsidies, despite the increase in subsidized prices, due to higher projected global oil prices). The move to phase fuel subsidies is also wise considering that the Statistical Review of World Energy 2013 showed that Indonesia may run

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out of oil by 2024, holding constant the figures for production and proven reserves (Siahaan 2013). On the back of rising fuel prices, its widespread impacts on headline inflation, and the weak rupiah stemming from market concerns over current account deficits, Bank Indonesia increased its policy rate (the BI rate) by 25 basis points in June and another 50 basis points in July. These rate adjustments had to be taken amid soaring inflationary pressures from the fuel price increase. In addition, Bank Indonesia adjusted its growth target range between 5.8 to 6.2 per cent, lower than the government’s 6.3 per cent target. On the financial market front, especially the banking sector, the challenges facing financial sector supervisors became more complex globally, including those in the emerging markets of East and Southeast Asia, such as Indonesia. The banking sectors are not only deeply interconnected regionally, but also globally. As elaborated, the local and regional banks have not only borrowed heavily from, but have also extended loans to, the global banking system. The traditional global banks, such as HSBC and Standard Chartered, have increasingly become regional banks. At the same time, many of the ASEAN banks, such as DBS, OCBC, UOB, MayBank and the CIMB, have become regional and global banks. Accordingly, the need to integrate financial market supervisory agencies is no longer a domestic issue (Lim and Siregar 2010). Given the cross-border nature of the operations of these banks, regular supervision of their domestic activities will not be sufficient to assess the overall risk exposures. These are a number of lessons from the recent global financial crisis that underscore the importance of establishing closer coordination among banking supervisors across borders.

Note 1.

Moody’s upgraded Indonesia’s rating to Baa3 in January 2012, with a stable outlook, from a Ba1 upgrade in January 2011. Fitch Ratings also upgraded Indonesia’s rating in February 2011 to BBB– with a stable outlook, from BB+ and a positive outlook. In April 2012, Standard & Poor’s affirmed its rating of BB+ and a positive outlook for the Indonesian economy. In October 2012, Rating and Investment Information Inc. (R&I) upgraded Indonesia’s sovereign credit rating to BBB– with a stable outlook on the grounds that Indonesia had achieved high growth amid the global economic downturn, fiscal management was conservative, the government’s debt burden was relatively low and the

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Reza Y. Siregar and Maria Monica Wihardja financial system had become more stable. Most recently, in November 2012, Japan Credit Rating Agency Ltd. (JCR) affirmed for the second time Indonesia’s sovereign rating of BBB– with a stable outlook, having already upgraded the rating from BB+ in July 2010.

References Briault, C. “The Rationale for a Single National Financial Services Regulator”. Financial Services Authority Occasional Paper, Series 2, 1999. de Haas, R. and I. van Lelyveld. “Internal Capital Markets and Lending by Multinational Bank Subsidiaries”. Journal of Financial Intermediation 19, no. 1 (2010): 1–25. International Monetary Fund (IMF). Unconventional Monetary Policies: Recent Experience and Prospects. Washington: International Monetary Fund, 2013. Kamil, H. and K. Rai. The Global Credit Crunch and Foreign Banks’ Lending to Emerging Markets: Why Did Latin America Fare Better? IMF Working Paper No. 10/102, 2010. Lim, V. and R. Siregar. “The Role of Central Banks in Sustaining Economic Recovery and in Achieving Financial Stability”. Journal of Advanced Studies in Finance 1, no. 1 (2010): 83–99. Nomura. “Asia’s Rising Risk Premium”. Global Market Research Anchor Report, June 2013. Pontines, V. and R. Siregar. “How Should We Bank with Foreigners? An Empirical of Lending Behaviour of International Banks to Six East Asian Countries”. International Review of Economics and Finance (forthcoming). Shirakawa, M. “Unconventional Monetary Policy — Central Banks: Facing the Challenges and Learning the Lessons”, Remarks at the Conference co-hosted by the People’s Bank of China and the Bank of International Settlements, Shanghai, August 2009. Siahaan, Tito Summa. “Indonesia Coal, Oil May Be Depleted in 10 Years: BP”. Jakarta Globe, 14 June 2013. Siregar, R and E.J. William. “Designing Financial Safety Net Structures in Indonesia: Selected Lessons and Challenges”. ASEAN Economic Bulletin 23, no.1 (2006): 98–113. Siregar, R. “Interest Rate Policy and Its Implication for the Banking Restructuring Programs in Indonesia during the 1997 Financial Crisis: An Empirical Investigation”. Institutional Change in Southeast Asia, edited by F. Sjoholm and J. Tongzon. London: Routledge, 2005, pp. 72–90. Taylor, M. and Fleming, A. “Integrated Financial Supervision: Lessons of Scandinavian Experience”. Finance and Development 36, no. 4 (1999).

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02 GlobalEco_Uncertainties.indd 53

2007

2001– 2006

US Fed Forerunner of central bank extraordinary measures. To combat deflation, weak growth and stabilize the financial system, the BOJ brought down interest rates to zero, introduced quantitative easing, credit easing and stock purchases. Further the BOJ also extended the maturity of funds-supplying operations, while at the same time making commitments on the duration of zero interest rate and quantitative easing.

BOJ

BOE

continued on next page

ECB provides liquidity to permit orderly functioning of the money market and announces supplementary three-month €40 billion longer-term refinancing operation (LTRO). (August)

ECB

Table A1: Quantitative Easing and Other Key Extraordinary Measures by Major Central Banks

Appendix Fragile Balance of Payments in Indonesia

53

4/10/15 8:10 AM

QE1, the Federal Reserve will purchase agency debt of Fannie Mae and Freddie Mac together with MBS guaranteed by these institutions. The Fed announces the creation of the Term Asset-Backed Securities Loan Facility (TALF) to provide liquidity to the ABS market. (25 Nov.)

QE1 (continued), the FOMC announces it will purchase longer-term Treasury securities (US$300 billion) over the next six months. (18 March)

QE2, the FOMC announces intention to purchase a further US$600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about US$75 billion per month. (3 Nov.)

2008

2009

2010

US Fed

Appendix — cont’d

Comprehensive Monetary Easing (CME), announcement of purchases of Japanese government bonds (JGBs), commercial paper, corporate bonds, exchange traded funds (ETFs) and Japanese real estate investment trusts (J-REITs). (5 Oct.)

BOJ

Asset Purchase Program 1, the MPC announces its first round of asset purchases, consisting mostly of conventional bonds with residual maturity between 5 to 25 years. (5 March)

BOE

02 GlobalEco_Uncertainties.indd 54

Securities Market Program (SMP) launched to ensure depth and liquidity in sovereign debt markets. (9 May)

Covered Bond Purchase Programme (CBPP) announced for €60 billion, one-year programme. (7 May)

ECB

54 Reza Y. Siregar and Maria Monica Wihardja

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02 GlobalEco_Uncertainties.indd 55

QE3, The FOMC will purchase US$40 billion MBS a month (Sept. 13) and longer-term Treasury securities at an initial pace of US$45 billion per month (12 Dec.)

2012

Sources: Shirakawa (2009) and IMF 2013.

2013

Operation Twist or Maturity Extension Program, the FOMC announces its intention to purchase US$400 billion of Treasury securities with remaining maturities of 6 years to 30 years and to sell an equal amount of Treasury securities with remaining maturities of 3 years or less. (21 Sept.)

2011

Quantitative and Qualitative Monetary Easing (QQME), announcement of intensified asset purchases with the goal of increasing the monetary base by JPY 60 to JPY 70 trillion annually, increasing the average maturity of JGBs held from 3 to 7 years and meeting the 2 per cent inflation target in 2 years. (4 April)

Funding for Lending Scheme (FLS), designed to increase lending to households and businesses by providing banks cheaper costs of funds. (12 July)

Asset Purchase Program 2, the MPC announces another round of purchases amid sluggish growth (6 Oct.)

Technical features of Outright Monetary Transactions (OMT) released, including strict and effective conditionality. (6 Sept.)

The ECB announced two three-year LTROs on Dec. 20, 2011 and Feb. 28, 2012, together with reduced reserve ratio and expanded collateral availability. (8 Dec.) Fragile Balance of Payments in Indonesia

55

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3 MALAYSIA IN THE MIDST OF GLOBAL ECONOMIC UNCERTAINTIES Tham Siew Yean

1. INTRODUCTION Malaysia experienced the highest growth rates during the period between the first two economic recessions (namely in 1985 and 1998), from 1986 till 1997, with an average rate of growth of 8.3 per cent. The economy, however, recovered the year following each of the aforementioned crises. The global financial crisis (GFC) in 2008 contributed to another contraction in Malaysia’s economic growth in 2009 and an equally rapid recovery the following year. Since then, Malaysia’s average growth rate has fallen to 5.4 per cent from 1999 to 2009. The country’s population has grown almost threefold from 10.8 million in 1970 to 27.8 million in 2009. Average GDP per capita has grown from RM1,932 to RM19,052 for the same period, placing Malaysia solidly in the upper-middle income group of countries. Although the economy recovered strongly in 2010, with a GDP growth of 7.2 per cent, growth dipped again to 5.1 per cent in 2011 and 2012. Nevertheless, as noted by Hill (2012), Malaysia’s growth has been the most volatile, compared with Singapore, Thailand, Korea and China.

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Since 2010, global uncertainty has continued to prevail, with recovery dependent on the continued sustainability and strength of private sector activity in the United States, while the need for structural reform and fiscal consolidation implies that recovery in the eurozone will take a longer period (Central Bank 2012). Japan’s growth also depends on the success of the aggressive quantitative easing and expansionary policies that have been undertaken since April 2013 to reinvigorate its economy and overcome the output gap and mild deflation that have plagued it since the 1990s. Concurrently, China’s slower growth will also have implications for the rest of the world. In the face of these uncertainties, it is important to examine the key policy initiatives that have been undertaken in Malaysia since 2008, to ascertain the impact of these policies on key economic indicators. Looking ahead, it is equally important to identify the macroeconomic and trade challenges facing the country, as well as the prospects of attaining the status of a high-income economy — targeted for 2020. The chapter is organized as follows: Section 2 outlines the main policy responses that have been undertaken since 2008, while Section 3 examines their impact on the economic performance of the country. The macroeconomic and trade challenges and prospects are presented in Section 4. The conclusion summarizes the key findings.

2. MALAYSIA’S POLICY RESPONSES TO GLOBAL UNCERTAINTIES Although Malaysia’s banking system has become more resilient after the Asian financial crisis (AFC) in 1998, the economy nevertheless contracted abruptly in 2008 with the sharp global contraction due to Malaysia’s strong trade links with the rest of the world. The Central Bank responded by implementing a countercyclical monetary policy (Alp et al. 2012). Since the Central Bank had been using interest rate targeting with floating exchange rates to manage price stability, the overnight policy rate (OPR)1 was reduced by a total of 150 basis points, from 3.5 per cent in November 2008 to 2 per cent in 2009, together with reductions in statutory requirements (Sukhdave 2011). Concurrently, an expansionary fiscal policy was also used to stimulate the economy. Two fiscal packages were released; the first was RM7 billion (or 1.04 per cent of GDP) in November 2008, while a second fiscal package of RM60 billion (or 9 per cent of GDP) was released in March 2009.2

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Tham Siew Yean

The Central Bank has emphasized that the exchange rate is determined by economic fundamentals and market conditions, with the reinstatement of a managed float after the removal of the peg in 2005. The non-internationalization of the ringgit is however maintained. Given Malaysia’s open economy, the Central Bank has occasionally intervened in the foreign exchange market to moderate large fluctuations in order to minimize disruptions to trade and investment, reduce misalignments and to facilitate orderly adjustments, but not to influence the underlying trend (Ooi 2008). For example, the Central Bank intervened from August 2008 to June 2009 to support the ringgit in response to the massive outflow of portfolio funds in the wake of the GFC and the declining demand for exports (IMF 2010). Likewise, foreign exchange reserves were used to manage exchange rate volatility in 2010 (IMF 2013a). In 2010 the government launched a New Economic Model (NEM) due to the slowing down of growth since the AFC. This is intended to propel the country towards the status of a high-income economy, with a targeted per capita income of US$15,000–20,000 by 2020 (NEAC 2010). The goals of the NEM — namely high income, inclusiveness, and sustainability — are to be achieved through four pillars of transformation. These are 1Malaysia, the Government Transformation Plan (GTP), the Economic Transformation Plan (ETP), and the Tenth Malaysia Plan. The first pillar seeks to preserve and enhance unity in the country, while the GTP aims to strengthen public services and facilitate a shift in the government’s role in the economy from a driver to an enabler. The ETP is a road map to increase private investment in the country (Malaysia 2010a), in line with the changing role of the government in the economy as well as its increasing fiscal constraints. The Tenth Malaysia Plan, covering the period from 2011 to 2015, is the most recent of the five-yearly development plans that map out the government’s plan for the country’s overall development (Malaysia 2010b). In line with the private-investment-led initiatives in the ETP, free trade agreements (FTAs) are negotiated to increase bilateral and regional market access as well as to increase inflows of foreign direct investment (FDI), as the stalling of the Doha Round of negotiations crushed hopes for success in gaining multilateral market access through the World Trade Organization (WTO). Since the manufacturing sector was opened in 2003, the focus of liberalization has been the services sector. Seventeen service sub-sectors were announced for liberalization in 2012 (Ministry of Finance 2013).3

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The recovery of the economy in 2010 led to an increase of the OPR to around 3 per cent in 2011 (Central Bank 2013a, see Table A.26, p. 23). According to the Central Bank, “the current stance of monetary policy is deemed to be appropriate given the outlook for inflation and growth”, and it has therefore maintained this OPR to date (Central Bank 2013b). Fiscal policy also continued to be expansionary, with increased government spending on fuel subsidies, wages, pensions, and cash transfers to targeted groups (Ministry of Finance 2013). Subsidies have and continue to be used to contain price increases in Malaysia (Thillainathan 2011). The inflationary impact of subsidy rationalization has in fact forced the government to postpone the rationalization of the petroleum subsidy since December 2010 (Ministry of Finance 2013). Similarly, the increasing cost of living has led to the introduction of several cash assistance programmes, totalling RM5 billion in the 2012 budget announcements. Expenditure and net lending grew steadily from 25.5 per cent of GDP in 2010 to 26.6 per cent of GDP in 2012 (see Table 3.1). Since revenue also grew due to higher collection from tax and non-tax revenue, the federal government’s fiscal deficit decreased from 5.4 per cent of GDP in 2010 to 4.5 per cent in 2012 (Malaysia 2013, see Table 1).

3. ECONOMIC PERFORMANCE: 2008–13 Malaysia’s economy demonstrated considerable resilience as it rebounded from the negative growth rate of –1.5 per cent in 2009 to 7.2 per cent in 2010, before dropping to 5.1 per cent in 2011 and 2012 (see Table 3.1). The projected growth rate for 2013 is around 5–6 per cent. Economic recovery was achieved in a relatively low inflation environment, while unemployment remained low at around 3 per cent in 2011 and 2012. Alp et al. (2012) found that the countercyclical monetary policy and discretionary interest rate cuts during the 2008–9 period substantially softened the impact of the GFC on the Malaysian economy. The real effective exchange rate (REER), which had been appreciating since 2005, depreciated sharply in 2009 before appreciating again in 2010 (see Figure 3.1). Since then the REER has fluctuated around a fairly horizontal trend, although the IMF’s analysis indicates that it may be undervalued relative to the level consistent with the fundamentals and desirable policies (IMF 2013b). The ringgit depreciated sharply against the U.S. dollar from the end of May 2013 to August 2013 due to large foreign outflows. This surge in capital outflows

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Tham Siew Yean TABLE 3.1 Macroeconomic Indicators of Malaysia, 2008–13 Item

est. 2012

proj. 2013

2008

2009

2010

2011

Real GDP (% change) 4.8 Saving and investment (% of GDP) Gross domestic investment 21.5 Gross national saving 38.5 Fiscal sector (% of GDP) Federal government overall balance –4.6 Revenue 20.8 Expenditure and net lending 25.4 Federal government non-oil primary –11.2  balance* Consolidated public sector overall –5.4  balance General government debt 41.2 Inflation and unemployment (period average, %) CPI inflaction 5.4 Unemployment rate 3.3

–1.5

7.2

5.1

17.8 33.4

23.1 34.2

23.6 34.6

28.0 34.0

29.4 35.3

–6.7 22.3 28.9 –13.6

–5.4 20.1 25.5 –10.6

–4.8 21.0 25.9 –10.3

–4.5 22.0 26.6 –9.6

–3.9 21.0 24.9 –8.4

–7.2

–2.5

–3.3

–5.1

–6.4

52.8

53.7

54.5

55.4

55.1

0.6 3.7

1.7 3.3

3.2 3.1

1.7 3.0

12.2 13.0

5.1 5.0–6.0**

Notes: *: Capital expenditure in the budget includes foreign fixed assets and other items, such as purchase of shares and land, which are excluded from public investment in the national accounts; est: estimated; proj: projected. Sources: IMF 2013; **: Central Bank 2013a.

from the region was attributed to the United States signalling at the end of May 2013 a tapering of its monetary stimulus programme. The cut in Fitch Ratings’ outlook on Malaysia’s sovereign debt due to worsening prospects for fiscal reforms has further aggravated the situation. In terms of the drivers of growth, recent decomposition of GDP by the Central Bank showed that domestic demand, or private and public consumption, have assumed a larger role, with their respective shares shifting from 25 per cent and 8 per cent in 2005 to 29 per cent and 9 per cent in 2012, while the role of the external sector has declined from 61 per cent to 54 per cent over the same period (see Table 3.2). The increase in private consumption was fuelled by a low unemployment rate, higher wages in the public sector, and cash transfers to the lower income groups that have a higher marginal propensity to consume.

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03 GlobalEco_Uncertainties.indd 61

2006

Source: International Monetary Fund (IMF).

98 2004

100

102

104

106

108

110

2008

2010

2012

2014

FIGURE 3.1 The Real Effective Exchange Rate, 2005–2012

REER (based on CPI)

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Tham Siew Yean TABLE 3.2 Drivers of Growth in Malaysia, 2005 and 2012

Year/Components

Exports

Private Consumption

Public Consumption

Investment

2005

61

25

8

6

2012

54

29

9

8

Notes: Decomposition based on adjustments to imports Source: Central Bank 2013a, p. 36, Chart 3

The share of investment has increased from 6 per cent to 8 per cent (see Table 3.2). Gross domestic investment started to recover from 2010 onwards, spurred by the implementation of the ETP, with high value private and public projects in oil and gas, real estate and infrastructure (see Table 3.1; Central Bank 2013b; Sivalingam 2013). This is reflected in the private investment indicators in Table 3.3, with approved capital investment increasing from 2009 to 2011, before dropping in 2012. The same table also shows greater foreign participation compared to domestic, and a greater share of new investments compared to reinvestments. In contrast, savings declined in 2012, thereby narrowing the savings investment gap in 2012 (see Table 3.1). The drop in the contribution of the external sector, or net exports, can be attributed to the weak external demand for Malaysia’s manufactured goods and commodities, as the United States, European Union and Japan struggle with economic recovery and stagnation. It should, however, be noted that Malaysia’s exports of these goods had been declining in competitiveness4 even before the onset of the GFC (Tham 2013). Imports, on the other hand, have increased steadily since 2009, due mainly to the import of capital and consumption goods (Central Bank 2013a). Capital imports and imports of consumption goods increased, respectively, at an average annual rate of 13.8 per cent and 13.4 per cent during 2010–12 due to an increase in investment activity and domestic demand, as well as an appreciation of the ringgit. The growth in the import of intermediate goods moderated in tandem with the moderating growth in the export of goods owing to the strong correlation between the two in Malaysia’s participation in the regional production networks. The trade balance fell from 2008 to 2009 and fell again from 2011 to 2012 (see Table 3.4).

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Malaysia in the Midst of Global Economic Uncertainties TABLE 3.3 Private Investment Indicators Item

Approvals by MIDA (Manufacturing sector) No. of projects Capital investment (RM billion) Local Foreign New investment (% share) Reinvestments (% share)

2007

2008

2009

2010

2011

2012

949.0 59.9 26.5 33.4 52.0 48.0

919.0 62.8 16.7 46.1 66.9 33.1

766.0 32.6 10.5 22.1 67.6 32.4

910.0 47.2 18.1 29.1 50.6 49.4

846.0 56.1 21.9 34.1 59.0 41.0

804.0 41.1 20.2 20.8 65.4 34.6

Source: Central Bank 2013.

TABLE 3.4 Balance of Payment, 2008–13 Item Balance of payments (US$ billion) Current account balance (% of GDP) Trade balance Services and income account  balance Capital and financial account  balance Errors and omissions Overall balance Gross official reserves (US$ billion) (months of following year’s imports) (% of short-term debt) Total external debt (US$ billion) (% of GDP) Of which: short-term (% of total) Debt service ratio (% of exports of goods and services) (% of exports of goods and non  factor services)

2008

2009

2010

2011

est. 2012

proj. 2013

39.4 17.1 51.6 –6.9

31.4 15.5 39.9 –3.0

27.3 11.1 41.8 –7.7

31.7 11.0 48.4 –9.8

18.1 6.0 41.1 –16.5

20.1 5.9 38.4 –10.9

–35.6

–22.8

–6.2

7.2

–3.8

–19.4

–9.4 –5.5 91.5 7.6 274.4 68.5 29.6 48.7

–4.7 3.9 96.7 6.1 250.4 68.0 33.6 56.8

–22.0 –0.8 106.5 5.9 207.3 74.1 30.0 69.3

–8.0 30.9 133.6 7.0 256.2 81.1 28.2 64.3

–8.2 6.1 139.7 6.7 251.1 85.5 28.1 65.1

0.0 0.7 140.4 6.4 235.0 90.0 26.6 66.4

2.8 2.9

6.6 7.0

7.7 8.1

10.2 10.8

8.2 8.8

7.6 8.1

Source: IMF 2013.

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Tham Siew Yean

Apart from the decline in trade balance, the decline in the current account balance from 17 per cent of GDP in 2008 to 6 per cent of GDP in 2012 (see Table 3.4) can also be attributed to the increasing services deficit and increasing income outflows as well as outflows in the form of current transfers (Sivalingam 2013). The services and income account balance is negative, reflecting the services account deficit since 20115 and the outflow of funds from Malaysia in the form of income earned by foreigners as dividends, investment income or payment for labour services. According to Sivalingam (2013), about 90 per cent of the outflow is estimated to be investment income or repatriation of dividends or profits from multinationals operating in Malaysia. The capital and financial account balance (see Table 3.4), which has been negative since 2008 due to greater outflows than inflows of direct investment, was reversed to positive in 2011 but turned negative again in 2012. Outflows are due to investments abroad by governmentlinked companies such as Malayan Banking (Maybank) and Commerce International Merchant Bank (CIMB), as well as private investments (Sivalingam 2013). Inflows of FDI have helped to reduce the capital and financial account deficit, although Malaysia has performed poorly as a developing host economy since the AFC. In 1993 Malaysia was among the top ten developing host economies for FDI, while in 2012 Malaysia was not even in the list of top 20 developing host economies (UNCTAD 2013). The deficit was reduced by a massive inflow of short-term portfolio investment in 2012. Overall balance of payments was in surplus for 2011 and 2012 (see Table 3.4). Gross official reserves continue to be positive and stand at about 131 per cent of the IMF’s composite reserve adequacy metric, covering 247 per cent of short-term capital and 31 per cent of broad money (IMF 2013b). The large reserves have been used to limit excess exchange rate volatility in view of Malaysia’s open economy and exposure to volatile portfolio flows. Malaysia’s total external debt and debt service ratio remain small, as the government’s debt is largely financed domestically. It is important to note that despite the favourable external position, the IMF’s (2013b) analysis of the matter concluded that the surplus in the current account and positive savings investment gap reflect three key structural factors. These are insufficient social safety nets, large exports of non-renewable resources (net oil and gas exports constituted 7 per cent of GDP), and bottlenecks to private investment, despite the recent increase

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under the ETP. The IMF further noted that the bulk of savings in Malaysia is in corporate savings, while household savings in the form of mandatory contributions to the Employees’ Provident Fund and other private savings instruments serve as partial social safety nets. These conclusions have implications for the sustainability of the favourable external balance of Malaysia.

4. MACROECONOMIC AND TRADE CHALLENGES AND PROSPECTS The main challenges ahead lie in managing the fiscal risks, sustaining private consumption, and navigating the shift from manufacturing as Malaysia aims to shift to a service-led economy in line with its aspirations to be a developed and high-income economy by 2020.

4.1 Fiscal Consolidation The main macroeconomic challenge is fiscal consolidation. Although the federal government’s fiscal deficit has been declining in line with its target of reducing this to 3 per cent by 2015, there is an urgent need for fiscal reforms. The federal government debt has increased from 51 per cent of GDP in 2011 to 53.7 per cent of GDP in 2012, which is close to the ceiling of 55 per cent of GDP, as stipulated by the government (Malaysia 2013). General government debt was 55.4 per cent of GDP in 2012 (see Table 3.1). Although the federal government’s debt is mostly financed domestically (cited as 96.5 per cent in 2012 in Malaysia 2013) and the government has capped debt service charges to below 15 per cent of revenue, the fiscal deficit is projected to increase again after 2015, due to declining oil revenue and rising pension and healthcare costs (IMF 2013b). The IMF (2013b) has recommended a progressive reduction of the federal government debt to 40 per cent of GDP, or the ratio prevailing before the GFC, by 2020. Moreover, the consolidated public sector deficit is increasing due to the large increase in spending of the non-financial public enterprises (NFPEs) (see Table 3.1). NFPEs are involved in projects that will have a significant impact on economic growth, such as the construction of the MRT from Sungai Buloh to Kajang (Malaysia 2013), but the IMF (2013b) has further noted that monitoring and controlling the implementation of these projects are difficult due to the long reporting lags.

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Fiscal reforms required include reforming the current revenue and expenditure pattern and practices. In terms of revenue generation, the continued dependence on oil for its revenue is not sustainable without diversifying the revenue base to a goods and sales tax as in other countries. However, only 1.8 million out of the 29 million population paid taxes in 2012 (Malaysia 2013). Hence, it is important to increase the tax-paying population first before implementing GST, as GST will be a viewed as a huge burden to citizens who are not used to paying any income tax. In terms of expenditure patterns, institutionalized leakages require a fundamental review of all non-developmental, non-priority and unproductive expenditures rather than an ad hoc cut in fiscal expenditures. The situation also requires better monitoring and a more transparent system, especially for the government’s procurement system. The country’s subsidy burden, which peaked at 4.7 per cent of GDP in 2008, declined subsequently to 3 per cent in 2010, but increased again to 4.1 per cent and 4.5 per cent of GDP in 2011 and 2012, respectively, due to higher provisions for the largest component, which is fuel subsidies (Yeah 2011; Malaysia 2013). In fact, more than half of Malaysia’s fiscal deficit can be attributed to subsidies, with a third contributed by fuel subsidies. While it is important to continue with the subsidy rationalization programme under the ETP, the rationalization may affect inflation. Unconditional cash transfers may also have a long-term impact on work incentives and the creation of a culture of government dependence (Nor Zahidi et al. 2012). Overall, greater transparency and accountability in spending is paramount for enhancing fiscal prudence and greater sustainability in fiscal management.

4.2 Sustaining Private Consumption’s Contribution to Growth One important lesson from the GFC is the danger of having a prolonged consumption boom that is funded by excessive debt growth and escalating household debt to personal income. Malaysia’s household debt to GDP ratio has grown steadily, from 33 per cent in 1997 to 47 per cent in 2000, to 70 per cent in 2009, and further still to 80.5 per cent in 2012. Personal consumption has been fuelled by debt rather than income, as personal consumption and debt grew annually at 7.7 and 7.1 per cent, respectively, while GDP grew at 5.4 per cent between 2005 and 2009 (Lim 2013). Malaysia also has one of the highest ratios of household debt to disposable income

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in the world (140 per cent), compared with other countries such as the United States (123 per cent), Singapore (105 per cent), Germany (95 per cent), France (93 per cent) and Thailand (53 per cent). The household debt service ratio grew from 39 per cent in 2006 to 49 per cent in 2009. In 2013 the three largest components of household debt were made up of residential properties (45 per cent), vehicles (18 per cent) and personal use (17 per cent) (Yeong 2013). The remaining debt is made up of non-residential properties (7 per cent), securities (6 per cent), credit cards (4 per cent) and others (3 per cent). The low interest environment as well as innovations in repayment in housing and car loans (such as low down-payments for house purchases, developers’ interest-bearing schemes introduced in 2007 to boost house sales, and the extension of car loan repayment periods) have contributed to the increase in household spending on housing and vehicles. The government’s cash transfers to low- and middle-income households as announced in the 2013 budget have further supported this consumption growth.6 Rising household debt has implications for the conduct of monetary policy, as increasing interest rates in the face of increasing domestic demand, rising real estate prices and a positive output gap, may lead to household insolvency, should growth falter. Concurrently, the openness in Malaysia’s economy also implies the need to keep interest rates low in the face of a weak and uncertain external demand in order to increase domestic demand. With conflicting demands on the interest rate policy and increasing concern over household debt, the Central Bank has instituted several macro-prudential measures since 2010, with the latest in July 2013 to take immediate effect. The goal of these measures is to curb the rise in household debt and house prices (IMF 2013a). The July 2013 measures are restrictions on the tenure of personal loans to a maximum of 10 years (from the previous 25), a reduction in the maximum financing period for residential and non-residential properties to 35 years (from the previous 45), prohibition of pre-approved personal financing products, and the requirement to observe a prudent debt service ratio not exceeding 60 per cent of a borrower’s income (Taing 2013). While it remains to be seen whether these macro-prudential measures will rein in excessive debt growth without stifling the country’s economic growth, the continuation of a low interest policy can still have a negative impact on savings, besides increasing the risks of over investment on unproductive sectors. Hence, Malaysia faces the same risks as other

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countries that have used a loose monetary policy to stimulate their economies, which is that the timing of the exit of such policies is crucial for managing the shift in monetary policy without an adverse impact on growth. Concurrently, deficiencies in social safety nets also imply that any external shocks that affect income and employment in the country may also worsen the ability to repay household debt.

4.3 Navigating the Shift from Manufacturing to Services Structurally, the share of services in Malaysia’s GDP has been increasing steadily while the share of manufacturing started to shrink from 2000 onwards (see Figure 3.2).7 The share of manufacturing employment, however, has remained around 28–29 per cent after 2000 (see Figure 3.3). While some may interpret the increase in the share of services in the economy as progress towards the structure of a developed economy, the decline of the manufacturing sector in terms of its share in output and employment (when migrant workers are not included), in fact reflects a stalling of industrial deepening in the country. This is reflected in the relatively limited backward linkages formed with the domestic economy, especially in the non-resource-based manufacturing sector (Loke and Tham 2014). In particular, Tham and Loke (2011a) found that the key manufacturing sub-sector, electrical and electronics, not only has relatively weaker backward linkages than other sub-sectors, but also has a consistently higher share of imports in the direct raw materials used compared to the other sub-sectors. More importantly, the backward linkages developed may not be with Malaysian firms, but rather transnational small and medium enterprises that have followed MNCs to this country to be their suppliers (see Capannelli 1999, p. 221). The large share of imported input with relatively weaker backward linkages shows that this sector is still much more integrated with the global rather than with the local economy. In turn, the literature on spillovers in Malaysia also indicates limited spillovers due to constrained absorptive capacities (Tham and Kam 2013). Despite the increasing share of services in GDP, its contribution to exports is quite small; around 13–15 per cent of total exports from 2008 to 2011. The profile of trade in services shows that most of the production of services is directed inwards towards the domestic economy, rather than outwards as shown by the relatively low export competitiveness of this sector, with the exception of travel services (Tham and Loke 2011b).

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Agriculture, Forestry & Fishing

Manufacturing

Services

Other

Note: 1978 prices 1970–95, 1987 prices since 1990, 2000 prices since 2005; e is estimation, f is forecast. Sources: Malaysia 1971, 1976, 1981, 1986, 1991a, 1991b, 1996, 2001, 2008–12 and Economic Report, various issues (Ministry of Finance, Kuala Lumpur).

60.00 50.00 40.00 30.00 20.00 10.00 0.00

GDP Share

FIGURE 3.2 Sectors’ Share in Malaysia’s GDP, 1970–12

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Agriculture, Forestry & Fishing

Manufacturing

Services

Other

Note: 1978 prices 1970–1995, 1987 prices since 1990, 2000 prices since 2005; e is estimation, and f is forecast. Sources: Malaysia (1971, 1976, 1981, 1986, 1991a, 1991b, 1996, 2001, 2008–2012) and Economic Report, various issues (Ministry of Finance, Kuala Lumpur).

60 50 40 30 20 10 0

Employment Share

FIGURE 3.3 Sectors’ Share in Malaysia’s Employment, 1970–12

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Malaysia’s export performance is therefore still dependent on manufactured goods and primary commodities. Given the importance of net exports as a driver of growth in the country (see Table 3.2), it is crucial to restore the competitiveness of goods exports while increasing export competitiveness of services. In this matter, the contribution of investment to growth has to be improved. In 1991, investment contributed 16 per cent towards the economic growth of the country, compared to its contribution of 6 per cent in 2005 (Central Bank 2013a). The recovery in private investment under the ETP has to be accelerated and sustained, given the subdued growth in private investment after the AFC. Private investment averaged only 11 per cent of real GDP from 2000 to 2009 compared to the average share of 22.9 per cent from 1990 to 1999 (Central Bank 2011). This in turn depends on the ability to increase labour productivity in both sectors, attract the right talents to facilitate the shift to a knowledge- and innovation-based economy, as well as the phasing out of the dependency on unskilled foreign workers. Malaysia has actively used free trade agreements (FTAs) to increase market access for its goods and services. Table 3.5 shows Malaysia as having the most FTAs among the ASEAN-5 countries, apart from Singapore, and China. To date, Malaysia has ratified six bilateral FTAs as well as the five extra-ASEAN FTAs. Nevertheless, utilization of these agreements has been relatively low (Mahani et al. 2012a) due to several reasons; namely, a lack of awareness of these agreements, especially among the small and medium enterprises, relatively high compliance costs compared to the margin of preference provided by these agreements, and the need to circumvent domestic regulations when accessing the service sectors of partner countries of these agreements (Tham 2013). Some of the developing partner countries of these agreements may not have the infrastructure to support the entry of Malaysian providers in some service sub-sectors where Malaysia has established a strong domestic market, as in private higher education (Mahani et al. 2012b). Hence, while many FTAs have been negotiated, ratified and enforced, accessing the benefits may not have kept up with ratification.

5. CONCLUSION Malaysia has successfully weathered the storms of the GFC through expansionary monetary and fiscal policies as well as targeted macro-

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1.0 2.0 2.0 3.0 2.0 3.0

1976– 1996

Source: UNESCAP 2013.

China Indonesia Malaysia Philippines Singapore Thailand

Country

1.0

1997– 2001 16.0 13.0 15.0 13.0 11.0 14.0

2002– 2006 4.0 4.0 6.0 3.0 7.0 4.0

2007– 2011

1.0

2012

Preferential trade agreements signed

1.0 2.0 2.0 3.0 2.0 3.0

1976– 1996

1.0

1997– 2001 15.0 11.0 12.0 11.0 10.0 14.0

2002– 2006 5.0 6.0 8.0 5.0 6.0 4.0

2007– 2011

Preferential trade agreements put into force

1.0

2012

TABLE 3.5 Preferential Trade Agreements, Number per Year and Trade Coverage

11.0 19.0 13.0 19.0 19.0 11.0

Total

31.2 56.5 58.4 50.8 66.8 50.6

Export

33.3 71.2 58.5 58.2 65.7 55.0

Import

Trade coverage under PTAs in percentage, averge 2008–2010

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prudential measures. Growth recovered a year after the GFC, with increasing domestic consumption taking up the slack in external demand. This has been achieved with relatively low domestic inflation and unemployment. Moving forward, there are several structural issues that need to be addressed to sustain the growth record. First, while rebalancing growth and shifting from export dependency has been the clarion call since the advent of the GFC, it is important to note that Malaysia is a small open economy. Increasing the contributions of domestic consumption can only be sustainable if private savings are large and social safety nets are in place. Alternatively, high incomes sustained by high productivity growth can also be used to fuel private consumption. Since this is not yet the case in Malaysia, the performance of net exports will continue to play an important role in determining future growth. This does not augur well, as the domestic conditions of trade partners continue to struggle with their own structural reforms. The contribution of investment to growth has to be improved in order to enhance the competitiveness of Malaysia’s exports of goods and services. This in turn depends on the ability to increase labour productivity in both sectors, attracting the right talent that can facilitate the shift to a knowledge- and innovation-based economy, as well as phasing out the dependency on unskilled foreign workers. The immediate policy considerations include timing the exit of the loose monetary policy while cutting down the fiscal deficit as targeted. Medium- and longer-term measures include a stricter adherence to fiscal consolidation, reducing household debt, and navigating the shift to a service-oriented economy. While the government is cognizant of the need for structural transformation as epitomized by the slew of policy initiatives since 2010, balancing the shift in monetary and fiscal policies, under a reduced fiscal space and a weak and faltering external front, remains a challenge for the future growth for Malaysia and other countries in the region. Malaysia is, however, more dependent on external demand than some of its bigger neighbouring countries.

Notes 1. 2.

The OPR is the sole indicator used to signal the monetary policy stance in Malaysia (Sukhdave 2011). Other complementary measures included measures to instill confidence in the

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3.

4. 5. 6.

7.

Tham Siew Yean financial system through the issuance of a blanket guarantee on bank deposits, extension of the Central Bank’s liquidity facilities to insurance and tactful companies, as well as the use of the U.S. dollar for financing trade; measures to ensure access to financing through the provision of special funds for small and medium enterprises, and the establishment of Danajamin, a financial guarantee insurer; and measures for debt resolution and restructuring through the provision of a one-year moratorium on housing loans for retrenched workers and a comprehensive debt resolution and restructuring mechanism (Sukhdave 2011). These include telecommunications service providers, technical and vocational schools, technical and vocational schools for students with special needs, private hospitals, departmental and specialty stores, incineration services, accounting and taxation services, skills training centres, courier services, international schools, and quantity surveying services. Export competitiveness is measured by the share of Malaysia’s goods exports to world goods exports. This declined from 1.81 to 1.48 from 2000 to 2008. The service account has been in deficit since independence, except for small surpluses from 2007 to 2010. This refers to the fiscal transfers of RM500 to households with monthly incomes of RM3,000 and below (Bantuan Rakyat 1Malaysia, or BRIM2.0), the RM100 schooling assistance to primary and secondary school students, and cash support to the armed forces (Central Bank 2013). It should be noted that the share of services in GDP has been the largest since Independence.

References Alp, H., E. Selim, and L. Subir. “An Assessment of Malaysian Monetary Policy during the Global Financial Crisis of 2008–09”. IMF Working Paper, WP/12/35, 2012. Capannelli, G. “Technology Transfer from Japanese Consumer Electronic Firms via Buyer–Supplier Relations”. In Industrial Technology Development in Malaysia: Industry and Firm Studies, edited by K.S. Jomo, G. Felker, and R. Rasiah. London: Routledge, 1999. Central Bank. Annual Report 2010. Kuala Lumpur: Central Bank, 2011. ———. Annual Report 2012. Kuala Lumpur: Central Bank, 2013a. ———. “Monetary Policy Statement, 9 May 2013”. Kuala Lumpur: Central Bank, 2013b. Hill, H. “Malaysian Economic Development: Looking Backwards and Forward”. In Graduating from the Middle: Malaysia’s Development Challenges, edited by H. Hill, S.Y. Tham, and H.M.Z. Ragayah. Abingdon: Routledge, 2012. International Monetary Fund. Malaysia 2010 Article IV Consultation. Washington, DC: IMF, 2010.

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———. Malaysia 2012 Article IV Consultation. Washington, DC: IMF, 2013a. ———. Malaysia: Financial Sector Stability Assessment. Washington, DC: IMF, 2013b. Lim, M.H. “Household Debt in Malaysia — Is It Sustainable?” Penang Monthly 2013. Penang Institute, 2013. Loke, W.H. and S.Y. Tham. “Vertical Specialization and Backward Linkages: Reconsidering Malaysian Manufacturing Development”. Malaysian Journal of Economic Studies (MJES), 51 (Special Issue, 2014): 57–76. Mahani, Z.A., G.M. Loh, and A.A. Nor Izzatina. “Achieving the AEC 2015: Challenges for the Malaysian Private Sector”. In Achieving the ASEAN Economic Community 2015: Challenges for Member Countries and Businesses, edited by S.B. Das. Singapore: Institute of Southeast Asian Studies, 2013. Mahani, Z.A., S.Y. Tham, and W.H. Loke. “Exporting Niches for Services Exports: The Case of Malaysia”. In Exporting Services: A Developing Country Perspective, edited by A.G. Goswami, A. Mattoo, and S. Saez. Washington DC: World Bank, 2012. Malaysia. Economic Transformation Programme: A Roadmap for Malaysia. Putrajaya: Performance Management and Delivery Unit (PEMANDU), 2010a. ———. Tenth Malaysia Plan: 2011–2015. Putrajaya: Economic Planning Unit (EPU), 2010b. Ministry of Finance. Economic Report 2012/13. Kuala Lumpur: Ministry of Finance, 2013. National Economic Advisory Council. The New Economic Model for Malaysia, 2010 . Nor Zahidi, A., Nurhisham, H., and A.M. Afiq. “Budget 2013: Aiming for More Balanced and Quality Growth”. Economic Research, vol. ER/014/2012. Kuala Lumpur: Malaysia Rating Corporation, 2012. Ooi, S.K. “Capital Flows and Financial Assets in Emerging Markets: Determinants, Consequences and Challenges for Central Banks: The Malaysian Experience”. BIS Papers no. 44, 2008. Sivalingam, G. “Can Malaysia’s Economy Beat the Odds in 2013?” ISEAS Perspective 16, 2013. Sukhdave, S. “Monetary Policy Framework in Malaysia”. Presentation at the Financial Sector Talent Enrichment Program (FSTEP), 12 April 2011. Taing, A. “Keeping the Lid on Household Debt”. Edge Malaysia, 8 July 2013. Tham, S.Y. “Trade and Growth: Navigating the Shift from Manufacturing to Services”. Presentation at the First Penang Economic Conference, Penang, 29–30 June 2013. Tham, S.Y. and J.Y. Kam. “Contribution of Foreign Direct Investment to Employment Generation and Skills Development in Electronic Component and ICT Goods Industries in Malaysia”. Draft Report Submitted to UNESCAP, Bangkok, 6 April 2013. Tham, S.Y. and W.H. Loke. “Industrial Deepening in Malaysia: Policy Lessons for Developing Countries”. Asian Development Review 28, no. 2 (2011a): 88–109.

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———. “Harnessing Services for Development in Malaysia”. In Malaysia’s SocioEconomic Transformation: Ideas for the Next Decade, edited by Sanchita Basu Das and Lee Poh Onn. Singapore: Institute of Southeast Asian Studies, 2014. Thillainathan, R. “A Critical Review of Price Control and Subsidies in Malaysia”. Presentation at the LSE Alumni’s Forum on the Rise and Fall of Subsidies, Kuala Lumpur, 26 May 2008. United Nations Conference for Trade and Development (UNCTAD). World Investment Report. Geneva: UNCTAD, 2013. United Nations’ Economic and Social Commission for Asia and the Pacific (UNESCAP). Asia-Pacific Trade and Investment Report 2012. New York: United Nations, 2013. Yeah, K.L. “Prices and Inflation in Malaysia”. Presentation at the Malaysia Institute of Economic Research (MIER) National Outlook Conference 2012–13, Kuala Lumpur, 2013. Yeong, E. “Downside Risk to Economic Growth”. The Sun, July 2013.

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4 SINGAPORE: REINVENTING ITSELF AMID GLOBAL ECONOMIC UNCERTAINTIES Sanchita Basu Das and Catherine Rose James

1. INTRODUCTION The sub-prime crisis that began in the U.S. housing market in 2007 snowballed into a global financial and economic crisis and is described as the most serious crisis to hit the global economy since the Great Depression. The contagion of the crisis transmitted from the financial sector to the real sector through demand slump, production plunge, unemployment rise and credit seize. Most worryingly, world trade — the main channel of crisis transmission — fell sharply. The GDP growth rates fell for both advanced and developing economies, leading to first-time contraction in global GDP since World War II. The crisis forced countries around the world to come up with aggressive and unconventional monetary and fiscal policy measures. There were several instances of coordinated policy actions by the central banks, which helped to avert an escalation of the crisis and prevented a meltdown of financial systems.

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The crisis also busted the myth that Asia was sufficiently decoupled from the Western financial systems and that it had become independent from the cyclical developments of the global economy (Yung 2011). This is reflected in empirical data which suggest that Asia has not been immune as indicated by losses to financial institutions in the region, impacts on the stock market, and widening sovereign spreads in the region. Singapore was no different from most of the Asian economies. It was the first East Asian nation to fall into recession, reflecting the vulnerability of the economy to global economic shocks. In 2008, GDP slumped due to a contraction in manufacturing activity in the second quarter, which subsequently extended to construction and a broad range of services. Its year-on-year real growth rate had plunged from 9 per cent in 2007 to 1.7 per cent in 2008 and further to –0.8 per cent in 2009 (see Figure 4.1). This prompted the policymakers of Singapore to come up with a series of fiscal and monetary policy measures that helped the city-state economy to catapult itself out of recession in the third quarter of 2009. Given this background, this chapter seeks to summarize the effects of the 2008 global financial crisis (GFC) on Singapore, and analyses the government’s policy response to the same. In the latter half it discusses Singapore’s economic outlook in the face of continuing global economic uncertainties, and evaluates how the island nation is faring in light of the government’s recent measures to revitalize the economy.

2. IMPACT OF THE GLOBAL FINANCIAL CRISIS ON SINGAPORE1 The Singapore economy entered the 2008 crisis from a position of strength. Real GDP growth had been high and sustained at around 9 per cent just before the crisis emerged. It had robust foreign exchange reserves and a large current account surplus (see Table 4.1). Good corporate governance and the credibility of policymakers have always helped to maintain the attraction of Singapore. The sound economic fundamentals of the economy have been supported by a well-supervised banking sector (Table 4.2). The banks are also well-capitalized, as the required capital (also known as Tier-I capital) that banks are supposed to hold averaged 11.3 per cent, which is nearly three times the Bank of International Settlements’ (BIS) recommendation of 4 per cent, and well above MAS’s 6 per cent minimum. The strong economic and banking

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2003

2002

2001

2000

Source: Singapore Department of Statistics.

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

2012

2011

2010

2009

2008

2007

2006

2005

2004

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14.0

16.0

GDP Growth (Y-O-Y, %)

FIGURE 4.1 Trends in Singapore’s GDP Growth Rate, 2007–13

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Sanchita Basu Das and Catherine Rose James TABLE 4.1 Selected Economic Indicators of Singapore, 2005–11

Real Economy GDP Real Growth Rate (%) Gross National Savings   (% of GDP) Gross Capital Formation   (% of GDP) Inflation (%) Public Finance

Government Surplus   (% of GDP)

2005

2006

2007

2008

2009

2010

2011

7.4 43.0

8.6 45.0

9.0 44.0

1.7 43

–0.8 42

14.8 47

5.2 44

20.0

20.0

20.0

29

26

22

22

0.5

1.0

1.0

6.6

0.6

2.8

5.2

6.5

9.5

11.5

13.1

8.1

0.9

8.6

23.0

25.0

24.0

14

16

24

22

10.0 193

12.0 209

11.5 235

6.9 250

6.1 264

18.5 289

6.6 308

Balance of Payment Current Account Balance   (% of GDP) Overall Balance (% of GDP) Official Foreign Reserves   (SG$ bn)

Source: Yearbook of Statistics Singapore 2012, Singapore, Department of Statistics.

fundamentals were also factors that helped Singapore to survive the crisis with minimum glitches.

2.1 Transmission of Global Crisis to Singapore There were at least three ways in which the global developments were tranmited to the Singapore economy in 2008. While the financial sector was affected by the cessation of credit flows, the real economy suffered as the external demand for manufactured goods choked up. In addition, it was the working class that suffered from the worst consequences of the recession.

2.2 Impact on the Real Sector Due to its structural dependence on international trade, the effects of the 2008 crisis on Singapore were transmitted via the slump in trade, investment

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Singapore: Reinventing Itself amid Global Economic Uncertainties TABLE 4.2 Selected Indicators on Banking Sector Financial Soundness, 2005–11 2005 2006

2007 2008 2009

Liquid DBU Assets to Total   DBU Assets DBU Non-bank Loans to DBU   Non-Bank Deposits

10.3

9.8

10.1

9.9

81.8

71.4

74.1

Regulatory Capital to Risk  Weighted Assets Regulatory Tier 1 Capital to Risk  Weighted Assets

15.8

15.4

11.4

3.8

Liquidity

2010

2011

10.3

9.3

9.9

78.3

71.9

74.4

87.0

13.5

14.7

17.3

18.6

16.0

11.2

9.8

11.5

14.1

15.5

13.5

2.8

1.5

1.7

2.4

1.6

1.2

Capital Adequacy (%)

Asset Quality (%)

Non-bank NPLs to Non-Bank   loans (%) Total Provisions to Non-Bank NPLs

78.7

89.5 115.6 108.5

90.8 110.9 125.5

ROA (simple average) ROE (simple average)

1.2 11.2

1.4 13.7

1.1 10.8

Profitability (%)

1.3 12.9

1.0 10.7

1.2 12.2

1.0 11.1

Source: MAS Financial Stability Reviews, November 2008, 2010, 2011, 2012.

and the services sector. Singapore’s manufacturing sector contracted on the back of falling global export demand. The year-on-year growth in the manufacturing sector plummeted from 12.5 per cent to –23.8 per cent from March 2008 to 2009. The effect on Singapore’s trade was significant, with importers in developed economies preferring to run down their inventories before placing new orders. The fall in end-use demand from the G-3 economies (United States, eurozone and Japan) resulted in synchronized decline in intermediate goods exports across Asian economies. Moreover, the decline in intra-Asian trade flows was amplified as intermediate goods crossed national borders several times during the production process. The country’s non-oil domestic exports (NODX) plummeted 35 per cent in January 2009, posting the biggest drop ever on record (see Figure 4.2). Singapore’s imports also fell subsequently, reflecting the drop in international oil prices and the moderation in domestic economic activity, as well as the growing import intensity of much of the export production.

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40

50

60

70

80

90

100

110

120

Source: CEIC Database.

Index : Jan 2008=100 1/2008 3/2008 5/2008

FIGURE 4.2 Trends in Singapore’s Total Non Oil Domestic Exports, 2008–13

7/2008 9/2008 11/2008 1/2009 3/2009 5/2009 7/2009 9/2009 11/2009 1/2010 3/2010 5/2010 7/2010 9/2010 11/2010 1/2011 3/2011 5/2011 7/2011 9/2011 11/2011 1/2012 3/2012 5/2012 7/2012 9/2012 11/2012 1/2013

82

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Singapore functions as a trade hub, supporting trade-related services from transportation to trade finance; hence the effects of the crisis were exacerbated. It increased the risk of trade financing owing to a greater probability of defaults. The economy felt the constraints of limited private insurance capacity to insure against buyers defaulting on payments, and a reduced credit risk appetite among banks. Another reason for the rapid contraction of Singapore’s GDP was its heavy dependence on foreign direct investment (FDI) for supply of capital, which accounted for 60 per cent of the gross fixed capital formation in the country in 2007. The country saw no FDI inflows in the second half of 2008 (see Figure 4.3). Besides trade and investment, Singapore’s economy has also been exposed to global shocks through its services sector, primarily the communication (transportation, logistics) and tourism sectors. For instance, since the onset of the global financial crisis, there was a steep fall in tourist arrivals in Singapore, particularly from neighbouring nations and the European Union. People cut down spending sharply on travel and tourism as the crisis severely hit consumer confidence and discretionary spending power. There was also a shift away from high-end tourists to budget travellers, resulting in a decline in growth of tourism receipts from 14 per cent in 2007 to 4.8 per cent in 2008 (see Figure 4.4).

2.3 Impact on the Financial and Banking Sectors As a small open economy with strong linkages to international events, the Singapore capital market mirrored the sell offs in the global equity markets. Stock market volumes and prices fell considerably from their peak in July–October 2007, with the domestic equity market falling from 3,500 points in December 2007 to 1,700 points in the last quarter of 2008, eroding millions of investors’ wealth (see Figure 4.5). Investors from the developed countries withdrew funds to meet challenges at home. As portfolio investment reduced, it became difficult to raise funds in Singapore’s domestic capital market. Balance sheets deteriorated for many firms, adversely affecting the domestic credit market and accentuating the problem of the liquidity crunch. The crisis also put pressure on the Singapore property market. Property prices dropped by over 40 per cent from the mid-2009 peak, with the Property Price Index for private residential property falling from 177 in

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0

2

4

6

8

10

12

14

16

18

20

Source: CEIC Database.

SGD billion Mar-2006 Jun-2006 Sep-2006 Dec-2006 Mar-2007 Jun-2007 FIGURE 4.3 FDI Inflows into Singapore, 2006–11

Sep-2007 Dec-2007 Mar-2008 Jun-2008 Sep-2008 Dec-2008 Mar-2009 Jun-2009 Sep-2009 Dec-2009 Mar-2010 Jun-2010 Sep-2010 Dec-2010 Mar-2011 Jun-2011 Sep-2011

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Tourist Arrivals ('000, 3 month moving average)

Source: CEIC Database.

0

200

400

600

800

1000

1200

1400

FIGURE 4.4 Trend in Tourist Arrivals, 2007–13

5/2010

1/2010

9/2009

5/2009

1/2009

9/2008

5/2008

1/2008

Visitor Arrivals ('000) (3-mma)

9/2012

5/2012

1/2012

9/2011

5/2011

Growth Rate (y-o-y)

-20.00

-15.00

-10.00

-5.00

0.00

5.00

10.00

15.00

20.00

25.00

30.00

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Growth in % 1/2013

1/2011

9/2010

9/2007

5/2007

1/2007

Source: Bloomberg.

FIGURE 4.5 Singapore Straits Times Index and Trends in Currency (SGD) Movement, 2007–13

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March 2008 to almost 140 within a year. Falling asset prices had serious implications for property developers, while the negative wealth effect had repercussions on consumer and investment spending in the country (see Figure 4.6). The sudden reversal of capital inflows had an effect on liquidity. The Asian Dollar Market experienced strains in tandem with tight liquidity conditions in other U.S. dollar funding centres. The SG$ SIBOR rose in line with the US$ LIBOR soon after the disruption in the financial system and failure of Lehman Brothers. The Singapore dollar money market also briefly came under upward pressure on lack of confidence. However, the damage to Singapore’s banking sector was contained, given its low level of exposure to securities linked to U.S. home mortgages or to distressed financial institutions like Bear Stearns and Lehman Brothers.

2.4 Impact on the Labour Market During the 2008 crisis, Singapore’s labour market weakened, with the total unemployment rate rising from 1.9 per cent in March 2008 to 3.3 per cent in March 2009. The main source of the weakness emerged from the manufacturing sector, specifically electronics, as the global slowdown dried up demand for manufactured exports, which in turn forced companies to reduce headcount and lower operating costs. Cost-cutting efforts, uncertainty in the banking sector, and delays and cancellations of investment projects weighed on Singapore’s 2.9-million-strong labour force. Nevertheless, the deterioration in the labour market was far more modest compared to the effects on neighbouring countries and during past recessions (Figure 4.6). In tandem with the weakening labour market, retrenchments jumped almost five times to 10,000 in the first quarter of 2009 from a year earlier. Apart from manufacturing, which accounted for more than 70 per cent of these retrenchments, the services sector also displaced a large number of workers.

3. SINGAPORE’S POLICY RESPONSE TO THE 2008 GFC The scale of the GFC saw co-ordinated action by the developed and developing nations in an attempt to prevent recession turning into a slump towards the end of 2008. Realizing the severity of the crisis, the government

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Source: CEIC Database.

0.0

1.0

2.0

3.0

4.0

5.0

% 6.0

Mar-2006 Jul-2006 Nov-2006

FIGURE 4.6 Trends in Singapore’s Unemployment Rate, 2006–13

Unemployment Rate: Total : SA

Mar-2007 Jul-2007 Nov-2007 Mar-2008 Jul-2008 Nov-2008 Mar-2009 Jul-2009 Nov-2009

Unemployment Rate: Resident: SA

Mar-2010 Jul-2010 Nov-2010 Mar-2011 Jul-2011 Nov-2011 Mar-2012 Jul-2012 Nov-2012 Mar-2013

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preponed the budget announcement by one month to January 2009 and decided to use the full array of fiscal measures to mitigate the effects of the crisis on the economy. The policymakers were faced with the task of boosting domestic demand to offset the slump in export demand and investment. The central bank also aimed at maintaining a low inflationary environment and ensuring the Singapore dollar remained an anchor of stability. On the supply side, policymakers were also faced with the challenge of keeping unemployment in check. Finally, Singapore’s emergence from the crisis also depended on its policy responses at both domestic and regional levels. This meant that policymakers had to work cautiously in tandem with other regional initiatives to preserve confidence in the financial system, which had been wrecked by the crisis.

3.1 Fiscal Policy Measures The fiscal policy in 2009 focused on the employability of people. It helped corporations to drive down costs and preserve employees. The economic downturn also became an opportunity to explore new growth strategies and to make investments in upgrading skills, training and infrastructure to improve competitiveness in the longer term. However, one should note that these measures did not burden the government’s fiscal position. As Singapore was running a balanced budget in the years preceding the crisis, fiscal policy in Singapore tended to be financed from accumulated budget surpluses rather than from borrowing. This enhanced the impact of temporary measures, as the government was unlikely to need to finance fiscal policy through higher future taxes. It also implied that the government did not need to borrow to finance the deficit and would therefore not draw on the credit in the market and crowd out private investments. Some of the measures included: • A SG$20.5 billion Resilience Package to help cushion businesses and households from the impact of the economic downturn. The measures included tax exemption/rebate schemes, assistance to businesses to preserve jobs, and enhancements to cash flow and investments in infrastructure for the long-term. The Resilience Package contained a diversified set of targeted measures, with multiple impact points for workers, households and businesses. It went into five main areas:

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•

•

•

•

SG$5.1 billion to preserving jobs, SG$5.8 billion to stimulate bank lending, SG$2.6 billion for various tax measures to improve cash flow of businesses, SG$2.6 billion to help households through moves like personal income tax rebates, SG$4.4 billion to bring forward infrastructure spending plus health and education improvements. For the first time, the government dug into its reserves to draw SG$4.9 billion to fund two temporary innovative measures — the Jobs Credit Scheme (JCS) and the Special Risk-Sharing Initiative. The JCS was a temporary employment subsidization programme aimed at lowering the cost of hires for companies. It was estimated to take up more than half of the SG$6.1 billion in special transfers earmarked for FY2009. Under this, employers received a 12 per cent cash grant on the first SG$2,500 of each month’s wages for each employee on their Central Provident Fund (CPF) payroll. Anecdotal evidence indicated that the savings and additional cash flow from the JCS were quite significant, especially for labour-intensive firms, and helped to save some jobs. To help new graduates and PMETs (Professionals, Managers, Executives and Technicians) to upgrade themselves and allow them to find jobs with ease in the future, course fee subsidies under the Skills Programme for Upgrading and Resilience (SPUR) was increased from 80 per cent to 90 per cent. Selected tertiary courses at UniSIM and Singapore’s three public universities were included under SPUR. Singapore’s Economic Development Board (EDB) was expected to complement SPUR with a SG$100 million programme. To support low-income workers, the government decided to adjust the Workfare Income Supplement (WIS) with an additional 50 per cent payment. In addition to a SG$200 increase in monthly salary of SG$1,000, the worker got another SG$600. The government also relaxed the eligibility criteria for the Workfare Special Payment to include odd job workers. In all, the temporary Workfare Income Supplement special payment was expected to cost the government SG$150 million. The government also announced plans to create 18,000 jobs in the public sector and government-supported sectors, including childcare, tertiary education and restructured hospitals. The government’s direct consumption of goods and services had a higher economic multiplier. It brought forward infrastructure projects and announced plans for rejuvenating public housing estates — both positive developments for the construction sector.

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• To enhance the competitiveness of businesses, the government cut the corporate income tax rate by 1 percentage point to 17 per cent from year of assessment (YA) 2010 in order to maintain Singapore’s attractiveness as a location for investments. By cutting the corporate income tax to among the lowest in the world, the government sharpened Singapore’s cost competitiveness and prepared the country for the upturn. It introduced the Special Risk-Sharing Initiative (SRI) to ensure that viable companies would continue to have access to credit to sustain operations and minimize job dismissals. The SRI comprised a new Bridging Loan Programme (BLP) and trade financing schemes. The new trade finance schemes were expected to help mid-sized and large exporters obtain loans and trade insurance on the scale they needed. The SRI was necessary to maintain the credit flows to worthy borrowers. The scheme was also aimed at stimulating bank lending and ensured that viable companies would continue to have access to credit to sustain their operations. • The property market was also bolstered with several measures. This included a 40 per cent property tax rebate for commercial assets and deferred property tax for approved development land to enable property developers to hold back on their intended developments. Property tax for the higher-valued secondary home was scrapped so as to prevent fire sales of high-end properties in the market. A 40 per cent property tax rebate for owner-occupied residential properties was announced to ensure that first-time homebuyers could afford public housing. This was coupled with an increase in the CPF housing grant by SG$10,000 to SG$40,000. • The Singapore government also offered a slew of measures to alleviate the pain of households. The government announced a personal income tax rebate of 20 per cent (capped at SG$2,000) in FY2009. It also doubled the Goods and Services Tax (GST) credits for households in FY2009. Low-income earners and the elderly also benefited in the form of increased allowances, service and conservancy rebates, topping up of the Elder Care Fund and Medifund.

3.2 Monetary Policy Measures Monetary policy has been eased in response to the economic crisis. In fact, MAS targeted for a low inflationary regime following the rapid hike in fuel and food prices in early 2008 and supported the growth rate when

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indirect impacts from the sub-prime crisis began to hit the city state’s exports. Hence, during the crisis, MAS abandoned its four-year-long strong Singapore dollar policy. In October 2008 MAS took a stance of zero appreciation for the Singapore dollar and later shifted the NEER2 policy band downwards (Figure 4.7). In the absence of domestic inflationary pressures, the MAS had allowed the Singapore dollar to fall against the U.S. dollar in line with other regional currencies. This was mainly to raise confidence in the face of a worsening global outlook. Although this was not enough to counteract fully the global slump, it helped to soften the blow from external headwinds and shore up confidence among the stakeholders in the country. Indeed, loose monetary policy helps in revitalizing an economy suffering from rapidly shrinking external demand. But the main cause of the 2008 crisis was from waning orders from overseas, and lowering the financial cost may not be a complete solution. On the contrary, access to credit became a bigger issue for most of the firms, especially SMEs, during the crisis. With the downturn, banks became stringent about lending, and loans from abroad had also dried up as liquidity problems hit the financial system in the advanced economies. Thus, getting credit for productive activities became a key issue at that time. Nevertheless, the government of Singapore introduced some fiscal measures (like credit-risk sharing) to boost the credit market.

3.3 Measures to Stabilize the Financial and Banking System The policymakers also worked cautiously in tandem with other regional initiatives to preserve confidence in the Singapore financial system. • In October 2008 the government provided a guarantee on bank deposits to restore depositors’ confidence in local banks. Moving in line with other central banks in the region, such as in Taiwan, Hong Kong, Malaysia and Indonesia, Singapore took it as a precautionary action to avoid an erosion of the banks’ deposit base, and consequently ensured a level international playing field for Singapore banks. The guarantee was backed by more than SG$200 billion of the reserves of the Singapore government. • MAS ensured enough liquidity in the system to maintain market confidence. It enhanced the liquidity in the system in two ways.

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Source: Bloomberg.

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1-Feb-06 1-May-06 1-Aug-06 1-Nov-06 1-Feb-07 1-May-07 1-Aug-07 1-Nov-07 1-Feb-08 1-May-08 1-Aug-08 1-Nov-08 1-Feb-09

FIGURE 4.7 MAS Exchange Rate Policy, 2009–13

1-May-09 1-Aug-09 1-Nov-09 1-Feb-10 1-May-10 1-Aug-10 1-Nov-10 1-Feb-11 1-May-11 1-Aug-11 1-Nov-11 1-Feb-12 1-May-12 1-Aug-12 1-Nov-12 1-Feb-13 1-May-13

Mid point of policy band

Lower Band

Higher Band

S$NEER

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Firstly, by maintaining a higher level of Singapore dollar liquidity in the banking system, and secondly, by ensuring that the financial market would not run short of U.S. dollars to meet any obligations amidst the global financial meltdown. It achieved this by setting up a US$30 billion swap line with the U.S. Federal Reserve. • In July 2008 MAS expanded the Standing Facility to include all participating banks of the MAS Electronic Payment System (MEPS+). This provided banks with the assurance that they would be able to access central bank liquidity if the need arose. Although all these policy actions were unable to forestall a recession, they mitigated the impact and averted an even sharper and prolonged downturn. Indeed, Singapore registered a positive rate of economic growth in the last two quarters of 2009 and recovered fully by the second quarter of 2010 due to recovery in exports and the manufacturing sector, particularly in the large economies of Asia (see Figure 4.1). The labour market also rebounded sharply, as the unemployment rate dropped dramatically to 2.9 per cent in December 2009 from a high of 5 per cent earlier in the year (see Figure 4.6).

4. STRATEGIES TO RE-BALANCE GROWTH The ADB’s economic outlook for 20133 estimates Singapore’s GDP growth to gradually accelerate over the next two years accompanied with a moderation in inflationary pressures. It believes that the economy would be able to weather the continued sluggishness in the global economy through “prudent economic policies, a flexible labour market, a sound banking system, and substantial foreign exchange reserves”. The Singapore economy is forecast to grow by 2.6 per cent in 2013, which tallies with the upper bound of the government’s estimate of 1–3 per cent, and by 3.7 per cent in 2014. While this is substantially lower than the 6 per cent average growth achieved during 2000–2010, it should be noted that the city state continues to remain at risk from the slow recovery in the United States, the ongoing sovereign-debt crisis in the eurozone, and the slowdown in growth in the People’s Republic of China as part of its restructuring process. Singapore’s export sector will continue to be affected, with ripple effects expected on its manufacturing sector, considering that the European Union and China4 were the city state’s largest NODX markets in 2012.

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In response to the global imbalances, as occurred in the past decade, several economies/groups of economies have had to consider substantial restructuring. For example, economists realize that the U.S. economy must move from its present consumption-fuelled growth to an exportled one, while East Asia and other major trading partners to the United States must do just the opposite. However, this is easier said than done, and involves real adjustments and microeconomic policy changes, such as retraining labourers to be able to shift to new economic sectors, which may require very different skills. Hence, a sustainable growth path and the capacity to avert similar financial crises in the future will necessitate countries to make significant adjustments to their medium- to long-term development strategies. In the case of Singapore, it realized the need of rebalancing soon after the onset of the 2008 crisis. It established the Economic Strategies Committee (ESC) in May 20095 to develop strategies for Singapore to maximize the opportunities in a new global environment. The ESC report was launched in January 2010, which recommended growth to be based on skills, innovation and productivity. The report outlined three broad priorities: (1) boost skills in every job, (2) deepen capabilities among Singapore companies to seize opportunities in Asia, (3) make Singapore a distinctive global city. The medium- to long-term policies that are going to help Singapore re-balance its growth are detailed below.

4.1 Improving Total Factor Productivity Total factor productivity (TFP) continues to be a major concern for Singapore (see Figure 4.8). According to a population white paper6 published by the National Population and Talent Division in January 2013, Singapore’s total population (resident plus non-resident) is likely to increase from 5.31 million to 5.8–6.0 million in 2020, and 6.5–6.9 million in 2030. This would translate into a decline in population growth to a rate of 1.46 per cent per annum versus 2.29 per cent per annum from 1961 to 2012. Growth in the workforce is also forecast to slow to 1–2 per cent per annum until 2020, and about 1 per cent per annum until 2030. From 1992 to 2012, the workforce grew 4 per cent on average per annum — the resident workforce at 2.5 per cent and the foreign workforce at 8.6 per cent per annum. Considering the slowing labour input, and assuming investment growth

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Manufacturing (rhs)

Construcon (rhs)

Q1-2010 Q4-2009

Q3-2009

Q2-2009

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Q4-2007

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Source: Compiled from various statistical yearbooks, MTI and www. singstat.com.sg.

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FIGURE 4.8 Labour Productivity by Industry, 2006–13

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remains constant, this implies that raising productivity is the only means by which to sustain growth. During 2001–10, Singapore achieved TFP growth of 1.8 per cent per annum. The aim of Singapore’s policymakers is to raise TFP growth to 2–3 per cent until 2020 to achieve 3–5 per cent GDP growth, assuming workforce growth slows to 1–2 per cent per annum. Beyond 2020, GDP growth is likely to slow to 2–3 per cent per year and boosting productivity growth will be even more of a priority. All this implies a sustained shift towards a higher value-added and innovation-driven economy. To galvanize a nation of higher productivity, Singapore set up the National Productivity and Continuing Education Council (NPCEC) in April 2010. The NPCEC adopted a sectoral approach, identifying sixteen priority sectors: construction; electronics; precision engineering; transport engineering; general manufacturing; retail; food and beverage; hotels; healthcare; info-comm, media and design; logistics and storage; administrative and support services; financial services; accountancy; social services; and process construction and maintenance. These sixteen sectors collectively contribute approximately 55 per cent of Singapore’s GDP and around 60 per cent of employment. This sectoral approach was complemented by horizontal productivity enablers such as: • For businesses, the S$2 billion National Productivity Fund (NPF) supports initiatives such as the Productivity and Innovation Credit and the enhanced Capability Development Scheme. • For workers, Continuing Education and Training (CET) schemes help Singaporeans upgrade their skills, become more productive, and increase their employability. Concurrently, policymakers in Singapore have tightened foreign workforce policies to moderate the demand for foreign workers and spur productivity improvements. Since July 2010, foreign worker levies for Work Permit and S Pass holders in all sectors have been raised every six months, with further announced increases to be phased in till July 2013. In 2012 the Dependency Ratio Ceilings for these workers in the manufacturing and services sectors were reduced. The qualifying criteria have been raised for Employment Pass and S Pass holders. These moves are expected to incentivize companies to invest in the training, re-engineering and capital equipment that is needed to spur productivity growth.

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4.2 Focusing on New Sectors of Growth7 For future growth areas, Singapore planning officials felt the need to strike a balance between leveraging Singapore’s core strengths — manufacturing; trade-related services; and modern services, including ICT, finance, professional and other business services — and new areas of growth. These will include:1. Develop and export “green urban solutions”: Being a city-state economy, Singapore needs to continually upgrade its urban infrastructure. At the same time, many countries in Asia are embarking on urbanization. Leveraging on its own need, Singapore could pioneer and export urban and green solutions. This includes smart transportation, energy efficiency and management, water and waste management, a focus on systems-level R&D, and increasing use of ICT. 2. Position itself as a consumer business centre: As Asia is witnessing a rising middle class that is driving global demand, Singapore is positioning itself as a location of choice from which consumer insights are developed; consumer-centric businesses are managed and grown; products and services are developed, tested and launched; and IP/ trademarks owned and anchored. 3. Deepen manufacturing and the manufacturing-related sector: Singapore’s manufacturing sector accounts for 20–25 per cent of GDP. To move to the next phase, the government has identified four key clusters — electronics, engineering, chemicals, and biomedical sciences. Leveraging on its base, Singapore seeks to extend its manufacturing activities both horizontally and vertically. For instance, with its expertise in electronics, Singapore could move to plastic-electronics. Similarly, expertise in precision engineering could allow it to seize new opportunities in the aerospace and medical technology industries. Significant opportunities also exist in manufacturing-related service industries. For example, aerospace companies not only produce highend components and systems, but also generate significant value through services such as maintenance, repair and overhaul. Likewise, ship-building complements the growth of maritime-related services such as repair, logistics and maritime insurance. 4. Become a leading financial and business hub: With regionalism gaining significance, trade in goods and services as well as the flow of capital and ideas between countries and regions will increase. Singapore

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is well-positioned to facilitate these flows. This could be achieved by four key service-related activities — strengthening Singapore’s position as a trade and transport hub, and accordingly build related services; continuing with its focus to grow as an international financial centre; growing modern business services, such as professional services, to support the range of activities of companies; and enhancing the capability and vibrancy of the ICT sector so as to help companies achieve competitive breakthroughs. 5. Encouraging innovation: It is believed that economic growth is driven by the successful commercialization of innovative ideas. In other words this means the translation of good ideas into products, services and solutions that can meet the challenges of changing user needs, new technologies and new competition. Singapore policymakers focused on five key areas to serve this area of growth — increasing investment in R&D, devoting resources towards commercialization and user-driven innovation, bridging the gap between research and commercialization, enabling the government as a sophisticated user for innovation; and a concerted push in promoting innovation in services to complement efforts to develop Singapore as a financial and business hub and a leading consumer business centre.

4.3 Revitalizing the Tourism Sector8 The Singapore tourism sector contributes 4 per cent to the country’s GDP and supports approximately 160,000 jobs. Since 2000 the sector has witnessed the introduction of major tourism projects — the establishment of the two integrated resorts and hosting of the Formula One Singapore Grand Prix. These lent fresh impetus to visitor arrivals and spending, accompanied by a revitalization of lifestyle offerings in dining, entertainment, retail and hospitality. In 2012 tourism receipts and international visitor arrivals reached an all-time high, registering S$23 billion in tourism receipts and visitor arrivals at 14.4 million. Over the ten-year period of 2002–12, tourism receipts grew at a compounded annual growth rate of 10 per cent, with a corresponding growth rate of 6.6 per cent in visitor arrivals. This spectacular performance was attributed to two factors: (1) The emergence of low-cost carriers and (2) the growing middle-class population, with higher disposable income for discretionary travel spending.

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Given the importance of this industry, Singapore’s main objective over the next few years is to promote “quality tourism”. This has three dimensions: (1) tourism will continue to be a major source of growth for Singapore, (2) it will lead to productive and innovative industries that will create jobs for Singaporeans, and (3) the government will continue to nurture public engagement and participation in order to develop the industry. Given these dimensions, Singapore adopted a four-pronged strategy: 1. Pursuing a yield-driven marketing approach — this is to seek greater returns from the marketing investments. 2. Enhancing destination attractiveness — this includes new attractions like the Art Science Museum, Gardens by the Bay, Marine Life Park, River Safari, Universal Studios and other upcoming infrastructure (national art gallery, Singapore Sports Hub), including MICE (meetings, incentives, conventions and exhibitions) venues. 3. Supporting industry competitiveness — this includes support to tourism-related companies and workers to make them more competitive, innovative and productive 4. Building local engagement — the Singapore Tourism Board (STB) will continue to work with industry to nurture public engagement and participation as part of development efforts. Moving towards this yield-driven quality growth, Singapore officials expect tourism receipts to grow by 4–6 per cent per annum, which is more than the 3–4 per cent annual average GDP growth expected for the rest of the economy.

4.4 Diversifying Export Markets and Promoter of FTAs As mentioned earlier, Singapore is highly dependent on its external sector. In 2010 external demand accounted for nearly three-quarter of Singapore’s total demand. Singapore’s dependence on trade means that trade barriers erected by other countries result in significant welfare losses for Singapore. Thus, Singapore is an avid supporter of the multilateral trading system of the World Trade Organization (WTO) and is actively involved in regionalization such as ASEAN, APEC and, more recently, TPP, RCEP and bilateral free trade agreements (FTAs). FTAs are important for Singapore

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as they reduce or eliminate trade barriers between the parties involved, and thus tend to increase trade between them. An FTA also provides legal certainty as it prevents a party to the FTA from unilaterally increasing trade barriers vis-à-vis its FTA partner.9 Furthermore, quality FTAs help to keep up the momentum of free trade and act as building blocks to a multilateral trade regime. Given these advantages, FTAs have been a crucial component of Singapore’s trade strategy over the past two decades. Since the signing of her first FTA under ASEAN in 1993, Singapore’s network of FTAs has expanded to cover 18 regional and bilateral FTAs with 24 trading partners.

5. CONCLUSION For an open and trade-dependent economy, one could say that Singapore has weathered the economic crisis well, which makes it an interesting case study. A major part of Singapore’s resilience is due to Singapore’s policy responses to the crisis. Subsequently, it has ambitiously embarked on a “new growth model”, with emphasis on productivity and inclusive growth.10 The events since 2007 have highlighted several lessons for policymakers; four key broad interrelated themes are: (1) de-coupling theory is a myth, (2) globalization raises vulnerability but increases efficiency, (3) strong economic fundamentals provide greater room to handle a crisis, and (4) coordinated policy action helps in faster recovery.

5.1 De-coupling Theory is a Myth Prior to the crisis there were a lot of discussions on decoupling of emerging and developing economies from the West. In other words, it was believed that even if the advanced economies went into recession, Asia would be affected very marginally and would largely continue with its growth. However, during the economic crisis in a rapidly globalizing world, the decoupling theory has almost lost its credibility. The reduction in growth has not been limited to the advanced economies. The decline from the actual growth rate for 2007 to the growth rate estimated for 2009 is essentially identical for all four groups of countries: 6.3 percentage points for the world on average, 6.1 percentage points for the advanced economies, 6.6 percentage points for the emerging and developing economies, and 7.6 percentage points for those in the Western Hemisphere.

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In the case of Singapore, which is a highly open economy, the transmission of the crisis took place through both trade and financial channels. Even though Singapore had very limited exposure to the toxic assets, the economy suffered the consequences of the recession that gripped the advanced economies in the world.

5.2 Globalization Raises Vulnerability but Increases Efficiency Globalization of trade (merchandise and services), finance, and labour (demand for labour and flow of remittances) had tied countries together to a much greater extent than they had been earlier. Any crisis that affects a major country or group of countries in the global economy or financial system will have some adverse effects on all other countries. As was the case for the 2008 economic crisis, even though its genesis was in the U.S. system, it affected nations far away from it. In the context of Singapore, its economy is one of the most open in the world. With a few exceptions, tariffs are zero, total merchandise trade is nearly four times GDP, and inflows of foreign direct investment are substantial. This high degree of openness leaves Singapore vulnerable to periodic external shocks. In addition, Singapore’s role as a regional financial hub has increased its exposure to financial weaknesses among regional economies. On the positive side, globalization has forced Singapore to improve overall economic management and increase efficiency. It has compelled the city state to develop social and economic institutions through administrative, legislative and legal reforms in order to remain attractive to regional economies. In this context, Singapore already strives to achieve the following: • Develop human capital, as it is a prerequisite for successful globalization. The knowledge economy requires educated and skilled people. • Build up domestic savings and put them to productive use. • Maintain strong macro-economic fundamentals. • Establish good governance at all levels. • Maintain an effective regulatory authority as an important requirement of an open economy.

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Thus, while globalization and the high degree of openness for Singapore implies increased vulnerability to external shocks, it also compels the city state towards better economic management, which eventually enables it to adjust to external disturbances due to its greater efficiency and competitiveness.

5.3 Strong Economic Fundamentals Provide Greater Room to Handle a Crisis In the face of a global crisis, a country will be better off if it has strong macro-economic fundamentals. This implies that the country’s fiscal affairs are reasonably stable, the inflation rate is low, the internal and external debt position is sustainable, and that the foreign reserve is sufficient. All this will make the country better off and will give it room to respond to external shocks through the use of appropriate domestic policies. Singapore has withstood the global crisis and has been almost on the path of recovery because of its strong economic fundamentals. With high current account surpluses, high savings rates, strong inflow of FDI, and negligible non-performing loans, Singapore was able to take timely and bold measures to counter the adverse shocks triggered by the crisis. In addition, due to sufficient accumulated foreign exchange reserves, the Government of Singapore was able to fund two extraordinary measures, measures which were temporary in nature and would not build into longer-term government programmes. Singapore also has a good track record of prudent fiscal and monetary policies, which was a great asset during the crisis. It helped reassure stakeholders that the fiscal and monetary easing taken by the authorities to address short-term problems were less likely to endanger the future commitments to its long-term goals.

5.4 Coordinated Policy Actions Helps in Faster Recovery Since the onslaught of the global financial and economic crisis in 2008, many countries unveiled various stimulus packages to bolster their weakening economies and fight the effects of a global slowdown. In November 2008, China and Germany proposed economic stimulus plans of US$586 billion and US$40 billion, respectively; Canada proposed a plan worth about US$24 billion in January 2009; France unveiled a US$34 billion plan in February

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2009; the United States Senate and House of Representatives reached a final deal on a US$789 billion economic stimulus bill in February 2009; and Singapore came up with a US$15 billion plan in January 2009. While the primary focus of each stimulus package is to revive economic growth in their own country, they also had ramifications for other economies. This is particularly so because nations are ever more dependent on each other in regard to export and investment growth, securities and property markets, and even consumer and investor confidence. This implies that the stimulus package and recovery plan of one country can eventually lead to relief and growth in another. Thus, in an increasingly globalized world, where financial and economic woes can spread quickly, the policy response must be global, coordinated and fast. Policy challenges need to be addressed at the country level, but the international community must act in a coordinated and supportive fashion to make each country’s task easier.

Notes   1. Drawing on Basu Das 2010.   2. The value of the Singapore dollar is monitored against a trade-weighted basket of currencies and is allowed to float within a prescribed policy band.   3. Asian Development Bank Outlook 2013, 1 August 2013 .  4. Singapore Business Review, 1 August 2013 .   5. Report of the Economic Strategies Committee, February 2010.   6. “A Sustainable Population for a Dynamic Singapore”, Population White Paper, January 2013   7. ESC Subcommittee on Seizing Growth Opportunities .   8. “Navigating the Next Phase of Tourism Growth”. Discussion Paper, Tourism Industry Conference 2013, Singapore Tourism Board.   9. “Do Free Trade Agreements Matter? Evaluating the Impact of FTAs on Singapore’s Domestic Exports of Goods”. Economic Survey of Singapore, Second Quarter, 2011. 10. IPS 2012 Report on Singapore Perspectives .

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References Basu Das, Sanchita. Road to Recovery: Singapore’s Journey through the Global Crisis. Singapore: Institute of Southeast Asian Studies, 2010. Yung, Chul Park. The Global Financial Crisis: Decoupling of East Asia: Myth or Reality. Japan: ADBI, 2011.

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5 THAILAND: DEPENDENCY OR DIVERSIFICATION? Somprawin Manprasert

1. INTRODUCTION Over the past two decades, Thailand, along with other Southeast Asian countries, has twice experienced severe economic downturns. The first, the infamous Asian financial crisis of 1997, originated in Thailand itself and then spread to other Southeast Asian countries. A combination of moral hazard in the financial sector, asset price bubbles, and mismanaged capital flow policy led to the country losing its competitiveness and this later prompted speculative attacks on the Thai baht; during 1998 the contraction of the Thai economy reached double-digit territory (–10.51 per cent) for the first time in its history. However, a heavily depreciated currency and explosive growth in exports helped the economy to recover quickly in the following years. Since then, the financial sector has been strengthened through the implementation of international-standard regulations as well as by close monitoring by the monetary authorities. Stabilization policy also aims to balance long-term growth and short-term price stability. In fact, Thai exporters enjoyed low inflation (averaging 2.5 per cent per year) and stable foreign exchange rates during the years 2000 to 2008, and

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international trade has thus been an important growth engine for the Thai economy over the past decade. In late 2008 Thailand experienced a second episode of economic turmoil, but this time the shocks came from external economies. The subprime crisis, led by a real estate bubble and unregulated growth in financial derivatives in the United States, precipitated a global economic meltdown. Because Thailand has been dependent on external demand since the currency crisis of 1997–98, the country suffered greatly. Although Thailand has been actively promoting free trade agreements (FTAs) with regional economies, including the ASEAN Free Trade Agreement (AFTA), the Thailand-Australia FTA, and the ASEAN-China Free Trade Agreement (ACFTA) in order to diversify its trading partners and export destinations, in 2009 the subprime crisis immediately reduced Thailand’s export growth to negative territory. This shows that Thailand is still vulnerable to fluctuations in the business cycle in the advanced economies, and this weakness has motivated policymakers to revisit their export-led growth policy. The literature indicates that there are three possible transmission channels for financial crises. These are the financial channel (including both liquidity crunches and capital market slumps), the international trade channel, and contagion. Some research suggests that trade linkage between countries is one of the most important transmission channels for crises. Eichengreen, Rose and Wyplosz (1997) and Glick and Rose (1999) show that financial crises can be transmitted to countries which have close trade linkages with the originating country. In the case of Thailand, Cheewatrakoolpong and Manprasert (2008) suggest that transmission of the subprime crisis to the Thai economy mostly occurred via international trade. Empirical evidence exists supporting the above argument. Figure 5.1 shows the relationship between Thailand’s international trade activity (export plus import in value terms) and world GDP growth. It can be observed that Thailand’s international trade growth moves in accordance with world GDP growth. In 2009 the subprime-led contraction in world GDP induced a sharp drop in Thai international trade. However, a rebound in world GDP during 2010 and a level-off of growth later also proves to have had an effect on the outlook for Thailand’s export growth. Figure 5.2 displays the moving correlation between Thailand’s exports and selected trading partners and it is clear that although ASEAN has been rapidly increasing its role in Thailand’s exports, the economic performance of the

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Sources: Ministry of Commerce (Thailand) and IMF.

-1.0

-30.0 World GDP Growth (RHS)

0.0

-20.0

Growth of Thailand’s International Trade

1.0

-10.0

2012

2.0 2011

0.0 2010

3.0

10.0

2009

4.0

20.0

2008

5.0

30.0

2007

6.0

40.0

FIGURE 5.1 World GDP Growth and International Trade Growth in Thailand 2007–12

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2003

2004

World

Sources: IMF, author’s calculation.

-0.4

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

ASEAN-5

2005

2006

China

2007

EU

2008

2009

Japan

2010

FIGURE 5.2 Moving Correlation between Thailand’s Exports and Partners’ GDP over the Past Decade

US

2011

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advanced economies, including the United States, European Union and Japan, still significantly determines Thailand’s export outlook. Recent work also provides empirical evidence showing that international trade linkages are in fact the main channel by which the subprime crisis was transmitted to the Thai economy. Sato and Shrestha (2012) constructed their Global Input-Output (GIO) system and examined the effects of the U.S. economic slowdown on Asian countries. They found that transmission of the crisis could also be explained through relationships with trading partners via international supply chain linkages. Cheewatrakoolpong and Manprasert (2012) employed the Global Trade Analysis Project model (GTAP) to evaluate the impact of the subprime crisis on the Thai economy and found that trade linkages are an important transmission channel because demand contraction can be indirectly transmitted through changes in the demand for intermediate goods and the resulting impact of the multiplier effect. The objective of this chapter is to look for answers to the question of, “How can we reduce the risks associated with disproportionate dependence on exports?” We will argue that given the current levels of globalization and connections in the international supply chain, it is impossible to reduce trade exposure. Rather, to cope with rising risk, Thailand needs to “diversify” its patterns of international trade transactions. Should we be concerned with disproportionate export dependency or with export diversification? To answer our question, several issues need to be examined further. In the next section we will recapitulate literature on the international business cycle and the role of production sharing in explaining business cycle synchronization. We will then argue that direct trade relationships, which are reported by international trade statistics, are distorted by the fact that regional countries, especially within ASEAN, share production networks, and exported goods can go through several re-exporting cycles before reaching consumers. The subsequent section will then examine how we can measure total linkages between countries when there are existing international production networks. Previous empirical work will also be discussed in support of claims regarding the importance of indirect trade channels. We will conclude with a discussion of policy choices for tackling rising vulnerability to external shocks.

2. LITERATURE REVIEW The international business cycle and the propagation between countries of fluctuations within it have been of interest to economists since the 1980s.

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Some of the most important work on this is in Cantor and Mark (1988), who extend Kydland and Prescott’s (1982) general equilibrium model to a model of two opened economies with homogenous characteristics in order to examine the transmission of technology shocks from one economy to the other. Cantor and Mark (1988) show that shocks can propagate across countries through international capital markets because of consumers’ intertemporal decision-making behaviour and, consequently, investments in both countries increase as a result of this international risksharing situation, implying a positive transmission of technology shocks. Zimmermann (1997) introduced heterogeneity to the two-country model as well as adding geographical distance between countries as a parameter. The model contains both small and large countries, where a small country is defined as one that has a higher ratio of international trade to national income. The research shows that small countries experience more volatility in macroeconomic variables than larger economies do. This applies to all variables, including private consumption, investment, employment, and the trade balance. Zimmermann (1997) also found that distance between countries has a significant effect on the transmission of the international business cycle. In fact the author argues that distance is actually more important than the level of international trade connection. The second generation of literature on the international business cycle focused on the role of production networks in the transmission of shocks. Ambler, Cardia and Zimmermann (2002) developed a twocountry model with multi-sector and multistage production processes. Intermediate goods — which may be traded between countries — are used in modelling the multistage production process, and the results of cross-correlations are consistent with actual data. Sensitivity analysis from their model shows that multistage production processes have an important role in the transmission of the international business cycle. Other factors that induce propagation between countries include capital adjustment costs and imperfect substitution of primary and intermediate goods. Recently, Burstein, Kurz and Tesar (2008) examined the effects of vertical integration on the business cycle. They found that countries engaged in production sharing exhibit co-movement in the business cycle, and the level of elasticity of substitution for intermediate goods has a significant impact on the co-movement of the partner countries. In addition to the theoretical models of the international business cycle, a large amount of work has focused on empirical work related to this field. Early works can be found in Backus, Kehoe and Kydland (1995) and Ambler, Cardia and Zimmermann (2004). Both papers examine the

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correlations between various macroeconomic variables across countries. Frankel and Rose (1996) calculate correlations between bilateral intensity of trade and bilateral correlation of real economic activity. They found that pairs of countries that exhibited high bilateral intensity of trade were often highly correlated in terms of their real economic activity. Ng (2010) extended this work by using trade data from twenty-four OECD (Organisation for Economic Co-operation and Development) countries, while also distinguishing complementary and substitution transactions within the general category of international trade. Ng (2010) found that co-movement in the international business cycle was in fact caused by complementary trade transactions. Evidence of the interrelation of the business cycles in Asian countries can be found in Selover (1999), who studied the relationships between the business cycles of Southeast Asian countries and their major trading partners, namely Japan, the United States and the European Union. Selover (1999) found that business cycles in South East Asian countries are explained by both world and regional components. Domestic shocks, such as political turbulence, natural disasters and policy failures within each country tend to affect the business cycle only locally, and are not likely to be transmitted to other regional economies. Shin and Wang (2003) examined the relationship between Korea and twelve other Asian countries. Their analysis separates trade into two types: inter-industry and intra-industry. The most notable findings show that an increase in overall levels of trade between the two countries does not affect business cycle synchronization; the level of intra-industry trade is in fact the main determinant of this co-movement. Kuroiwa and Heng (2008) point out that the explosive growth in Southeast Asian countries between 1985 and 2005 is linked to the expansion in intra-trade industry through MNEs (multinational enterprises). The literature thus points to the important role of international production networks and synchronization between these in determining the international business cycle. Therefore, in order to measure real linkages between countries, we may also need to take into account indirect channels arising from production sharing. Two countries which have only low levels of bilateral trade may be indirectly linked through a third-party country which imports intermediate goods from a producer country, then assembles and re-exports them to the destination country. For example, Thailand exports disk drives to China as intermediate inputs for notebooks,

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which are then re-exported to the United States as finished products. In this case, Thailand’s export of disk drives is an indirect link to the United States, and this would not be observed in the international trade statistics. Direct bilateral statistics therefore underestimate trade linkages between intermediate producers and final destinations, and this in turn raises issues concerning how we might measure the real exposure between countries. This will be examined in the next section.

3. MEASURE OF TOTAL TRADE LINKAGES: THE CASE OF THAILAND The calculation of total trade linkages in this section will be based on the work of Cheewatrakoolpong and Manprasert (2013), who have constructed a simple algorithm that calculates total trade linkages between countries by exploiting data from the United Nations Comtrade and coefficients from the Global Trade Analysis Project (GTAP). According to their work, the total trade linkages among countries in the world economy can be calculated by: L = D(I — (I — A)S)-1 where, L is a vector of calculated total trade linkages with trading partners, D is a vector of reported direct trade statistics with trading partners, I is an identity matrix, A is a diagonal matrix containing the share of domestic final consumption, and S is a matrix of export shares. In short, the matrix multiplication on the right-hand side calculates the infinite sum of re-exporting activities for a given country to its final destination. Thus, the total linkages li (i.e., element at row ith of a vector L) refers to the quantity of finished products being consumed at the final destination. The results for Thailand’s total trade linkages against selected trading partners are discussed below.

3.1 Patterns of Cross-country Trade Linkages Although we have calculated the total trade linkages for all bilateral relationships between 129 countries, here we discuss only some interesting

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results of Thai trade relationships. This is because Thailand is well known as an assembly hub for manufacturing industries in Southeast Asia. Regional integration (i.e., ASEAN) has thus far helped stimulate the development of international production networks among member countries, and therefore using Thailand as a case study should illuminate the importance of understanding total trade linkages. In this analysis we will examine only Thailand’s top thirty trading partners, though these countries account for 85 per cent of the country’s total trade linkages. By using Thailand as a base country for the analysis, in this section we will highlight the differences between reported international trade statistics (i.e., direct trade linkages) and our total linkage figures calculated from the trade matrix. Table 5.1 reports the results for trade destination exposure of Thailand to its top-thirty trading partners in 2011. Looking at the results, we observe significant differences between Thailand’s trade exposure when considering total linkages rather than direct trade figures. For example, Thailand’s exports to the United States increase from 9.6 to 12.8 per cent after accounting for indirect trade transactions through other countries. Similar patterns also appear in Thai trade relations with other countries. For example, exports to Germany (DEU), France (FRA) and Japan (JPN) increase by 1.1, 0.7 and 0.6 per cent, respectively. On the other hand, the reverse occurs with Thailand’s export figures to Malaysia (MYS), Singapore (SGP), Hong Kong (HKG), Vietnam (VNM), the Philippines (PHL) and Cambodia (KHM). International trade exposure to Thailand from these countries decreases by as much as 2.9 per cent with Malaysia and by 0.5 per cent in the case of the Philippines and Cambodia. When we rank the trade shares according to the total linkages and compare this with direct trade figures, the ranking of importance of Thailand’s trade partners also changes significantly. Germany, France, Italy and Canada move up the rankings significantly, while it is also worth noting that the United States and China remain the most important export destinations for Thailand when using either measure. In contrast, most of the decreases in Thailand’s trade exposure come from regional trading partners who are members of ASEAN. This finding supports the view that regional economic integration within Southeast Asia could in fact encourage production linkages among member countries. Since our matrix calculation implies an infinite sum of every re-export leg from the country of origin, we could in fact decompose this infinite sum to only first-round linkages — in other words, a simple multiplication of only two legs of export shares by destination. This simple analysis allows

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Thailand: Dependency or Diversification? TABLE 5.1 Direct Trade Statistics and Calculated Total Linkages of Thailand and Trading Partners Trade Linkages to Thailand

US China Japan Hong Kong Indonesia Australia India Germany Malaysia Korea Singapore UK Netherlands Vietnam Switzerland France Philippines Taiwan Italy Brazil UAE Canada Belgium South Africa Rest of SE Asia Laos Mexico Russia Cambodia Turkey

Trading Partners Rank

Direct

Total

Difference

Direct

Total

Change

9.6% 12.0% 10.5% 7.2% 4.4% 3.5% 2.3% 1.6% 5.4% 2.0% 5.0% 1.7% 2.0% 3.1% 2.1% 0.9% 2.0% 1.7% 0.8% 1.0% 1.2% 0.7% 0.8% 1.0% 1.3% 1.2% 0.6% 0.5% 1.3% 0.5%

12.8% 11.8% 11.2% 5.2% 3.8% 3.5% 2.8% 2.7% 2.5% 2.5% 2.5% 2.3% 2.1% 1.9% 1.6% 1.6% 1.5% 1.5% 1.3% 1.2% 1.2% 1.1% 1.0% 0.9% 0.9% 0.9% 0.8% 0.8% 0.8% 0.8%

3.3% –0.2% 0.6% –2.0% –0.6% 0.0% 0.6% 1.1% –2.9% 0.5% –2.5% 0.6% 0.1% –1.2% –0.5% 0.7% –0.5% –0.2% 0.5% 0.3% 0.0% 0.4% 0.2% 0.0% –0.4% –0.4% 0.3% 0.3% –0.5% 0.2%

3 1 2 4 7 8 10 17 5 13 6 15 14 9 11 25 12 16 26 22 21 28 27 24 18 20 30 33 19 31

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

2 –1 –1 0 2 2 3 9 –4 3 –5 3 1 –5 –4 9 –5 –2 7 2 0 6 4 0 –7 –6 3 5 –10 1

Sources: UN Comtrade and author’s calculation.

us to examine the degree of complication in transnational production networks. Figure 5.3 compares trade shares between direct, first-round, and total linkages for Thailand’s top-thirty trading partners. We found that the differences appear only between direct trade shares and others; computed trade exposure in first-round and total linkages do not differ significantly

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DEU

AUS IND

HKG IDN

CHN

JPN

USA

Sources: UN Comtrade and author’s calculation.

0.0%

2.0%

4.0%

6.0%

8.0%

Direct

First Round

FRA

NLD GBR

10.0%

CHE

12.0%

PHL

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Total

ITA

14.0%

FIGURE 5.3 Comparison between Direct, First-round, and Total Trade Linkages

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TUR KHM

RUS MEX

LAO XSE

ZAF BEL

CAN ARE

BRA

TWN VNM KOR

SGP

MYS

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from one another. This may imply that the structure of international production networks in general involves only double-legged linkages, particularly in the case of Thailand. It also suggests that Thailand may be a producer of almost-finished products for the international supply chain.

3.2 Patterns in Trade Linkages In this section we observe patterns in Thailand’s international trade exposure over the period 2000 to 2011. For analytical purposes, we have grouped trading partners according to regional integration, namely the European Union, ASEAN and Australia–New Zealand (ANZ). The results show that Thailand has been more exposed than originally thought to China, ASEAN and Australia–New Zealand during the past decade. In particular, total exposure to China tripled between 2000 and 2011. Exports to Australia–New Zealand doubled, while total trade linkages to ASEAN increased by 50 per cent during the same period. On the other hand, connections to G3 countries have been decreasing over time. Over this period trade linkages to the United States declined by more than half, as did exposure to the European Union and Japan. It is worth noting that figures for Thailand’s direct trade with China, Japan and Australia–New Zealand are quite similar to total linkages, implying that these direct trade statistics could well represent the level of true exposure to those same countries. Differences between calculated total linkages and direct trade figures are found in exports to the United States, the European Union and ASEAN. While the reported direct trade transactions from Thailand to the first two regions seem to be consistently understated over time, exports to ASEAN have been exaggerated. Although the reported figures may obscure these relationships, the calculated total linkages show that Thailand’s exports to ASEAN have been increasing over time. The same can also be seen in the patterns of exports to the European Union and the United States; total linkages to these regions have declined in line with direct trade figures. These findings imply that Thailand has been exporting intermediate goods and that the majority of export-oriented production activities are focused on intermediate goods. Thus, if we shift the growth engine from external to domestic demand, we also need to change the pattern of production, because local demand would need to consume finished goods, but this type of restructuring process (shifting from intermediate goods

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to finished goods) would not be achieved easily or over a short timehorizon. In addition, failure to switch production to finished products to meet domestic demand may simply draw in greater amounts of imported finished products in the short-run.

4. DEPENDENCY OR DIVERSIFICATION? The previous section has highlighted the importance to Thailand of changing patterns of international trade over the past decade. The patterns we have discussed have also emerged globally. Cheewatrakoolpong and Manprasert (2013) have found that on average, the proportion of indirect trade transactions in international trade increased by 1.1 per cent globally over the past decade. Recent empirical work underscores the importance of these indirect linkages in explaining synchronization of international business cycles. Research has confirmed this role in crisis transmission. Park (2007) employed the Oxford Economics Global Model to evaluate the possible impact of negative shocks in the United States, and found that a U.S. economic slowdown on its own would not have a direct impact on the East Asian economies. However, the impact became significant through a slowdown in China. Abeysinghe and Forbes (2005) examined two linkages that could transmit a crisis or shock from one country to another: bilateral-trade flows and output-multiplier effects. The study employed the structural VAR approach and found that direct trade flows can explain only a small part of the diffusion of the crisis. The results show that the output-multiplier effects actually account for the transmission of an economic slowdown to a country that has low levels of direct trade linkages. Hesebe and Shrestha (2006) examined the degree of regional economic integration in Asia using the International Input-Output data from the Institute of Developing Economies (IDE). They found that “The average self-dependence in East Asia countries has been decreasing continuously. Such a decline in self-dependence means that the East Asian countries on average depend more on non-regional countries than intra-regional trade, which may be due to the globalizing force in the region” (p. 1772). Recently, Cheewatrakoolpong and Manprasert (2012) employed the CGE model to examine the pattern of crisis transmission from the United States to Thailand by separating international trade transactions into direct and indirect linkages. They found that Thailand was in fact seriously affected by the U.S. slowdown through indirect channels to a great degree. Most importantly, decreases in demand for intermediate goods caused significant indirect effects.

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Thailand: Dependency or Diversification? FIGURE 5.4 Pattern of Trade Exposures to Thailand over Time 14.0%

16.0%

12.0%

14.0% 12.0%

10.0%

10.0%

8.0%

8.0%

6.0%

6.0%

4.0%

4.0%

2.0%

2.0%

0.0%

0.0% 2000

2005 China (total)

2011

2000

China (direct)

2005 Japan (total)

25.0%

30.0%

20.0%

25.0%

2011 Japan (direct)

20.0%

15.0%

15.0%

10.0%

10.0%

5.0%

5.0% 0.0%

0.0% 2000

2005

ASEAN (total)

2000

2011

2005 US (total)

ASEAN (direct)

4.5%

16.0%

4.0%

14.0%

3.5%

12.0%

3.0%

2011 US (direct)

10.0%

2.5%

8.0%

2.0%

6.0%

1.5% 1.0%

4.0%

0.5%

2.0% 0.0%

0.0% 2000

2005 ANZ (total)

2011 ANZ (direct)

2000

2005 EU (total)

2011 EU (direct)

Sources: UN Comtrade and author’s calculations.

Given a situation where Thailand has been integrated into the world business cycle through its engagement in international production networks, it might not be easy to substitute domestic demand for external demand. This is because our production activities are mainly focused on the manufacture of intermediate goods for export; shifting dependency towards domestic demand requires changes in local production from intermediate goods to finished goods. After all, local consumers need finished goods to consume, not intermediate ones.

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How might this vulnerability to external shocks be reduced? Financial theory suggests that reduction of exposure to risks can be achieved by diversification. In the literature on international trade, much work supports this argument and points to the benefits of achieving both destination diversification and product diversification. For example, Al-Marhubi (2000) shows that diversification has an impact on the long-term growth of the country. Work by Da Costa Neto and Romeu (2011) reveals that destination concentration plays a small role in crisis transmission. However, product concentration in exporting activities significantly exacerbates collapses in trade when external economies enter a downturn. He, Cheung and Chang (2007) argue that output fluctuations in East Asian countries seem not to be decoupled from the United States, and in fact they found that the region has reduced its diversification in export destination because of changing trade patterns in recent years. They suggest that “the desirable way to reduce external vulnerabilities is to diversify export markets and to further strengthen domestic institutions and policies in order to reduce the impact of temporary shocks, not by reducing the degree of openness or share of exports in GDP” (He, Cheung and Chang 2007, p. 1). These findings prompt us to conclude our main question here: dependency or diversification? The policy implications of this rest on the importance of risk management in international trade activities, but export diversification should help protect Thailand in an era of global economic uncertainties.

References Abeysinghe, T. and K. Forbes. “Trade Linkages and Output-Multiplier Effects: A Structural VAR Approach with a Focus on Asia”. Review of International Economics 13, no. 2 (2005): 356–75. Al-Marhubi, F. “Export Diversification and Growth: An Empirical Investigation”. Applied Economics Letters 4, no. 9 (2000): 559–62. Ambler, S., E. Cardia, and C. Zimmerman. “International Transmission of the Business Cycle in a Multi-sector Model”. European Economic Review 46, no. 2 (2002): 273–300. ———. “International Business Cycles: What are the Facts?” Journal of Monetary Economics 51, no. 2 (2004): 257–76. Backus, D., P. Kehoe, and F. Kydland. “International Business Cycle: Theory vs. Evidence. Frontiers of Business Cycle Research”. Princeton, NJ: Princeton University Press, 1995. Bank for International Settlements. “BIS 78th Annual Report”. Bank for International Settlements, 2008.

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Burstein, A., C. Kurz, and L. Tesar. “Trade, Production Sharing, and the International Transmission of Business Cycles”. Journal of Monetary Economics 55, no. 4 (2008): 775–95. Cantor R. and N.C. Mark. “The International Transmission of Real Business Cycles”. International Economic Review 29, no. 3 (1988): 493–507. Cheewatrakoolpong, K. and S. Manprasert. “Effects of the US Subprime Crisis on the Thai Economy”. Chulalongkorn Business Review 117–18 (July–December 2008): 1–23. ———. “Trade Concentration and Crisis Spillover: Case Study of Transmission of the Subprime Crisis to Thailand”. ARTNeT Working Paper Series no. 112. Bangkok: United Nations Economic and Social Commission for Asia and the Pacific (UN ESCAP), 2012. ———. “Trade Linkages and Crisis Spillovers: The Case of East Asian Countries”. Asian Economic Papers 13, no. 1 (2014). Da Costa Neto, N. and R. Romeu. “Did Export Diversification Soften the Impact of the Global Financial Crisis?” IMF Working Paper WP/11/99. Washington, DC: International Monetary Fund, 2011. Eichengreen, B., A. Rose, and C. Wyplosz. “Contagious Currency Crises”. NBER Working Paper Series no. 5681. Cambridge, MA: National Bureau of Economic Research, 1997. Frankel, J. and A. Rose. “Currency Crashes in Emerging Markets: Empirical Indicators”. NBER Working Paper no. 5437. Cambridge, MA: National Bureau of Economic Research, 1996. Glick, R. and A. Rose. “Why are Currency Crises Contagious?” Review of World Economics 134, no. 4 (1999): 664–91. Hasebe Y. and N. Shrestha. “Economic Integration in East Asia: An International Input-Output Analysis”. World Economy 29, no. 12 (2006): 1709–35. He, D., L. Cheung, and J. Chang. “Sense and Nonsense on Asia’s Export Dependency and the Decoupling Thesis”. Hong Kong Monetary Authority Working Paper no. 03/2007. Hong Kong, 2007. Johnson, R. and G. Noguera. “Accounting for Intermediates: Production Sharing and Trade in Value Added”. Journal of International Economics 86, no. 2 (2012): 224–36. Koopman, R., Z. Wang, and S. Wei. “How Much of Chinese Exports is Really Made in China? Assessing Domestic Value-added When Processing Trade is Pervasive”. NBER Working Paper no. 14109. Cambridge, MA: National Bureau of Economic Research, 2008. Kuroiwa, I. and T.M. Heng. Production Networks and Industrial Clusters: Integrating Economies in Southeast Asia. Singapore: Institute of Developing Economies and Institute of Southeast Asian Studies, 2008. Kydland, F.E. and E.C. Prescott. “Time to Build and Aggregate Fluctuations”. Econometrica 50, no. 6 (1982): 1345–70.

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Ng, E.Y. “Production Fragmentation and Business Cycle Co-movement”. Journal of International Economics 82, no. 1 (2010): 1–14. Park, C.Y. “Can East Asia Weather a US Slowdown?” ERD Working Paper Series no. 95. Manila: Asian Development Bank, 2007. Sato, K. and N. Shrestha. “Global and Regional Shock Transmission — New Evidence from Globally Integrated Input-Output Table”. Singapore: The 13th International Convention of the East Asian Economic Association, 2012. Selover, D.D. “International Interdependence and Business Cycle Transmission in ASEAN”. Journal of the Japanese and International Economics 13 (1999): 230–53. Shin, K. and Y. Wang. “Trade Integration and Business Cycle Synchronization in East Asia”. KIEP Working Paper no. 03–01. Korea: Korea Institute for International Economic Policy, 2003. Zimmermann, C. “International Real Business Cycles among Heterogeneous Countries”. European Economic Review 41, no. 2 (1997): 319–55.

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6 VIETNAM’S ECONOMIC EXPERIENCE SINCE WTO ACCESSION Vo Tri Thanh

1. INTRODUCTION The past six years have been a memorable experience for Vietnam. After a long period of continuous high growth and macroeconomic stability till 2007, Vietnam pitched itself to foreign investors as one of the most attractive investment destinations. The accession to the World Trade Organization (WTO) further consolidated optimism about Vietnam’s growth prospects. However, after a short period of overly optimistic expectations in the first half of 2007, Vietnam had to start worrying about the overall economic situation. The accumulated inflationary pressures from continuous credit and public investment expansions, in combination with external shocks such as rising energy and rice prices, and inappropriate policy responses to a surge in capital inflows in 2007, sent the country into macroeconomic turbulence and saw it struggle to formulate a proper stabilization policy. A policy package to deal with macroeconomic instability has been implemented since March 2008. And whilst the macroeconomic situation somewhat improved by the end of 2008, the country suffered serious

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adverse impacts from the global financial crisis and recession. The policy stance then had to be reverted to prevent an economic downturn, via coordinated stimulus measures. Economic growth subsequently recovered but was accompanied by increasing macroeconomic instability. The situation necessitated a further switch in macroeconomic policies towards curbing inflation and restoring macroeconomic stability, which has been a dominant policy trend since early 2011. This chapter will look into Vietnam’s key experiences with macroeconomic policy management since the WTO accession in 2007. In doing so, the chapter portrays the main patterns of macroeconomic performance and related policy responses. The key focus is on the three sub-periods of macroeconomic instability or economic downturn that forced Vietnam to switch the policy stance. This will be the basis to determine the key lessons of policy management since 2007. The remainder of the chapter is structured as follows: Section 2 provides an overview of Vietnam’s macroeconomic performance and policy changes since the WTO accession in 2007. Section 3 analyses the issue of macroeconomic instability and the policy responses implemented in late 2007 to 2008. Section 4 focuses on the economic downturn and stimulus package implemented in Vietnam in late 2008 to 2009. Section 5 then summarizes the key policy responses by the Government of Vietnam to macroeconomic instability and structural problems since 2011. Finally, Section 6 draws out some key lessons from Vietnam’s experience with macroeconomic stabilization since 2007.

2. VIETNAM’S MACROECONOMIC PERFORMANCE AND POLICY CHANGES SINCE WTO ACCESSION 2.1 Economic Growth Economic growth in Vietnam tended to slow down in the post-WTO era. The GDP growth rate of Vietnam in 2007–11 was only 6.6 per cent annually, less than the average of 7.8 per cent during the five-year period of 2002–6; and even lower than the average of 7 per cent during the East Asian financial crisis (1996–2000). Consequently, Vietnam could not achieve the 7.5–8 per cent economic growth target of the 2006–10 five-year plan. The pace of economic growth became even slower in 2012 and 2013, reaching 5.03 per cent in 2012 and 4.9 per cent in the first half of 2013 (Table 6.1). Although Vietnam’s GDP growth rate declined dramatically since 2000,

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125

Vietnam’s Economic Experience since WTO Accession TABLE 6.1 Economic Growth in Vietnam, 2007–Q2/2013 (%) 2007

2008

2009

2010

2011

2012

Q1/2013

6M/2013

Overall

18.46

6.31

5.32

6.78

5.89

5.03

4.89

4.90

Forestry & fisheries

13.76

4.68

1.82

2.78

4.89

2.72

2.24

2.07

Construction

10.18

5.97

5.54

7.68

5.53

4.52

4.93

5.18

Services

18.88

7.41

6.63

7.54

7.01

6.42

5.65

5.92

Source: General Statistics Office.

it was still better than the much lower or even negative growth rates experienced by many other countries in the context of financial crisis and economic recession. From the supply side, till 2010 GDP growth continued to be driven by the construction industry. Growth of the sector dropped from 10.2 per cent in 2007 to 5.5 per cent in 2009, before recovering to 7.7 per cent in 2010. Since 2011, however, the construction industry no longer plays the growth-driver role in Vietnam; growth figures fell to 5.5 per cent in 2011 and 4.5 per cent in 2012, and barely recovered to 5.2 per cent in the first half of 2013. Meanwhile, the services sector demonstrated the most rapid growth, reaching 6.4 per cent in 2012 and 5.9 per cent in the first half of 2013. The agriculture, forestry and fishery sector continued to experience slower growth, particularly evident during 2011–13. Vietnam’s economic growth relies heavily on foreign savings. Due to the rapid increase in domestic consumption during 2007–8, domestic savings as a proportion of GDP fell from 30.6 per cent in 2006 to 28.8 per cent in 2008. As domestic investment expanded up to 2010, the domestic savingsinvestment gap (much more than 10 percentage points) kept widening, and it could hardly be met by overseas capital in a sustainable manner. Following the cuts in public investment and tightened macroeconomic policies since 2011, the investment ratio contracted to around 30 per cent of GDP. As such, the reliance on foreign savings was reduced.

2.2 Inflation From the beginning of 2008 consumer-price-index-based inflation1 started to rise. The figure reached a peak of 28.3 per cent in August 2008, and

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even attained the enormous rate of 16.5 per cent after removing the prices of food and foodstuffs, which account for a large share in the CPI basket (about 43 per cent). The administrative upward adjustment of petroleum prices also had some effect on higher inflation (see Figure 6.1). Since September 2008, the month-on-month inflation has declined significantly, to –0.19 per cent in October, –0.76 per cent in November, and –0.68 per cent in December, leaving the year-on-year inflation rate of 19.9 per cent for 2008 as a whole. This decline continued until March 2009, when year-on-year inflation reached 11.3 per cent while month-on-month inflation was low. The underlying reasons were due to both good luck (falling international prices of rice and fuels) and better policy implementation (the impact of stabilization policies). In subsequent months until September 2009, year-on-year inflation went down further to 2.4 per cent, yet monthon-month inflation tended to hike2 due to the increases in money supply, salaries/wages and international prices. During the last quarter of 2009, inflation started to accelerate again: year-on-year inflation rose to over 6.5 per cent in December from just under 3 per cent in October. For 2009 as a whole, the CPI-based inflation rate was reported at just below 6.9 per cent. Since September 2010, inflation (based on year-on-year CPI) started to regain its uptrend, though the acceleration was not as much as in 2007–8. CPI of December 2010 went up by 11.8 per cent compared with that of the same period of 2009, while the average CPI in 2009 increased by about 9.2 per cent relative to that in 2009. The prices of housing, construction materials, dining and food services increased at the highest rates. CPI continued to increase in 2011, and even exceeded the target set by the National Assembly. For instance, in the first five months of the year, the inflation rate was 12.1 per cent, much higher than the 2011 target of 7 per cent. Thus, the government requested the National Assembly to adjust the inflation target, first to 15 per cent and then to 17 per cent. By August 2011 the year-on-year inflation rate reached 23 per cent. The inflationary pressure gradually lessened towards the end of the year. The inflation rate, though still high, continued to decline. By December 2011 the year-on-year inflation rate had reached 18.1 per cent, while average inflation for 2011 was approximately 18.6 per cent. High inflation in 2010–11 resulted from both domestic and external factors. The external factors included inflationary pressures in many countries, higher prices of inputs, natural calamities, and epidemics. Meanwhile, high inflation could also be attributed to domestic factors such

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2006

CPI inflation

2007

Food and foodstuffs

2008

2009

Non-food

2010

2012

Housing and construction materials

2011

2013

1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7 9 11 1 3 5 7

Source: General Statistics Office.

0

10

20

30

40

50

FIGURE 6.1 Year-on-Year Inflation Ratio, 01/2006–08/2013 (%)

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Vo Tri Thanh

as mounting consumer demand and purchasing power (particularly the period around the Lunar New Year and at the end of the year), increases in the prices of essential goods (petroleum, electricity, water, etc.), the effects of the crawling-peg exchange rate policy, and the failure to properly retreat from the stimulus package to address the economic downturn in 2009. Acknowledging the inflationary pressure since late 2010, the government decided to tighten macroeconomic policies. The policy stance was again switched to macroeconomic stabilization, with the indicated willingness to accept lower economic growth. Higher consistency in policies towards this target was also in place, thereby helping reduce inflation since September 2011. Aggregate demand thus contracted with the reduction of both public investment and growth of M2, while a stable exchange rate was maintained. Year-on-year inflation dropped rapidly from 23 per cent in August 2011 to 18.1 per cent in December 2011, then 6.8 per cent in December 2012 before recovering slowly to 7.5 per cent in August 2013. Notably, the increase in inflation was largely due to the price adjustment of basic goods and services (such as petroleum, electricity, health care, etc.). Evidence of macroeconomic stability became evident, albeit at the expense of slower economic growth.

2.3 Balance of Payments Vietnam continued to run a current account deficit until 2011, yet the deficit increased over time. The deficit was valued at US$10.7 billion (or 11.9 per cent of GDP) in 2008, US$6.6 billion (6.8 per cent of GDP) in 2009, and US$4.4 billion (4 per cent of GDP) in 2010. This result is remarkable, given the fact that the country only incurred a current account deficit of under US$0.2 billion (or 0.3 per cent of GDP) in 2006. The increase in current account deficit was largely due to the surge in trade deficit, to nearly US$12.8 billion (14.2 per cent of GDP) in 2008, US$7.6 billion (7.8 per cent of GDP) in 2009 and US$5.2 billion (4.8 per cent of GDP) in 2010, compared with nearly US$2.8 billion (4.6 per cent GDP) in 2006. The trend had only been reversed since 2011 in the context of slower economic growth following tightened macroeconomic policies. The current account was in a small surplus in 2011 (US$236 million), which was then widened to over US$6.5 billion in the first nine months of 2012. In the meantime the capital account has been in surplus since 2007. In 2008 the surplus amounted to US$12.3 billion thanks to the massive inflows

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of foreign investment. The figure then fell sharply to US$7.1 billion in 2009 and US$6.2 billion in 2010. This contraction of capital account surplus has continued even since 2011, as slower economic growth failed to induce foreign capital inflows. The surplus had come down to only US$2.9 billion in the first nine months of 2012. Accordingly, the overall balance of payments (BOP) exhibited drastic variations. The BOP switched from a huge surplus in 2007 (US$10.2 billion) to a massive deficit in 2009 (US$8.5 billion). Since 2010 the BOP was improved to reach a surplus of US$1.1 billion in 2011and US$8.2 billion in the first nine months of 2012. These variations were largely due to changes in current account deficit as well as the sources to finance such deficits.

2.4 Exchange Rate In the period 2007–11, the VND/USD exchange rate exhibited complicated movements in different directions (see Figure 6.2). In order to promote export growth in particular and export-led economic growth in general, the dong had to undergo nominal depreciation against the U.S. dollar. The extent of depreciation depended on the State Bank of Vietnam’s (SBV) assessment of international trade and the specific situation of the foreign exchange market. Consequently, for a long period since the 1990s, the dong has depreciated continuously in nominal terms against the U.S. dollar.3 Till mid-2011, the VND/USD exchange rate only decreased during a short period of time, from October 2007 to April 2008. Even in the years when the VND/USD exchange rate exhibited an upward trend, the extent of increase became much more unpredictable; a result of market factors and partly the management of the exchange rate policy. Demand-supply in the foreign exchange market were affected by factors such as foreign capital flows (since the end of 2006), fluctuations of gold prices and gold export-imports, higher imports due to the expansion of assets and income, and changes of exports due to the effects of development phases of the world economy (growth – recession – recovery). Under some circumstances the SBV conducted exchange rate policy in an inconsistent manner. The utilization of the permitted trading band instead of adjusting the official exchange rate sometimes led to unexpected outcomes. Despite administrative measures (such as state corporations being requested to sell foreign currencies for banks) as well as statements from SBV’s leaders, the SBV failed to narrow the gap between the parallel

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% GDP

3.7 14.4

6,550

2,124

6,243

2,623

10,206

FDI (net)

Foreign loans (net)

Indirect investment (net)

Currencies and deposits

9.1

474

677

–578

2,963

9,279

12,341

7,311

–4,401

–950

0.5

0.7

–0.6

3.3

10.2

13.5

8.0

–4.8

–1.0

Sources: Vo and Nguyen 2010 and International Financial Statistics.

8.8

3.0

9.2

25.0

6,430

17,730

–3.1

–1.3

–14.6 –12,783 –14.0

Capital account

Balance of payment (including Errors and Omissions)

$ mil.

2008 –9.9 –10,823 –11.9

% GDP

Transfers (net)

–2,168

Investment income (net)

–894

Trade in goods (FOB)

Trade in services

–6,992

–10,360

Current account

$ mil.

2007

–8,465

–4,803

128

5,146

6,900

7,172

6,448

–3,028

–2,421

–7,607

–6,608

$ mil.

–8.7

–4.9

0.1

5.3

7.1

7.4

6.6

–3.1

–2.5

–7.8

–6.8

% GDP

2009

TABLE 6.2 Balance of Payments

–1,765

–7,063

2,383

3,794

7,100

6,201

7,885

–4,564

–2,461

–5,147

–4,287

$ mil.

–1.7

–6.6

2.2

3.6

6.7

5.8

7.4

–4.3

–2.3

–4.8

–4.0

% GDP

2010

1,151

–6,402

1,412

4,900

6,480

6,390

8,685

–5,019

–2,980

–450

236

$ mil.

1.0

–5.3

1.2

4.1

5.4

5.3

7.2

–4.2

–2.5

–0.4

0.2

% GDP

2011

8,170

–5,844

1,364

1,944

5,450

2,915

6,051

–3,920

–2,430

6,816

6,517

$ mil.

—

—

—

—

—

—

—

—

—

—

—

% GDP

Q3/2012

130 Vo Tri Thanh

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exchange rate in the free market and that in the commercial banks (Truong et al. 2011). In other cases, the official exchange rate was kept stable for too long a period, and was only adjusted when the cumulative pressure from the parallel market became severe. In such cases the extent of adjustment was relatively significant. Figure 6.2 depicts the movement of the VND/USD exchange rate for 2007–13. In the first nine months of 2007, the interbank VND/USD exchange rate was gradually increased by the SBV. The degree of adjustment was insignificant; only about 0.4 per cent over the whole period. However, this modest increase was attributed to the management of an exchange rate policy that did not closely capture actual changes in the market. As a result, the parallel exchange rate (the exchange rate set by participants in the free market) exceeded the permitted ceiling rate in the formal market in August 2007. Between October 2007 and March 2008, the rapid increase of foreign capital inflows to Vietnam exerted pressures on the dong to appreciate in nominal terms against the U.S. dollar. The interbank VND/USD exchange rate announced by the SBV was reduced at a faster pace (by approximately 1.3 per cent) than the increase in the first nine months of 2007. Between April 2008 and December 2008, the VND/USD exchange rate tended to increase, due to a high trade deficit, divestment of foreign capital to foreign countries in the context of domestic macroeconomic instability and global economic recession, and a rush to purchase foreign currencies. From the beginning of 2010 the VND/USD exchange rate continued to increase. However, the foreign exchange market still saw tension that required the SBV to increase the interbank exchange rate considerably. In February 2010 the SBV increased the interbank exchange rate by about 3.4 per cent. In August 2010 the SBV once again raised the interbank VND/ USD exchange rate, by 2.1 per cent to 18,932. But these measures only helped the official exchange rate to maintain the race with the parallel rate. Meanwhile, confidence in the dong was not significantly improved; neither businesses nor individuals were very much motivated to reduce the amount of U.S. dollars they held, not to mention the expectation on further appreciation of the U.S. dollar against the dong. Consequently, the gap between the official and parallel exchange rate became wider. At the end of November 2010 the parallel VND/USD exchange rate jumped to 21,380–21,450, leading to a gap of 10 per cent between the two, the biggest in the history of Vietnam’s finance since 1990. As a result the SBV had to

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132

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Parallel rate Ceiling rate Floor rate Official interbank rate

Source: Nguyen 2013.

15,500

16,500

17,500

18,500

19,500

20,500

21,500

22,500

FIGURE 6.2 Movements of VND/USD Exchange Rate, 01/2007–08/2013

08/2013 07/2013 06/2013 05/2013 04/2013 03/2013 02/2013 01/2013 12/2012 11/2012 10/2012 09/2012 08/2012 07/2012 06/2012 05/2012 04/2012 03/2012 02/2012 01/2012 12/2011 11/2011 10/2011 09/2011 08/2011 07/2011 06/2011 05/2011 04/2011 03/2011 02/2011 01/2011 12/2010 11/2010 10/2010 09/2010 08/2010 07/2010 06/2010 05/2010 04/2010 03/2010 02/2010 01/2010 12/2009 11/2009 10/2009 09/2009 08/2009 07/2009 06/2009 05/2009 04/2009 03/2009 02/2009 01/2009 12/2008 11/2008 10/2008 09/2008 08/2008 07/2008 06/2008 05/2008 04/2008 03/2008 02/2008 01/2008 12/2007 11/2007 10/2007 09/2007 08/2007 07/2007 06/2007 05/2007 04/2007 03/2007 02/2007 01/2007

Commercial bank rate

Vo Tri Thanh

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increase the official VND/USD exchange rate by about 9.3 per cent (see Figure 6.2). The situation only saw a significant improvement after the implementation of Resolution No. 11/NQ-CP (referred to as Resolution 11) in February 2011, aimed at comprehensively controlling inflation and stabilizing the macro economy. Still, the exchange rate has only stabilized since late 2011, following the announcement of the SBV. Accordingly, to help control inflation, the official exchange rate was kept rather stable and only underwent a minor adjustment (of 1 per cent) in late June 2013. As noted earlier, the stable exchange rate rested heavily on an improved trade balance, a better supply of the U.S. dollar in the foreign exchange market, and the determination of the SBV in restoring stability to the exchange rate.

3. MACROECONOMIC INSTABILITY AND POLICY RESPONSES IN LATE 2007 TO 2008 Vo and Nguyen (2009) have identified several causes of the rapid surge in inflation till mid-2008. First, expansionary macroeconomic policies in the previous period, while contributing to impressive growth performance, also built up dramatic inflationary pressures. More importantly, the emphasis on simultaneously sustaining high economic growth and macroeconomic stability seemingly reflected the improper recognition of the trade-off between economic growth and inflation. Also, overshadowed by the acceleration of growth and integration attempts, high inflation did not turn out to be a severe problem at the time. As such, the persisting inflationary pressures until 2007 were underestimated, and they remained without being addressed. As contended by Vo and Pham (2008), the macroeconomic policy responses up to February 2008 seemed to be less effective in stabilizing the economy or in reducing policy inconsistencies and financial risks. Second, international prices have been high, while the crawling-peg exchange rate regime produced the effect of importing inflation. For example, prices of primary commodities went up by 29.4 per cent in 2007, and by 24.6 per cent in the first eight months of 2008, while the figures for energy prices are 44 per cent and 32.1 per cent, respectively. In particular, rice prices soared in the first eight months of 2008, by almost 95 per cent.4 From Vietnam’s perspective, the import price index increased 18.2 per cent

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in 2008, while the corresponding figure for imported food and foodstuffs reached 21.6 per cent. Meanwhile, seeking to promote export growth, Vietnam allowed for a gradual devaluation of the nominal VND/USD exchange rate. In this context, however, the country effectively imported inflation from the world market into the domestic one. Third, the massive unprecedented increase in foreign capital inflows in 2007 left policymakers uncertain about how to formulate their policy responses. Vietnam’s accession to the WTO in 2007 also made foreign investors more confident of the country’s development prospects. This led to a dramatic surge in capital inflows, even prior to the accession as discussed earlier. Exchange rate inflexibility along inadequate sterilization led to a dramatic increase in money supply. In 2007 as a whole, M2 went up by almost 49.1 per cent (much higher than the 29.7 in 2006). Subsequent administrative measures in early 2008 to withdraw money failed to produce the desired effect, while leaving a number of banks, particularly small ones, with liquidity shortages. The comprehensive policy responses, which marked a turning point in Vietnam’s policymaking process, only came with the Political Bureau’s Conclusion No. 22–KL/BCT and Government Resolution No. 10/2008/NQCP dated 17 April 2008. These set out the objectives and policy packages more clearly and consistently. Specifically, the most essential policy target was to control inflation and stabilize the (macro-)economy, while the growth target would be lowered. In addition the government resolution specified eight policy directions (including monetary policy, exchange rate policy, fiscal policy and public investment, trade policy, price policy, capital flows management, social safety net policy, and information and communication policy) for coordinated implementation. A summary of the follow-up policies is as follows. Monetary policy was tightened with the objective of total credit growth of below 30 per cent in 2008. The reserve requirement ratios increased by one percentage point for all terms and currencies. Policy interest rates, after experiencing a low and stable level during 2005–7, started rising more or less in February 2008 and then increased sharply on 17 May 2008 (Figure 6.3). As a result, short-term deposit rates and lending rates in June 2008 reached 17–18 per cent per year and 23–25 per cent per year, respectively. In addition, the requirements on the reporting regime of commercial banks and the close supervision over credit institutions, particularly with regard to loans relating to real estate and securities, were strengthened.

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2

4

6

8

10

Source: SBV.

%/year

12

14

16

Re-financing interest rate

Discount interest rate

Basic interest rate

Jan- Feb- Mar- Apr- May- Jun- Jul- Aug- Sep- Oct- Nov- Dec- Jan- Feb- Mar- Apr- May- Jun- Oct- Nov- Nov- Dec- Dec- Feb- Apr- Mai- Jul- Nov- Dec07 07 07 07 07 07 07 07 07 07 07 07 08 08 08 08 08 08 08 08 08 08 08 09 09 09 09 09 09

FIGURE 6.3 Policy Interest Rates in Vietnam, 2007–9

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Regarding exchange rate policy, the band for exchange rate fluctuation was cautiously expanded from 0.5 per cent to 0.75 per cent on 24 December 2007, to 1 per cent on 10 March 2008, and 2 per cent (plus an official VND/ USD rate increase from 16,139 to 16,461) on 27 June 2008. In addition, in May 2008, the time of the U.S. dollar fever, supervision and checking of foreign currency exchange agents was exercised, and the sale of foreign currencies to individuals was banned. In late June 2008 the SBV banned commercial banks from trading the U.S. dollar through a third foreign currency. The SBV has also intervened constantly in the foreign exchange market. By the end of July 2008, both interbank and parallel rates moved to below the official ceiling band. The pressure on dong depreciation, however, remained. Fiscal policy was also tightened, starting with the request to all ministries, government agencies and localities to reduce their current budget expenditure by 10 per cent. The government also requested ministries and localities, the large state-owned enterprises (SOEs), especially state business groups, to reduce investments outside the so-called core businesses (especially in financial and real estate) as well as rescheduling/ cutting unnecessary or inefficient investment projects. By 25 July 2008 various public/SOE investments amounting to 36,000 billion dong (more than US$2.1 billion) were reportedly cut or rescheduled. Nevertheless, actual progress at reducing public/SOE investment was rather slow and was later ignored as the country switched to demand stimulus to prevent economic downturn. Another aspect, trade policy, has been adjusted to facilitate export activities. In addition trade policy has shifted from reducing import tariffs in 2007 to increasing import tariffs of many products to narrow the trade deficits. Quotas had been imposed on rice exports to ensure national food security. This contributed to smaller trade deficits in the first half of 2008. Price controls continued to be exercised. Petrol prices increased by 12 per cent in February 2008 and remained unchanged (together with prices of cement, steel, coal, drugs, and air and train tickets) until June 2008. Prices then rose by a further 31 per cent in July 2008. The government also gave instructions to stabilize the prices of electricity, drinking water and bus fares until the end of 2008. These measures prevented some prices from going up, but were accompanied by a substantial burden of subsidies and a distortion of resources. While market-based intervention remained largely absent, this raised concern about the sustainability of administrative price controls.

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Vietnam remained open to foreign capital flows. The emphasis was on increasing the transparency of capital flows. In fact, statistics of capital flows are still rather limited and unreliable (Vo 2008; Vo and Pham 2008). Another issue has been the question of how to determine and apply appropriate measures to manage capital flows in the context of high current account deficits and the “mixed” confidence of foreign investors. The above policy measures together with the negative effects of the global financial crisis and economic recession led to an absolute fall in prices in late 2008. Even at this stage, it was almost impossible to track the extent to which the policy measures actually produced the desired effects. Nonetheless, in times of greater turbulence, this marked a valuable first effort on the part of the government in adapting to a more target-based comprehensive policymaking process. Various social policies were implemented to support vulnerable groups, such as measures to mitigate hunger and poverty, support for households affected by natural disasters and disease, support for fishermen to procure and build fishing boats, etc. However, there has been a lack of robust analysis of the social impact of slower economic growth, food price volatility and spiralling energy prices, which has undermined approaches to support vulnerable groups. The government had aimed to disseminate information on the socioeconomic situation and economic policies in a transparent and accountable manner, to make clear their message of macroeconomic stabilization. However, reception by the market was rather tepid (Vo 2008). A lack of close coordination between ministries, ministerial-line agencies and localities triggered suspicion among the public and the market. Information on Vietnam’s macroeconomic situation, to a significant extent, has been dominated by (private/foreign) financial institutions, which may not sufficiently avoid conflicts of interest.

4. ECONOMIC DOWNTURN AND STIMULUS PACKAGE IMPLEMENTATION IN LATE 2008 TO 2009 Vietnam has adopted a number of policy changes to stimulate domestic economic activities. One such measure has been the easing of the monetary policy. The reserve requirement ratio (RRR) was reduced significantly from 10 per cent in November 2008 to 3 per cent in March 2009. In the meantime the base interest rate was cut from 13 per cent in October 2008 to 7 per cent in February 2009, and remained unchanged until November 2009

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when it was raised to 8 per cent. Similar changes were also put in place for the re-financing and discount rates (see Figure 6.3). The exchange rate policy has been implemented in a more flexible manner. The official daily-announced interbank exchange rate was gradually adjusted upward to over 17,000 VND/1USD in early October 2009. The band for exchange rate transactions, relative to the official rate, was also widened from 2 per cent as at June 2008 to 3 per cent in November 2008 and 5 per cent in March 2009. Despite pledged commitments to maintain stability in exchange rate policy, the SBV decided to raise the interbank exchange rate in November 2009, from 17,034 on 25 November to 17,961 on 26 November. Simultaneously the trading band was narrowed to 3 per cent. Although this change appeared reasonable in the context of the rapidly growing trade deficit and mounting pressure in the foreign exchange market, it contradicted the pledged commitment and failed to be accompanied by adequate public justification. Also, like other countries, Vietnam implemented a (fiscal) stimulus package. The package was initiated in Resolution No. 30/2008/NQ-CP in December 2008, and has been realized since February 2009 with a total value of 145.6 trillion dong (or about US$8 billion, or 8.7 per cent of GDP). The four main components of the stimulus package are an interest rate subsidy for current capital loans; state development investment; exemption, reduction and deferral of taxes; and other expenditures to ensure social safety.5 The announced and disbursed values of each item are tabulated in Table 6.3. The above policy measures have produced certain positive impacts on the economy, though it is hardly possible to differentiate their influences from other factors such as the recoveries of the world and regional economies. Economic growth appeared to accelerate during 2009, from 3.1 per cent in the first quarter to 4.5 per cent in the second, 5.8 per cent in the third, and almost 7.8 per cent in the fourth. The construction sector appeared to reap the greatest benefit, as its growth in 2009 (over 11.4 per cent) was higher than that in 2008 (–0.4 per cent). Import growth remained negative, but the pace of the reduction was smaller. In fact import growth was –45 per cent for the first quarter of 2009, –34.1 for the first half, –25.2 for the first three quarters, and –14.7 for 2009 as a whole. In addition, the issues of unemployed/laid-off workers and business bankruptcy became less serious than expected in early 2009. There were several explanations for this. First, the stimulus package had a positive

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Vietnam’s Economic Experience since WTO Accession TABLE 6.3 Vietnam’s Fiscal Stimulus Package in 2009 (billion dong)

Announcement 1

Interest rate subsidy for current capital loans

17,000

2

State development investment

90,800

Various items6

70,800

Issuance of additional bonds

20,000

3

Exemption, reduction and deferral of taxes

28,000

4

Other expenditures to ensure social security Total

9,800

145,600

Source: MPI 2009.

influence on growth and, accordingly, job creation. Second, Vietnamese firms have undertaken several measures reflecting short-term adjustment to lessen the impact on job losses, such as a rotation of workers, a reduction of working time, rotational vacations, and 70 per cent of the basic wage to retain workers. Workers themselves are also less demanding, as they had to choose either to work for fewer hours and remain employed, or to leave firms without any compensation. Third, domestic consumption went up, as proxied by the growth in retail sales of over 10 per cent in real terms. This in turn helped sustain domestic demand for products, thereby increasing derived demand for labour. Finally, the agricultural sector played an important role as the buffer to absorb the labour laid off by industrial enterprises. Consequently, the issue of unemployment was mitigated effectively. Nevertheless, the cost of implementation of the stimulus package could be too high. A study by the Central Institute for Economic Management (CIEM) shows that the growth rate could be only lower by about 1 to 1.3 percentage points compared to the figure of 5.3 in 2009 (CIEM 2013). Moreover, trade and current account deficits continued to be high and the BOP switched to a huge deficit in parallel with escalating dollarization (and goldization). The budget deficit increased to 6.9 per cent of GDP. Moreover, speculative activities in financial markets and the real estate sector have been encouraged. Together with the “under-standards” loans, this can lead to much higher non-performing loans in subsequent years.

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5. POLICY RESPONSES TO MACROECONOMIC INSTABILITY AND STRUCTURAL PROBLEMS SINCE 2011 In the face of accelerating inflation in late 2010, the Government of Vietnam decided to undertake bold and comprehensive measures to stabilize the macroeconomic environment. In late February 2011 the government issued Resolution 11 setting out key policy directions for such measures. First, attempts were made to tighten the monetary policy. The specific target for M2 growth was lowered to 15–16 per cent in 2011, compared to the actual figure of 25 per cent in 2010. Meanwhile, credit growth for 2011 was constrained at below 20 per cent, compared to about 30 per cent in 2010. In line with this the SBV decided to raise the rates of key monetary instruments several times. Ultimately, the refinancing rate went up to 14 per cent in April 2011, from 9 per cent in early 2011. Similarly, the rediscount rate rose from 7 per cent to 13 per cent in the same period. The repo rate for open-market transactions also rose, albeit more gradually, from 10 per cent to 15 per cent. Together with these adjustments, the SBV also applied administrative targets to the operations of the commercial banks, thereby constraining growth of credit and M2. Consequently, by the end of July (compared to end of 2010), M2 only went up by 3.5 per cent, while credit growth attained 7.8 per cent. Second, the government undertook joint efforts to tighten fiscal policy and to reduce public spending. Specifically, the budget deficit is to be kept under 5 per cent of GDP. Meanwhile, public investment is to be cut across the board, including investment from the budget, bond issuance, state credit, and SOE earnings. In the first eight months of 2011, budget revenues attained 411.4 trillion dong (69.1 per cent of the planned figure), while budget expenditure was 450.7 trillion dong (or 62.1 per cent of the planned figure), of which implemented investment accounted for 111.1 trillion dong (58.3 per cent of the planned figure). By the end of July 2011, the reduction of public investment projects reportedly amounted to 81.5 trillion dong.7 Third, joint measures have been dedicated to easing pressure on the foreign-exchange market and making the dong more attractive. These include (1) the imposition of a ceiling of 14 per cent on dongdenominated deposits and 3 per cent (and subsequently to 2 per cent) on USD-denominated deposits; (2) raising the required reserve ratio on USDdenominated deposits from 4 per cent to 6 per cent, 7 per cent, and then

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to 8 per cent; (3) control imports (in compliance with WTO commitments) and lending in USD (more restrictive conditions); (4) introducing surrender policies for SOEs, especially the large corporations; (5) some intervention in the “parallel market”; and (6) consolidation of market confidence on the dong. However, these measures have not always led to the desired results. For instance, the ceilings on dong-denominated deposits failed to be binding in practice, due to general liquidity shortage and competition between banks. Specifically, the interest rate on dong-denominated deposits was reported at 15.5 per cent on average, though being recorded at 14 per cent. That is, imposing the administrative ceiling produced the side effect of undermining market transparency. Finally, the government implemented several measures to support priority areas such as small and medium enterprises (SMEs) and agricultural business activities, and to ensure social security. In April 2011 the prime minister approved the rescheduling of corporate income tax payments for certain groups of SMEs for one year. Billions of dong were spent to subsidize various consumer products, thereby helping to restrain inflation. Up until the end of 2011, economic performance in the wake of Resolution 11 was still mixed. Year-on-year GDP growth reached 5.4 per cent for the first quarter of 2011, and attained 5.9 per cent for the whole year. The industrial index continued to rise, albeit at a slower pace. Yet inventory appeared to have overly accumulated, reflected by the yearon-year growth of 17.8 per cent in early August and 23 per cent in early December. Total investment decreased drastically relative to GDP (at current prices). Together with efforts to cut down public investment, investment from the budget decelerated, reaching a growth of only 6.7 per cent on a year-on-year basis. Merchandise trade continued to expand, with export growth being faster than import growth. Market responses to Resolution 11 and related measures have generally been positive, though participants remained doubtful about whether the efforts brought about the desired level of macroeconomic stability. Since April 2011 the nominal exchange rate has relatively stabilized, with the gap between official and parallel exchange rates being almost negligible. There has also been a shift from households and corporations holding U.S. dollars to holding dong, but only on a short-term basis. This tendency could be explained by the persistently high depreciation pressure on the VND/ USD exchange rate due to high inflation and the huge trade deficit. Over

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time this pressure eased due to the more dramatic fall in import demand, while inflows of foreign exchange were quite robust. Nevertheless the market remained sceptical as to whether the macroeconomic situation had exhibited any fundamental improvement. The credit default swap (CDS) premium on five-year government bonds again increased after a short period of decline. Meanwhile, the country’s credit ratings remained unchanged relative to the level prior to Resolution 11. More importantly, the effectiveness of inflation control remains largely questionable. Despite enormous and successive pressure to combat inflation, only since September 2011 has it been able to be reduced, albeit at the cost of significantly smaller growth of aggregate demand and nationwide business difficulties. And there is virtually no further room to contain cost-push inflation, since the tariff is almost zero, interest rates are already high and there are no strategic reserves or subsidies. In addition, drawing from similar experiences in inflation control in 2008, market participants started to cast greater doubt about the actual seriousness of Resolution 11 along the course of its implementation. There were several justifications for this. On the one hand, things failed to go smoothly during “the transfer of government powers”. As mentioned previously, monthon-month inflation has been high, even in May and July 2011 during the respective elections of the National Assembly members and of the new government — when bold measures were rarely undertaken. On the other hand, efforts so far to tighten fiscal policy and public investment may not have been sufficient to relax inflationary pressure. Additional efforts may be required in order to achieve macroeconomic stabilization. In the meantime the government was subject to mounting pressures from business communities and other interest groups who have suffered business and social difficulties. Facing this dilemma, the agencies involved appear to have diverted their attention away from the final target (i.e., inflation) towards intermediate ones (i.e., the extent to which they have achieved those set out in Resolution 11). Still, economic performance in 2012 and the first half of 2013 saw some noteworthy developments. Macroeconomic stability has improved, as reflected by the sharp deceleration of year-on-year inflation to around 7 per cent, a rather stable nominal exchange rate, surpluses of trade and BOP, and a rapid increase in foreign reserves. Nevertheless, ample risks remain evident. Such risks include the possibility of returning to high inflation and difficulty in keeping the budget deficit below the ceiling. The

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banking system also remains fragile, with less than sufficient progress of restructuring. Even confidence in macroeconomic stabilization is relatively low, making way for speculative activities. Improvement of macroeconomic stability also came at the expense of robust production activities. Aggregate demand decreased significantly, leading to stagnation of production activities in many sectors and a frozen real estate sector. Access to credit and finance is difficult, in the context of huge bad debt and, in part, large outstanding debt from public construction projects. At this stage Vietnam is seeking to fulfil rather ambitious goals. Macroeconomic stability is still given priority, but the need for more “reasonable” growth has been profound. During the process, Vietnam has also opted to accelerate structural reform, especially of SOEs, the financial and banking sector, and public investment. At the same time, Vietnam is engaging itself in deeper integration, negotiating various trade deals, such as TPP, VN-EU FTA, RCEP, etc. Meanwhile the country is also under huge constraints, which place restrictions on human and financial resources. Vietnamese society has also become more vocal about the policy objectives and the pace of domestic reform, including political reforms. Yet this should be seen as a motivator of reform, rather than cited as an obstacle to further action.

6. LESSONS LEARNT Vietnam’s experiences with macroeconomic policy management since 2007 justify the attention to several lessons. First, international economic integration is an integral component of reforms, but emerges only as a prerequisite to sustain growth and development. Domestic reforms, including structural reform and the maintenance of macroeconomic stability, are key to maximizing benefits and mitigating the effects of any external shocks. In this regard, economic integration may create greater pressure for domestic reform. Second, in the face of (potentially) re-accelerating inflation, the government needs to issue a clear message to the market about its stance on stabilizing the macroeconomic environment. Having undergone a long period of growth-induced expansion of credit and investment, such a message is critical to ensure that market participants realize the government’s first priority of reducing inflation. Underlying this message is the acknowledgement of the trade-off between economic growth and

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inflation. The virtual absence of this acknowledgement in mid-2008 prevented thorough measures for macroeconomic stabilization, and inflation fell in late 2008 largely due to the effects of the global economic recession. Issuing a clear message for macroeconomic stabilization is the first essential step, but adhering to such a message is of even greater importance. That is, any changes in policies, including even policy stances, should be fully justifiable and accountable by concerned agencies. The call for relaxing monetary policy in June–July 2011 by different interest groups, including even some ministries, did more harm than good to the realization of the targets set out in Resolution 11. Third, policy moves should be consistent with the goals set out in the policy message. In other words, in striving to switch towards macroeconomic stabilization after a long period of growth promotion, Vietnam should have harmonized its policy efforts towards reducing inflation. Specifically, macroeconomic stabilization should not be deemed as the target of either monetary or fiscal policy. For example, the target of inflation reduction could not be achieved by tightened monetary policy while the fiscal policy failed to act in a sufficiently cooperative manner. Maintaining policy consistency in this sense is critical, notwithstanding the difficulty caused by different macroeconomic policies being approved at different paces. Without policy consistency, market participants may quickly interpret this as a lack of seriousness towards macroeconomic stabilization. At the same time, policy consistency would also help to prevent speculative activities and an associated distortion of resource allocation. More fundamentally, therefore, curbing inflation in Vietnam should go in line with longer-term measures to address inherent macroeconomic imbalances. Fourth, the macroeconomic policies should be properly coordinated to ensure better consistency of policy stance. From Vietnam’s experience, adhering to tightened monetary policy whilst carrying out somewhat expansionary fiscal policy (for higher growth) may actually undermine the effectiveness of inflation control. For effective policy coordination, nevertheless, there is no fixed doctrine. The technicalities of policy coordination — such as timeliness of policy communication, sharing information, etc. — in Vietnam may not be fully applicable for other countries, nor may they necessarily be mimicked in future attempts at inflation control. As a key principle, the “art” of formulating macroeconomic policies should aim at a common final target, depending on the context and the extent to which the trade-off between inflation and growth is acceptable. Most importantly, policy coordination and cooperation necessitate

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improvements in the accountability of the relevant government agencies, which in turn will play a pivotal role in enhancing policy credibility in the longer run. Fifth, Vietnam should carefully consider her choice of exchange rate regime. At this stage, the country pursues a crawling-peg exchange rate system, with gradual adjustment to support export growth and restrain trade deficit. Nevertheless, past devaluations of the VND/USD exchange rate were well shadowed by relatively high domestic inflation (Truong Dinh Tuyen 2011) and, thus, had almost no positive impact on export growth. In the meantime this has led to the so-called “imported inflation” to Vietnam, particularly when international market prices were high (e.g., in 2008). In the short-term the country should maintain the current exchange rate system. Of key importance is the assurance of competitiveness and flexibility of the exchange rate, thereby contributing to effective monetary policy, particularly in the context of high capital mobility and dollarization. As a bottom line, ensuring macroeconomic policy consistency is essential to avoid financial speculation and crisis.8 Sixth, in connection with the above lessons, adequate attention should be paid to improving the financial monitoring and surveillance system. This system helps to issue early warning signals of financial stress, including macroeconomic-related financial risks. During times of tightened macroeconomic policies, the need for this system increases. For example, in the context of relatively scarce credit, surveillance helps to identify risks and prevent collapse in other important markets (such as real estate and stock markets). It should be noted that improvement of the system would take time, but that this would contribute immensely to sounder and more justified macroeconomic policy formulation. The costs that Vietnam incurred as a result of her reacting only after macroeconomic turbulence emerged (e.g., in 2008), highlights just how necessary this improvement is. Seventh, in controlling inflation, Vietnam should retreat from using administrative measures. Furthermore, Vietnam should eschew policymaking based on administrative measures. Such measures may produce the desired effects in a relatively short period of time. For example, constraining credit growth after Resolution 11 led to a significantly slower expansion of credit, thereby easing inflationary pressure from the monetary side. However, such measures were not sustainable, as they were not based on robust market relations. And, as already mentioned, the ceiling on the dong-denominated deposit rate failed to be binding because it could

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not supply credit institutions with sufficient liquidity, particularly in the context of the tightened monetary policy. Therefore, refraining from using administrative intervention may in the long run actually improve the credibility and predictability of policies that facilitate effective interactions between state agencies and market participants. Finally, in times of high inflation with tightened macroeconomic policies, Vietnam should dedicate proper support to disadvantaged groups. In the past decades the country has made profound achievements in reducing the incidence of poverty.9 With continuing economic growth, there is the possibility for further poverty reduction. However, while such a growth often fails to be beneficial for everyone, high inflation may erode the living standards of the poor and near poor, thereby reverting any progress in poverty reduction. Given that the country must implement commitments to liberalize the prices of key products, subsidizing such products may not be an option; nor will subsidies be efficient, since they would also benefit the rich. The attempts made to directly support the poor and other disadvantaged groups were reasonable. Whether they could be repeated in the future though depends on the ability of the state budget and firms to be able to accommodate larger provisions to the poor and employees, respectively.

Notes 1. On a year-on-year basis. 2. The month-on-month inflation rates for April to September 2009 were 0.3, 0.4, 0.6, 0.5, 0.2 and 0.6 per cent, respectively. 3. For further reference, see Vo and Nguyen (2009) and CIEM (2010). 4. Based on the price of Thai rice. Source: International Financial Statistics. 5. For instance, Vietnam decided to give 200,000 dong to each poor household to help them prepare for the lunar Tet in 2009. 6. Including the advancement of the budget for investment projects of high importance, carried-over capital expenditure from 2008, investment from State budget, etc. 7. It is not clear whether this figure includes the transfers of funds from one project to another or the credits the SOEs attempt to get. 8. Macroeconomic policy reflects maintaining the sustainable relationship between exchange rates and interest rates at any point in time: CPI: i = i* + fd (forward) or UPI: i = i* + Dse (expected depreciation). 9. Vietnam’s poverty rate fell from 58.1 per cent in 1990 to 37.4 per cent in 1998, and just over 12 per cent in 2010.

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References Central Institute for Economic Management (CIEM). Impacts of International Economic Integration on Vietnam’s Economy after Three Years of WTO Membership. Hanoi, 2010. CIEM. Đánh giá tổng thể tình hình kinh tế — xã hội của Việt Nam sau 5 năm gia nhập Tổ chức Thương mại Thế giới [Comprehensive evaluation of Vietnam’s socio-economic performance 5 years after accession to the WTO]. Hanoi: Report to the Government, May 2013. CIEM. Vietnam’s Economy in 2010. Hanoi: Finance Publishing, 2011. Ministry of Planning and Investment. Báo cáo tình hình phát triển kinh tế — xã hội 9 tháng đầu năm và dự báo cả năm 2009 [Report to the government on socio-economic developments in the first 9 months of 2009 and projection for the whole year]. Hanoi, 2009. State Bank of Vietnam (SBV). Annual reports for various years. Truong, Dinh Tuyen et al. “Impact of WTO and FTAs on Merchandise Trade and Proposals for Trade Policy till 2015”. Report of MUTRAP III Activity. Hanoi, 2011. Vo, Tri Thanh. “Viet Nam’s Current Macroeconomic Situation: Issues and Government Policy Responses”. Unpublished paper, 2008. Vo, Tri Thanh and Anh Duong Nguyen. “Vietnam after Two Years of WTO Accession: What Lessons Can Be Learnt”. ASEAN Economic Bulletin 26, no. 1 (2009): 115–35. ———. “Tackling the Global Financial Crisis in Vietnam”. In Managing Economic Crisis in Southeast Asia, edited by Swee-Hock Saw. Singapore: Institute of Southeast Asian Studies, 2010. Vo, Tri Thanh and Chi Quang Pham. “Managing Capital Flows: The Case of Viet Nam”. ADBI Discussion Paper, 2008 .

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7 GLOBAL ECONOMIC IMBALANCES AND REFORM POLICY: EVIDENCE FROM ASIAN ECONOMIES Aekapol Chongvilaivan

1. INTRODUCTION Export-led growth strategies have by and large been seen as a key engine of economic growth among the Asian economies. Persistent account surpluses achieved through a wide array of policy pushes such as import substitution and export orientation since the 1950s have allowed these economies to attain economic development at a pace otherwise unachieable. A great deal of research has confirmed that export-led growth has delivered enormous benefits to the Asian economies in terms of staggering economic growth, accelerated poverty reduction, rapid productivity growth, sharp surges in income per capita, and outward-looking industrialization (see, for instance, Thangavelu et al. 2009; Greenaway and Kneller 2007; Hsieh 2002; and Aw et al. 2000, among many others). Nevertheless, the adverse impacts of the global financial crisis in 2008–9 have made it excruciatingly clear that excessive dependence on external demand and persistent current account surpluses as a prime

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1990

Source: Author’s compilation.

-4

-2

0

2

4

6

Asian Economies All WDI Economies

1995

Advanced Economies

2000

FIGURE 7.1 Trends of Current Account Balances (% of GDP), 1990–2005

2005

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driver of economic growth are highly perilous. On the one hand, the sudden collapse of export demand from the United States and the eurozone appeared to be a crucial transmission mechanism through which the global economic meltdown propelled the Asian economies into a sharp recession. On the other, persistent current account surpluses, together with inadequate domestic demand (i.e., consumption and investment), bear the brunt of responsibility for global economic imbalances, which are in turn a root cause of the global financial crisis. Table 7.1 demonstrates this point by presenting the trends of current account balances as a share of GDP since the 1990s. It can be observed that the Asian economies, on average, consistently ran current account surpluses amounting to 4–6 per cent of GDP. These figures are well above the of 0–1 per cent averaged among advanced economies, and the deficits of 2–3 per cent for all countries in the World Bank’s World Development Indicators (WDI) database. Public and policy debates on reducing dependence on external export demands, as well as implementing global economic rebalancing in Asia, hinge on two policy options: domestic financial reforms and increasing social safety net expenditure (Servén and Nguyen 2013; and Adams and Park 2009). The idea is that the lack of a well-functioning financial market within the region imposes financial constraints on households and firms which are ultimately translated into inadequate domestic consumption and investment. This also implies that the Asian miracles in the 1980s and 1990s would not have been possible without persistent current account surpluses. Moreover, deficiency, if not an absence, of social protection and safety nets, particularly public healthcare, essentially forces households to run excessively precautionary savings as leverage in case of external shocks. Therefore, greater spending on social safety nets will potentially reduce the need to set aside extra financial resources, thereby reviving domestic consumption and investment. Figures 7.2 and 7.3 substantiate this point. Figure 7.2 reveals the trends of domestic financial reform in the Asian economies in comparison with advanced and WDI economies. While the improvement of the index normalized between 0 and 1 implies that the Asian economies have consistently embarked on domestic financial reforms, the levels of financial market development among the Asian economies seriously lag behind not only the advanced economies, but also the global average as well. Likewise, as shown in Figure 7.3, the shares of public healthcare expenditure in GDP

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0.8

0.6

Source: Author’s compilation.

0.4

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1

1990

Asian Economies All WDI Economies

1995

2005

Advanced Economies

2000

FIGURE 7.2 Trends of Domestic Financial Reforms (normalized between 0 and 1), 1990–2005

Global Economic Imbalances and Reform Policy

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10

8

6

4

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1995 Asian Economies All WDI Economies

2000

2005 Advanced Economies

FIGURE 7.3 Trends of Public Healthcare Spending (% of GDP), 1995–2005

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among the Asian economies were as low as less than 5 per cent throughout the period 1995–2005, whereas public healthcare spending accounts for nearly 10 per cent of GDP among advanced economies and approximately 6 per cent for all WDI countries. Given the pivotal roles in addressing Asia’s global economic imbalances of (1) domestic financial reform and (2) revitalizing expenditure on social safety nets, this chapter seeks to empirically investigate the extent to which these aspects of domestic structural reform may offer a panacea for economic rebalancing. The findings will be significant for sustainable growth among the Asian economies facing global economic uncertainties. Using a panel of nine major Asian countries spanning the period 1973–2005, the empirical framework in this chapter builds on the standard model of current account balance determinants from Chinn and Prasad (2003) and Chinn and Ito (2007), incorporating a newly developed database of domestic financial reform (Abiad et al. 2008) together with a proxy of social safety net spending. After addressing various econometric issues such as heterogeneity of disturbances, unobservable country-specific characteristics and missing observations, the parameter estimates produce satisfactorily robust findings that domestic financial reforms offer the Asian economies an impetus for curbing persistent current account surpluses, while the effects of social safety net spending on current account balances appear to be weak. A robustness check based on estimations of savings and investment equations, paints a clearer picture that, while domestic financial reforms mitigate the need for saving, having a well-functioning financial market does not seem to bring about a boost in investment. Moreover, while public expenditure on social safety nets only weakly influences national savings (consistent with the baseline results), social protection spending is found to render support to national investment. This chapter is structured as follows: Section 2 elaborates the empirical model of current account balance determinants, building upon the earlier works by Chinn and Prasad (2003) and Chinn and Ito (2007). Section 3 depicts the data sources and measurement employed. Section 4 discusses the empirical strategies for addressing various econometric issues. Section 5 presents and analyses the empirical findings. Section 6 concludes with policy implications.

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2. THE MODEL Central to the analysis of this chapter is the effect of domestic financial market reform and social protection on global imbalances — the extent to which the Asian economies, in general, run persistent current account surpluses, thanks to inadequate domestic demand coupled with excessive savings. The cleanest econometrics specification perhaps rests with the work put forward by Chinn and Prasad (2003) and Chinn and Ito (2007). Their empirical strategy essentially models the current account balances by controlling for various macroeconomic and policy proxies. The empirical model in this chapter builds on this approach by introducing variables capturing financial market reforms and social safety net spending, on top of the conventional control variables in the current account equation. Specifically, the econometric specification examined in this chapter can be loosely written as:

yit = a + X'itβ + Z'itγ + ι'μi + εit,

(1)

where the subscripts refer to country i = 1…,N and time period t = 1,…,T. The left-hand variable, yit, represents three dependent variables of global imbalances — current account balances (CABit), national savings (SAVit), and national investment (INVit) — expressed in terms of a share in GDP. Since the dataset pertains to country samples with differences in levels of economic development as well as other structural factors, the vector μi enters Specification 1 to control for unobservable country-specific characteristics such as policy and technological shocks; it also controls for persistent country-specific differences in current account balances, national savings, and investment. εit denotes the stochastic error term and is assumed to be normally distributed, with E(εit) = 0 and Var(εit) = σ2. The vector Xit comprises the conventional control variables of current account balances as in Chinn and Prasad (2003) and Chinn and Ito (2007). These include net government spending (GOVit), net foreign assets (FASSETit), relative income (RIit), young and old dependent population (YDEPit and ODEPit, respectively), financial deepening (FDEEPit), capital control (KCONit), aggregate output growth (GROWTHit), volatility of terms of trade (TOTit), and trade and financial openness (XMOPENit and KAOPENit). Intuitively, it is anticipated that net government spending (GOVit) will be negatively correlated with current account balances, as a higher

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level of public spending (or lower level of public savings) implies a higher level of import consumption, thereby constituting current account deficits. Net foreign assets (FASSETit) can be hypothesized to positively influence current account balances, as a country with a significant stock of foreign assets tends to have a better “initial condition” and, at least from an inter-temporal viewpoint, stands to enjoy current account surpluses. Relative income (RIit) is associated with the “stages of development” hypothesis in which a country at the initial stage of development is prone to import capital intensively, and thus run a current account deficit. As a country tries to move up the stages of development, it is tempted to run current account surpluses to pay off external liabilities and to export capital to less-developed countries. Young and old dependent population ratios — denoted by YDEPit and ODEPit, respectively — aim to capture the demographic profile of a country. Higher population dependency is expected to bring about a lower level of national savings and, as a result, current account deficits. As in Edward (1995), the correlation between current account balances and financial deepening (FDEEPit) can be either positive or negative. On the one hand, a sophisticated financial system can be expected to induce savings, and advocates current account surpluses. The emerging financial constraints facing individuals in an advanced financial market, on the other hand, can suggest the opposite. The roles of capital controls (KCONit) in current account determination are not straightforward. The reason pertains to the timing of imposing capital controls. Typically, capital controls have to do with a country’s prevention of capital flights triggered by persistent current account deficits. However, limited room for external financing due to capital controls consequently bolsters current account deficits. The effects of aggregate output growth (GROWTHit) can be either positive or negative, depending on whether output growth is permanent or transitory. If growth is permanent, according to the life cycle permanent income hypothesis, an increase in consumption without a rise in current income implies a lower level of savings, thus exacerbating current account balances. If growth is short-lived, an increase in income without changes in consumption implies a higher level of savings and current account surpluses. Likewise, the effects of terms of trade volatility (TOTit) are less clear-cut. In principle, more volatile terms of trade imply short-term fluctuations of current account balances and may induce precautionary savings, ultimately inducing a country to run current account surpluses.

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However, it is also possible that a high volatility of terms of trade makes a country less conducive to capital inflows, and therefore undermines current account balances. Trade and financial openness (XMOPENit and KAOPENit, respectively) tend to exhibit a negative relationship with current account balances. This is particularly the case among developing countries in which their ability to generate earnings through commodity exports is relatively low. Moreover, a higher degree of financial openness implies greater attractiveness to capital inflows, which in turn impinges negatively on current account balances. The vector Zit contains the crux variables, domestic financial reform (FINREFit) and social safety net spending (SOCPROit). In the context of the Asian economies, the lack of financial reforms has been widely deemed a culprit of persistent current account balances and a root cause of global imbalances. At the household level, underdeveloped financial markets discourage consumption and induce households to set aside excessive precautionary financial resources. The limited access to external credit, likewise, forces firms, especially small and medium enterprises (SMEs), to count on their internal sources of funds. Similarly, inadequate, if not absent, social safety nets such as healthcare and unemployment benefits, spawn the need for precautionary savings among individuals and households, which offer them a buffer against economic and social uncertainties. Therefore, domestic financial reforms and social protection can be hypothesized to be negatively correlated with current account balances. Table 7.1 recapitulates the discussions in this section by summarizing the control variables together with their abbreviations and expected signs.

3. DATA SOURCES AND MEASUREMENT Most macroeconomic and policy variables are constructed from the WDI, which contains a wide array of country-level information on macroeconomic, political, and social development, except for the proxies of capital openness (KAOPENit) and financial reforms (FINREFit). The former is measured by the well-known Chinn-Ito Index of financial openness and retrieved from Chinn and Ito (2006, 2008). The latter makes use of a new database of financial reforms developed by Abiad et al. (2008) which covers ninety-one economies over the period 1973–2005. This database provides the scores of seven dimensions of financial sector policy: (1) credit controls and excessively high reserve requirements; (2) interest rate controls; (3) entry barriers; (4) state ownership in the banking sector; (5) capital

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TABLE 7.1 Determinants of Current Account Balances — Definitions and Expected Signs Variable

Definition

GOV FASSET RI YDEP ODEP FDEEP KCON GROWTH TOT XMOPEN KAOPEN

Net government spending Net foreign assets Relative income Young population dependency Old population dependency Financial deepening Capital control Aggregate output growth Terms of trade volatility Trade openness Financial market/capital account openness

FINREF SOCPRO

Financial market reform Social protection/social safety nets

Expected Sign – + +/– – – +/– +/– +/– +/– – – – –

Source: Author’s compilation.

account restrictions; (6) prudential regulations and supervision of the banking sector; and (7) securities market policy. The financial reform variable (FINREFit) in our estimations is the summation of the seven dimensions and is normalized between nil and unity. To maintain consistency in the set of countries used in the analysis of financial reforms, countries which cannot be matched among the three datasets or which contain an insufficient number of observations have been dropped. After the data-cleaning procedure, the final dataset comprises eighty-four economies worldwide, spanning the period 1973–2005. Of these eighty-four countries, nine are labelled as “Asian countries” — China, India, Indonesia, Japan, the Philippines, Singapore, Thailand and Vietnam.1 The measurement of the remaining variables can be depicted as follows. The government budget balances (GOVit) are defined as government spending net of tax revenue, expressed as a share of GDP. The ratio of foreign assets to GDP (FASSETit) is utilized as a proxy of exposure to international financial markets. Entering Specification 1 in both linear and quadratic terms, relative income (RIit) is measured by the ratio of a country i’s GDP (in U.S. dollars) to the United States’ GDP. Young and old dependency ratios, denoted by YDEPit and ODEPit, are measured by the proportion of population ages 0–14 and ages 65 and above, respectively. Financial deepening (FDEEPit) is proxied by the ratio of domestic credit to

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the private sector to GDP. The notion of capital control (KCONit) is captured by the strength of the legal rights index; it ranges between 0 (weak) and 10 (strong), and measures the degree to which collateral and bankruptcy laws protect the rights of borrowers and lenders, and thus facilitate lending. Terms of trade volatility (TOTit) is the standard deviation of terms of trade during 1991–2010, and enters the dataset as a time-invariant variable. The rate of output growth (GROWTHit), as usual, is the growth rate of GDP. The ratio of exports and imports to GDP (XMOPENit) accounts for the degree of trade openness. Lastly, social protection (SOCPROit) is measured by the share of public healthcare expenditure to GDP. Tables 7.2 and 7.3 provide the summary of statistics and their correlation matrix, respectively.

4. EMPIRICAL STRATEGIES The simplest empirical estimation for Specification 1 perhaps hinges on the standard ordinary least squares (OLS) estimation. However, there are at least three econometric issues which may pose concerns for the consistency and efficiency of OLS estimation, and which need to be meticulously addressed in the estimation. These include heteroskedasticity, unobserved country-specific effects, and missing-variable biases. TABLE 7.2 Summary of Statistics Variable

Obs.

Mean

S.D.

Minimum

Maximum

GOV FASSET RI YDEP ODEP FDEEP KCON GROWTH TOT XMOPEN KAOPEN FINREF SOCPRO

2460 2460 2460 2460 2460 2460 2460 2460 2460 2460 2460 2460 2460

–.2653 3.614 .0411 57.12 11.96 43.08 .3740 3.336 8.65 58.54 .0908 .4812 2.350

2.887 66.17 .1319 24.09 6.863 39.02 1.508 4.838 7.501 35.75 1.509 .3037 3.361

–16.36 –1431.1 0 19.87 3.980 0 0 –44.9 0 0 –1.831 0 0

17.21 2309.4 1 106.46 30.05 231.08 10 26.4 31.85 428.5 2.500 1 15.60

Source: Author’s compilation.

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1.0 –0.006 1.0 0.08 –0.002 0.04 –0.05 –0.002 0.02 –0.01 0.05 –0.10 0.05 –0.11 0.09 0.003 –0.10 –0.02 0.06 –0.10 0.04 –0.12 0.09 –0.04 0.06

FASSET

Source: Author’s calculation.

GOV FASSET RI YDEP ODEP FDEEP KCON KAOPEN TOT GROWTH XMOPEN FINREF SOCPRO

GOV 1.0 –0.28 0.27 0.49 0.005 0.31 –0.15 –0.01 –0.20 0.21 0.08

RI

1.0 –0.85 –0.55 –0.15 –0.50 0.52 0.05 –0.25 –0.62 –0.36

YDEP

1.0 0.48 0.10 0.51 –0.47 –0.13 0.21 0.54 0.31

ODEP

1.0 0.13 0.47 –0.24 0.02 0.12 0.51 0.27

FDEEP

1.0 0.16 –0.06 0.10 0.19 0.26 0.33 1.0 –0.22 0.02 0.18 0.66 0.41

KCON KAOPEN

1.0 0.08 –0.20 –0.29 –0.13

TOT

TABLE 7.3 Correlation Matrix of Independent Variables

1.0 0.03 0.06 0.07

1.0 0.34 0.25

1.0 .64

1.0

GROWTH XMOPEN FINREF SOCPRO

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The stochastic error term εit is not likely to be homoskedastic, thanks to the variation in the size of the countries in the dataset. This includes large economies like China, Japan and India and smaller economies like Singapore, Thailand and Vietnam. As is well known, when heteroskedasticity is present, standard OLS estimates are biased. To tackle this problem, White’s (1980) heteroskedasticity-robust standard-error procedure is employed in the estimations of Specification 1. Additionally, the country-specific effects (μi) are introduced in Specification 1 in order to control for unobservable country-specific characteristics. Intuitively, persistent country-specific differences in development levels and overall technological progress, among other unobservable external shocks, potentially exert influence on the dependent variables — current account balances (CABit), national savings (SAVit), and national investment (INVit). If the unobservable country-specific effects exist, the OLS estimation tends to yield biased results. To address these issues, the empirical strategies opt for the Fixed Effects (FE) and Random Effects (RE) estimations. Lastly, the dataset employed in this chapter is subject to biases arising from missing observations. It can be observed from the summary of statistics in Table 7.2 that many variables, particularly RI, FDEEP, KCON, TOT, XMOPEN, FINREF and SOCPRO, pertain to a number of missing observations. Therefore, the empirical strategies discussed thus far, i.e., OLS, FE and RE, will entail substantial losses of observations because the observations with missing variables will be automatically dropped from the estimations. To correct this problem, this chapter employs missingvariable regression, thereby allowing the estimates to reflect all available information in the dataset. In doing so, all estimations are augmented by the missing-variable dummies, and all missing observations are replaced by nil.2 With this technique, the missing-variable dummies essentially filter out the missing variables for each observation while preserving the observations with some variables missing in the estimations. This approach enables the estimates to fully take into account all available information in the dataset.

5. EMPIRICAL RESULTS 5.1 The Baseline Estimations Table 7.4 reports the baseline parameter estimates based on Specification 1, in which the current account balances enter the specification as a

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dependent variable. As discussed in the previous section, the country samples are grouped into two sub-groups — the pooled samples and Asian economy samples — for the reason that the core interest of this chapter is to empirically investigate the effects of financial sector reform and social protection policies on mitigating global imbalances in Asia. Therefore, performing the estimations in the two sub-groups offers a comparison between the empirical findings in a general context and those in the context of Asian economies. The first three columns in Table 7.4 portray the parameter estimates using the pooled samples which include all eighty-four countries in the WDI dataset (See Section 3.2). The first column is pertinent to the standard OLS estimates with the heteroskedasticity-robust estimators. However, the OLS estimation is not likely to yield consistent estimates because it assumes away the unobserved country-specific effects such as persistent country-level differences, technological differences, and other unobservable time-invariant shocks. To capture the unobservable country-specific characteristics, the second and third columns reveal the Fixed Effects and Random Effects, respectively. Under the Fixed Effects estimations, two issues should be highlighted. First, the terms of trade volatility (TOT) — which, by construction, is a cross-section variable — needs to be dropped due to its collinearity. In addition, the Durbin-Watson F test is also carried out against the null hypothesis of no country-specific effects. Under the Random Effects, the maximum likelihood estimation (MLE) is employed, together with the Likelihood-Ratio (LR) test for the presence of random effects. As is well known, the LR test statistics are chi-squared distributed against the null of no random effects. It should be noted that in all estimations, the missing-variable regressions are employed to preserve the observations with some missing variables, thereby fully utilizing all of the available information in the dataset. In the last three columns, this estimation procedure is repeated on the Asian economy samples. In the estimations with the pooled samples, the Durbin-Watson F statistic under the Fixed Effects model is statistically significant, implying that the null hypothesis of no country-specific effects can be rejected and that the standard OLS estimates in the first column tend to be biased. The LR Test for the random effects, in addition, is also statistically significant and rejects the null hypothesis of no random effects. Hence, the ensuing discussions for the pooled samples will be based on the Random Effects estimates. In the estimations with the samples restricted to the Asian economies, in contrast, while the F statistic continues to reject the null of

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RE-MILE

OLS

FE

RE-MILE

2,180 .2214 32.93*** —— —— ——

2,180 .1112 11.81*** —— 14.48*** ——

2,180 —— —— 268.27*** —— 661.99***

244 .6167 23.37*** —— —— ——

244 .6196 19.63*** —— 4.73*** ——

244 —— —— 233.97*** —— .0000

.0312 (.0367) –.1075*** (.0391) –.0887** (.0382) –.1949** (.0960) –.0258 (.1256) –.1949* (.1063) .0195** (.0078) .0071*** (.0015) .0080*** (.0015) .2885*** (.0394) .3377*** (.0380) .2885*** (.0349) 9.717*** (2.673) –8.378 (21.25) 13.92 (9.538) –16.30 (14.13) –52.83 (35.78) –16.30 (18.89) –10.45*** (2.355) 12.69 (29.01) –12.52 (10.32) 28.98 (22.76) 52.93 (42.77) 28.98 (31.36) –.0806*** (.0101) –.1104*** (.0205) –.1014*** (.0172) –.0838* (.0478) –3.836*** (.0724) –.0838* (.0439) –.0651* (.0345) –.0218 (.0864) –.0551 (.0601) .2590 (.1747) –.0837 (.2674) .2590 (.2179) .0203*** (.0047) –.0107* (.0056) –.0054 (.0053) .0087 (.0141) .0211 (.0200) .0087 (.0118) .4272* (.2543) .1729 (.1504) .1832 (.1492) 1,468*** (.4211) 1.459*** (.4142) 1.468*** (.4135) .0431 (.1100) .1029 (.1211) .1261 (.1167) –.2710 (.3876) –.0804 (.5015) –.2710 (.3270) .0211 (.0257) —— .0305 (.0623) –.2853* (.1510) —— –.2853* (.1365) –.0620* (.0328) –.0826*** (.0231) –.0805*** (.0228) –.3914*** (.1019) –.2730*** (.0785) –.3914*** (.0767) .0095* (.0057) .0203*** (.0057) .0201*** (.0052) –.0376*** (.0137) –.0770*** (.0227) –.0376*** (.0108) –1.630*** (.6065) –2.020** (.8127) –1.843** (.7618) –2.833 (2.524) –13.88*** (3.138) –2.833 (2.335) –.2741*** (.0962) –.2176** (.0907) –.2106** (.0873) –1,409*** (.5404) –.9545 (.6284) –1.409*** (.5471) 2.351 (1.647) 5.847*** (2.183) 4.928** (1.991) 5,800 (4.585) 29.96*** (7.018) 5.800 (4.570)

FE

Asian Economies

Note: (1) * Statistically significant at 10%; ** statistically significant at 5%; *** statistically significant at 1%; (2) Robust standard errors in parentheses; (3) F Test is based on the null hypothesis of no country-specific effects; and (4) Likelihood-ratio (LR) Test is chi-squared distributed, based on the null hypothesis of no random effects.

No. of Obs R squared F Statistics LR Chi-squared F Test LR Test

GOV FASSET RI RI2 YDEP ODEP FDEEP KCON KAOPEN TOT GROWTH XMOPEN FINREF SOCPRO Constant

OLS

Pooled Samples

TABLE 7.4 Parameter Estimates of the Current Account Balance Equation

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no country-specific effects, the LR test statistic is statistically insignificant, and therefore the null hypothesis of no random effects cannot be rejected. Hence, the interpretation based on the Asian economy samples will hinge on the Fixed Effects model in the fifth column. The key hypothesis that financial reforms offer a panacea for persistent current account surpluses in the Asian economies holds empirically. The coefficient of FINREF under the Fixed Effects model in the fifth column appears to be negative and statistically significant at the 1 per cent level. This finding is consistent with the RE estimation based on the pooled samples in the third column, where the coefficient of FINREF is also negative and statistically significant at the 5 per cent level. Intuitively, the lack of well-functioning financial markets in Asia imposes “financial repression taxes” on households and firms, ultimately spawning inadequate domestic demands and persistent current account surpluses. On the one hand, financial repression discourages household consumption and induces excessive savings. The limited access to external sources of funds due to slumbering financial development, on the other hand, forces firms to bank on internal sources of funds, and therefore underinvestment among firms, particularly SMEs, will eventually be translated into persistent current account surpluses. Although putting in place social protection and social safety nets — i.e., increasing healthcare expenditure — in Asia contributes negatively to current account balances, the coefficient of SOCPRO appears to be statistically insignificant. This result contrasts with the estimates under the pooled samples, where the coefficient of SOCPRO is negative and statistically significant at 5 per cent. The weak evidence of a relationship between social protection spending and current account balances among the Asian economies may be explained by the fact that healthcare programmes in the region are typically neither universal nor uniform. As households remain exposed to social shocks and have limited access to social protection, additional social protection expenditure renders infinitesimal influence on household consumption, and precautionary savings by and large continue to be imperative. In addition to the core explanatory variables of financial reforms and social safety nets, the examination of the remaining control variables yields the following findings. The relationship between net public spending on current account balances, albeit of the expected sign (negative), turns out to be insignificant among the samples of the Asian economies. When the

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pooled samples are utilized, however, the coefficient of GOV is negative and statistically significant at the 5 per cent level. The coefficients of net foreign assets (FASSET) seems to satisfy the “initial condition” hypothesis, since the estimates are positive and statistically significant at 1 per cent across all estimations with both pooled and restricted samples. In the context of Asia, this finding is understandable given the knowledge that most Asian economies are emerging markets. Therefore, the higher level of net foreign assets to begin with implies their capacity to run current account surpluses to service external debts. The “stages of development” hypothesis predicts that countries at the initial stages of development rely on capital imports to grow and hence tend to run current account deficits (Roldos 1996). As they move up the stages of development, countries become less reliant on capital imports and are able to export capital to less-developed countries. As a result, more-developed countries are expected to run current account surpluses. Nevertheless, the coefficients of RI for both linear and quadratic terms turn out consistently to be statistically insignificant. This implies that the evidence does not provide any support to this hypothesis. The demographic factors exert an influential role in determining current account balances. The coefficients of the young population dependency ratio (YDEP) appear to be negative and statistically significant at 1 per cent, as expected, while the coefficients of the old population dependency ratio (ODEP), though negative, are statistically insignificant. The findings that young population dependency undermines current account balances, but old population dependency does not, are also observed in the estimations with the pooled samples. An explanation is that the large size of the young population relative to the working-age population necessitates household spending for dependents, such as on education, food and healthcare, which eventually discourages household savings. The estimates reveal merely weak evidence that financial deepening proxied by the ratio of domestic credit available to the private sector to GDP has to do with the status of current account balances. As shown in Table 7.4, the coefficients of FDEEP are statistically insignificant in estimations with both Asian economy and pooled samples. The absence of a relationship between financial deepening and current account balances perhaps rests with its contrasting effects on national savings, as suggested by Edwards (1995). On the one hand, more sophisticated financial markets encourage saving, whilst a greater amount of borrowing imposes constraints on private savings.

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The role of capital controls in current account determination is discerned among the Asian economies, although the relationship appears to be weak in the pooled samples. In particular, the coefficients of capital controls (KCON) are positive and statistically significant at 1 per cent in the estimations with the Asian economy samples, but the effects turn out to be statistically insignificant in the estimations with the pooled samples. As discussed in the previous section, the positive correlation between capital controls and current account balances can be rationalized by the extent to which capital controls are induced by severe current account deficits, and therefore the imposition of capital controls will help an economy better manage current account balances, and result in a decline in current account deficits. Financial openness captured by the Chinn-Ito index (KAOPEN) does not seem to render support to the hypothesis that exposure to international financial markets puts downward pressure on current account balances. As presented in Table 7.4, none of the estimations produces statistically significant parameters for KAOPEN, although the coefficients are negative and consistent with the hypothesis in the case of the Asian economies. Now that the terms of trade volatility (TOT) is a time-invariant variable, it has been dropped in the Fixed Effects estimations. However, the OLS and Random Effects estimates indicate a negative relationship between terms of trade volatility and current account balances in the context of the Asian economies. In addition, the results based on the Asian economy samples contrast with those based on the pooled samples, which yield positive yet statistically insignificant estimates. The assumption is that an economy with high terms of trade volatility tends to be less conducive to foreign investment and capital, which in turn exacerbates its capability to run current account surpluses. The GDP growth rates are negatively correlated with current account balances. As shown in Table 7.4, the coefficients of GROWTH exhibit a statistically significant, negative sign across all estimations. Hence, the economies that experience a higher growth of outputs are prone to be characterized by current account deficits. As elaborated in the preceding section, the negative relationship between GDP growth and current account balances can be explained by the extent to which individuals and households deem higher output growth as permanent. From the perspective of the life cycle permanent income hypothesis, a rise in GDP growth is associated with higher consumption and less savings, thereby leading to current account deficits.

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Lastly, the estimates associated with trade openness (XMOPEN) are contradictory with the prior hypothesis. In the samples restricted to the Asian economies, the coefficients of XMOPEN are negative and statistically significant at 1 per cent, implying that the Asian economies which are more exposed to international trade tend to run current account deficits. However, when the samples are unrestricted, the results suggest the opposite. The coefficients of XMOPEN are positive and statistically significant at 1 per cent, and thus a higher degree of international trade exposure pertains to the greater extent of current account surpluses. Although these results are quite surprising, they may be explained by the fact that the Asian economies in general have comparative advantage in low value-added, labour-intensive production and typically count on imports of high valueadded, capital intensive goods. Therefore, an economy with more exposure to international trade is likely to run current account deficits.

5.2 Robustness Checks: Effects on National Savings and Investment A natural extension of the empirical analysis regarding the determinants of current account balances is to investigate national savings and investment in lieu of current account balances, which constitute the channels through which financial reform and social safety nets influence the status of an economy’s current accounts.3 To this end the empirical methodology depicted in Section 4.1 was carried out on the equations of national savings and investment. Since national savings is associated positively with current account balances, the expected signs of parameter estimates in the national savings equation remain unchanged. In contrast, investment reduces an economy’s ability to run current account surpluses, and thus the expected signs in Table 7.1 are opposite in the investment equation. In light of this, it should be highlighted that examining the national savings and investment equations potentially provides a clearer insight into the mechanisms through which domestic financial reform and spending on social safety nets, among other control variables, shape current account balances. As portrayed in Table 7.5, in the national savings equation, the F Test is statistically significant at 1 per cent; therefore, the null hypothesis of no country-specific effects can be rejected. Moreover, the LR Test under MLE is also statistically significant at 1 per cent and hence in favour of

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OLS

2,173 .4777 82.60*** —— —— ——

.1040** (.0458) .0159* (.0085) 11.64*** (2.908) –15.53*** (.2709) –.2043*** (.0147) –.3067*** (.0420) .0684*** (.0049) –.1532 (.22909) –.2630** (.1217) .0544* (.0324) .3578*** (.0531) .0477*** (.0052) –6.183*** (.8110) –.6288*** (.0952) 35.56*** (2.084)

FE

2,173 .1400 15.31*** —— 21.99*** ——

–.1509*** (.0421) .0041** (.0016) 114.2*** (22.94) –100.2*** (31.31) –.0388* (.0223) –.4480*** (.0932) .0047 (.0061) –.3309** (.1638) –.1004 (.1327) —— .1831*** (.0252) .0350*** (.0066) –.9178 (.8841) –.2541*** (.0980) 27.21*** (2.368)

RE-MILE

OLS

FE

2,173 —— —— 339.24*** —— 957.95***

244 .8216 71.09*** —— —— ——

244 .6172 19.44*** —— 8.01*** ——

–.1311*** (.0417) .2420*** (.0908) .3037*** (.1066) .0047*** (.0016) .1317*** (.0331) .2384*** (.0337) 73.62*** (13.71) 4.190 (12.60) –17.51 (30.36) –71.84*** (15.00) –11.22 (20.72) –15.27 (36.29) –.0832*** (.0208) –.1910*** (.0467) –.1860*** (.0614) –.3321*** (.0742) –.7322*** (.1676) –1.098*** (.2270) .0089 (.0059) .0828*** (.0112) .1371*** (.0166) –.3350** (.1631) –.0285 (.4088) .2909 (.3515) –.1327 (.1299) .2563 (.3470) .5658 (.4256) –.0643 (.0986) –.4394*** (.1323) —— .1964*** (.0252) .2441*** (.0683) .2804*** (.0667) .0401*** (.0062) –.0192* (.0101) –.0593*** (.0192) –1.956** (.8590) –3.979* (2.148) –6.298** (2.663) –.3031*** (.0954) –.4313 (.5040) –.6759 (.5333) 29.97*** (2.405) 47.67*** (4.951) 47.30*** (5.956)

Asian Economies RE-MILE

244 —— —— 243.56*** —— 29.77***

.2403*** (.0928) .2113*** (.0316) –1.435 (18.31) –12.81 (30.00) –.1838*** (.0490) –.9535*** (.1850) .1172*** (.0144) .2676 (.3377) .6072* (.3582) –.4825* (.2470) .2634*** (.0635) –.0416*** (.0113) –6.005*** (2.287) –.4827 (.4900) 47.69*** (4.844)

Note: (1) * Statistically significant at 10%; ** statistically significant at 5%; *** statistically significant at 1%; (2) Robust standard errors in parentheses; (3) F Test is based on the null hypothesis of no country-specific effects; and (4) Likelihood-ratio (LR) Test is chi-squared distributed, based on the null hypothesis of no random effects.

No. of Obs R squared F Statistics LR Chi-squared F Test LR Test

GOV FASSET RI RI2 YDEP ODEP FDEEP KCON KAOPEN TOT GROWTH XMOPEN FINREF SOCPRO Constant

Pooled Samples

TABLE 7.5 Parameter Estimates of the National Savings Equation

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the Random Effects estimates, as opposed to the Fixed Effects estimates. Given these two considerations, the interpretations of Table 7.5 are based on the RE-MLE estimates for both pooled and Asian economy samples. Our main findings are satisfactorily robust. Among the Asian economies, financial reforms have negative effects on national savings, since a well-functioning financial market mitigates repression taxes on households and bolsters consumption. Likewise, greater access to external credit induces firms to leverage on new business opportunities and investment. The negative correlation between financial reform and national savings is also observed in the estimations with pooled samples. As in the baseline results, the estimates reveal only weak evidence that spending on social safety nets offers a panacea for the need for precautionary savings in the context of the Asian economies, even though it could discourage excessive savings in the pooled samples. In addition to the key determinants of national savings, the coefficients of several other control variables remain qualitatively unchanged. These include net foreign assets (FASS), relative income (RI), young population dependency ratio (YDEP), terms of trade volatility (TOT) and trade openness (XMOPEN). Nevertheless, some sensitivity is observed and can be recapitulated as follows. The coefficients of net government spending (GOV) become positive and statistically significant in the estimations with samples confined to the Asian economies, even though the estimations with the pooled samples still yield the result that net government spending reduces national savings. The coefficients of the old population dependency ratio are negative and statistically significant, and thus of the expected sign, and the result is consistent across the estimations with both pooled and restricted samples. Financial deepening (FDEEP) still exhibits a positive sign, but the coefficient turns out to be statistically significant at 1 per cent in the Asian economy samples. The effects of capital controls (KCON), albeit still positive, become statistically insignificant in the samples restricted to the Asian economies. The coefficients of capital account openness (KAOPEN) demonstrate slight sensitivity as the RE-MLE estimate of the Asian economies becomes positive and statistically significant, though only at the 10 per cent level. Lastly, GDP growth helps boost national savings, and thus the positive relationship is opposed to the effects of GDP growth on current account balances. Table 7.6 reveals the estimates of the national investment equation. As before, the F Test in the estimations with both pooled and restricted

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RE-MILE

OLS

FE

RE-MILE

2,383 .3741 72.54*** —— —— ——

2,383 .1999 25.87*** —— 17.21*** ——

2,383 —— —— 491.28*** —— 748.07***

272 .6973 55.77*** —— —— ——

272 .5745 16.40*** —— 7.98*** ——

272 —— —— 228.89*** —— 22.80***

.0294 (.0374) –.1074*** (.0392) –.0964** (.0389) .2363** (.0998) .0646 (.1250) .1627 (.1125) –.0005 (.0018) –.0014 (.0014) –.0011 (.0014) –.1652*** (.0355) –.1477*** (.0372) –.1330*** (.0346) 12.65*** (2.906) 166.0*** (20.54) 80.29*** (13.11) 31.66* (16.39) 104.1*** (35.43) 63.73*** (21.59) –14.90*** (2.507) –164.9*** (27.89) –79.87*** (14.05) –67.93** (28.11) –137.28*** (40.65) –105.6*** (33.83) –.1398*** (.0120) .0687*** (.0179) .0178 (.0176) –.1834*** (.0488) .0748 (.0657) .0346 (.0641) –.2832*** (.0391) –.4881*** (.0807) –.3044*** (.0668) –1.081*** (.1757) –1.235*** (.2308) –1.207*** (.1962) .0401*** (.0048) .0142*** (.0054) .0145*** (.0053) .0836*** (.0142) .1189*** (.0186) .1126*** (.0164) –.4001* (.2282) –.1493 (.1534) –.1519 (.1532) –.9240* (.5565) –.5951 (.4160) –.6711* (.4009) –.1647 (.1040) .0868 (.1181) .0090 (.1161) 1.082*** (.3631) .0670 (.4803) .2693 (.4255) .1192*** (.0249) —— –.0372 (.0823) –.1608 (.1324) —— –.2994 (.3556) .4073*** (.0391) .2857*** (.0214) .2970*** (.0214) .6481*** (.0866) .5418*** (.0754) .5574*** (.0731) .0464*** (.0082) .0387*** (.0060) .0408*** (.0056) .0164 (.0124) –.0030 (.0216) .0086 (.0137) –5.151*** (.7217) .3645 (.7945) –1.002 (.7852) –6.587** (2.628) 3.622 (2.945) 1.565 (2.908) –.0793 (.0817) .0445 (.0880) –.0366 (.0861) 1.156** (.5269) 1.086* (.5785) 1.029* (.5440) 30.35*** (1.751) 17.09*** (1.987) 20.33*** (2.066) 43.34*** (2.272) 19.84*** (6.418) 27.19*** (6.247)

FE

Asian Economies

Note: (1) * Statistically significant at 10%; ** statistically significant at 5%; *** statistically significant at 1%; (2) Robust standard errors in parentheses; (3) F Test is based on the null hypothesis of no country-specific effects; and (4) Likelihood-ratio (LR) Test is chi-squared distributed, based on the null hypothesis of no random effects.

No. of Obs R squared F Statistics LR Chi-squared F Test LR Test

GOV FASSET RI RI2 YDEP ODEP FDEEP KCON KAOPEN TOT GROWTH XMOPEN FINREF SOCPRO Constant

OLS

Pooled Samples

TABLE 7.6 Parameter Estimates of the National Investment Equation

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samples consistently rejects the null hypothesis of no unobservable country-specific effects, implying that the OLS estimates may be biased and inconsistent. Further investigation using the LR Test indicates the presence of random effects. Therefore, the Random Effects estimations based on the Maximum Likelihood estimators are the most appropriate in the national investment equation. Interestingly, while preceding estimations point to domestic financial reforms as a panacea for persistent current account surpluses and excessive savings, financial reforms are not found to have augmenting effects on national investment. As shown in Table 7.6, the coefficients of FINREF for the samples of the Asian economies appear to be positive and statistically insignificant, while those for the pooled samples are negative and statistically insignificant. Rather, expenditure on social safety nets essentially boosts national investment, as the coefficient of SOCPRO for the Asian economies is positive and statistically significant, though only at 10 per cent. Apart from financial reform and expenditure on social safety nets, other control variables seem to influence national investment in a rather different way from current account balances, except net government spending (GOV), net foreign assets (FASSET), capital account openness (KAOPEN) and GDP growth (GROWTH). That is, in the context of the Asian economies, net government spending does not have significant effects on national investment. Foreign assets, as expected, put downward pressure on investment (thereby boosting current account balances). The coefficients of capital account openness, as before, are statistically insignificant. Lastly, GDP growth perks up national investment, thereby undermining current account balances. In the context of the Asian economies, the effects of other control variables on national investment can be summarized as follows. First, the coefficient of relative income (RI) in a linear term is positive and statistically significant at 1 per cent, whereas that in a quadratic term is negative and statistically significant at 1 per cent. This suggests that a relationship between relative income and national savings is concave — increasing, but at a decreasing rate. Second, the influence of the demographic profile on national investment is quite in contrast with current account balances and national savings in the sense that the old population dependency (ODEP) is negatively related to national investment, while the young population dependency (YDEP) has only a weak relationship with national investment.

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Third, financial deepening (FDEEP) substantiating national investment as the coefficients of FDEEP are consistently positive and statistically significant at 1 per cent. This is understandable given that more relaxed financial constraints among households and firms would lead to higher national investment. Fourth, capital controls (KCON) discourage national investment, although the negative coefficient of KCON is statistically significant only at the 10 per cent level. This can be rationalized by the fact that foreign investment plays a pivotal role in national investment, especially among the Asian economies, and thus imposing capital controls is expected to deter national investment. And lastly, the effects of terms of trade volatility and trade openness become statistically insignificant in the national investment equation.

6. CONCLUSION This chapter has empirically investigated two drivers of current account balances — domestic financial reform and spending on social safety nets — using a panel of nine major Asian economies during the period 1973–2005. The empirical framework was built on the conventional setting as in Chinn and Prasad (2003) and Chinn and Ito (2007) by incorporating the newly developed indicators of domestic financial reform (Abiad et al. 2008) on top of a proxy of social safety net spending. The panel-data estimates yield satisfactorily robust findings that domestic financial reforms essentially reduce the need for current account surpluses, as available funds for consumption and investment among households and firms perk up domestic demand and discourage the Asian economies from running current account surpluses. In contrast, the estimations find only weak evidence that social protection can do the same job. Although expenditure on social protection, i.e., public healthcare, is found to have a negative influence on current account balances, the effects appear to be statistically insignificant. The empirical exercises in this chapter shed light on the macroeconomic policies that can taper global economic imbalances — issues which have been widely debated, yet by and large unanswered empirically. The issues are that the Asian economies have by far leveraged on the export-led growth model, and inadequate domestic demand has been translated into persistent account surpluses as well as mounting global imbalances. The experience during the global financial crisis of 2008–9 has made it

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abundantly clear that a situation of excessive dependence on external demand and persistent current account surpluses as a prime driver of economic growth is highly perilous, due to inefficiency of resource misallocation as well as susceptibility to external shocks. In this regard, the findings presented in this chapter underline that domestic financial reforms hold the key to boosting domestic demand, unwinding persistent current account surpluses, and ultimately ushering in global economic rebalancing.

Notes 1. The Republic of Korea is excluded from our dataset due to the absence of financial reform variables. India is included because India is a vital part of East Asian regionalism and on an equal footing with China in terms of contributions to persistent current account surpluses. 2. To save space, the parameter estimates of the missing-variable dummies are suppressed in the empirical results discussed later in this chapter. 3. As discussed by Ito and Voltz (2013), the coefficients of the national and saving equations should conceptually be added to those in the current account equation. However, this is not the case empirically for two reasons. First, the estimations of the current account equation implicitly account for the covariance of disturbances in the national savings and investment equations, while the equation-by-equation estimations of the national savings and investment equations do not. Moreover, in practice, differences in data conventions imply that national savings and investment are not added to current account balances.

References Abiad, Abdul, Enrica Detragiache, and Thierry Tressel. “A New Database of Financial Reforms”. IMF Working Papers no. 266. Washington, DC: International Monetary Fund, 2008. Adams, Charles and Donghyun Park. “Causes and Consequances of Global Imbalances: Perspectives from Developing Asia”. Asian Development Review 26, no. 1 (2009): 19–47. Aw, Bee Yan, Sukkyun Chung, and Mark J. Roberts. “Productivity and Turnover in the Export Market: Micro-level Evidence from the Republic of Korea and Taiwan (China)”. World Bank Economic Review 14, no. 1 (2000): 65–90. Chinn, Menzie D. and Eswar S. Prasad. “Medium-term Determinants of Current Accounts in Industrial and Developing Countries: An Empirical Exploration”. Journal of International Economics 59, no. 1 (2003): 47–76.

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Chinn, Menzie D. and Hiro Ito. “What Matters for Financial Development? Capital Controls, Institutions, and Interactions”. Journal of Development Economics 81, no. 1 (2006): 163–92. ———. “Current Account Balances, Financial Development and Institutions: Assaying the World ‘Savings Glut’”. Journal of International Money and Finance 26, no. 4 (2007): 546–69. ———. “A New Measure of Financial Openness”. Journal of Comparative Policy Analysis 10, no. 3 (2008): 309–22. Edward, Sebastian. “Why are Saving Rates So Different across Countries? An International Comparative Analysis”. NBER Working Papers no. 5097. Massachusetts: National Bureau of Economic Research, 1995. Greenaway, David and Richard Kneller. “Industry Differences in the Effect of Export Market Entry: Learning by Exporting?” Review of World Economics 143, no. 3 (2007): 416–32. Hsieh, Chang-Tai. “What Explains the Industrial Revolution in East Asia? Evidence from the Factor Markets”. American Economic Review 92, no. 3 (2002): 502–26. Ito, Hiro and Ulrich Volz. “China and Global Balances from a View of Sectoral Reforms”. Review of International Economics 21, no. 1 (2013): 57–71. Roldos, Jorge. “Human Capital, Borrowing Constraints, and the Stages of the Balance of Payments”. Washington, DC: International Monetary Fund, 1996. Servén, Luis and Ha Nguyen. “Global Imbalances: Origin and Prospects”. World Bank Research Observer (forthcoming). Thangavelu, Shandre M., Yik Wei Yong, and Aekapol Chongvilaivan. “FDI, Growth, and the Asian financial Crisis: The Experience of Selected Asian Countries”. World Economy 32, no. 10 (2009): 1461–77. White, Halbert. “A Heteroskedasticity-robust Covariance Matrix Estimator and a Direct Test for Heteroskedasticity”. Econometrica 48, no. 4 (1980): 817–38.

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8 FOREIGN EXCHANGE RATE ADJUSTMENT POLICIES IN ASIA Paitoon Wiboonchutikula, Bangorn Tubtimtong, and Nuchit Pruektanakul

1. INTRODUCTION Global imbalances emerged in the world economy after the 1997 Asian financial and currency crises, and policymakers and academics have since been concerned about the consequences and how to correct them. Subsequently, in 2008 the financial crisis erupted in the United States and spread to other developed countries, resulting in a deep and prolonged recession that has continued to plague the global economy until today. Most economists believe that the global imbalances are one of the major factors to have contributed to the crisis. There has been excessive consumption and deficits in current accounts of major industrial countries, while large surpluses and insufficient consumption have been observed in the emerging economies, mostly in East and Southeast Asia. Half a decade has passed since the 2008 crisis began, but the global imbalances remain. The large industrial countries together with major emerging economies (the G-20) initiated many meetings to coordinate international macroeconomic policies aimed at reducing the imbalances. All have agreed that exchange rates and

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macroeconomic adjustments should be made, but there is no agreement on who should take the action. Before the 2008 crisis, neither the surplus nor the deficit countries were willing to adjust their exchange rates or macroeconomic policies to reduce the global imbalances. The Asian countries have been criticized for their continued pursuit of export-oriented policies which have rewarded them with a very rapid and successful growth performance over the past decades. Hausmann et al. (2004) claim that the rapid growth of trade and employment was associated with depreciation of these countries’ exchange rates in real terms. That is, once these countries shifted their policies towards an export orientation, attention was paid to maintaining their real exchange rates favourable to exports in order to achieve desirable rates of output and employment growth. On one hand, the relatively low real exchange rate enabled their exports to be attractive in the world markets; on the other, it prevented their imports from growing too fast. In a nutshell, currency appreciation or, to be more precise, attempts to keep real exchange rates from appreciation, have made it possible for Asian economies to pursue an export-led growth strategy and to continue to mount foreign reserves. In 2005 the U.S. government strongly urged the country with the most current account surplus — China — to revalue its currency on the belief that the yuan was substantially undervalued. In response to the accusation of undervaluation, Chinese authorities announced in July 2005 that the yuan would immediately appreciate against the U.S. dollar by 2.1 per cent, from 8.28 to 8.11 yuan per dollar, and it would become adjustable based on market demand and supply with reference to a basket of currencies instead of pegging to the dollar. However, the small exchange rate adjustment after the announcement did little to change the U.S. trade deficits with China. Furthermore, it failed to stop the United States from accusing China of manipulating its currency for the purpose of gaining unfair trade advantages. Bergsten (2006) notes that such manipulation also induces other Asian countries to intervene in their currency markets so as to keep their currencies weak against the dollar and maintain competitiveness with Chinese goods. As a result, persistent current account surpluses prevail, not only in China, but also in other export-oriented Asian countries. Based on the above, this chapter aims to address the question of whether Asian countries can help global current account rebalancing by their exchange rate adjustments. Could real exchange rate revaluation of the Chinese yuan and appreciation of the Asian currencies help reduce their trade surpluses and, at the same time, reduce U.S. trade deficits? What

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will be the impact on the deficit and the surplus countries if both agree to adjust their exchange rates and macroeconomic policies to rebalance the sources of world consumption? In other words, are there mutual incentives for both surplus and deficit countries to cooperate and take policy actions to reduce global imbalances? To answer the above, we employ a global macro-econometric model, namely, the Cambridge-Alphametrics Model of the world economy (CAM), as a tool for simulating results based on different scenarios. The remainder of the chapter is organized as follows: Section 2 provides an overview of global imbalances and the foreign exchange rate policies in Asia. Section 3 provides a brief introduction to the CAM structure and how to conduct the simulation analysis. Section 4 presents and analyses the simulation results under the various scenarios of foreign exchange rate adjustments and macroeconomic policies of both the surplus and deficit countries aimed at achieving sustainable growth under a more balanced world economy. Lastly, Section 5 concludes and provides policy implications from our findings.

2. GLOBAL IMBALANCES AND THE ASIAN FOREIGN EXCHANGE RATE POLICIES 2.1 Global Imbalances and Asia Global imbalances reflected by persistent current account deficits in the United States and developed countries and surpluses in China and other Asian countries have emerged in the world economy for more than a decade. The size and growth of the imbalances have been shown to gradually spawn a financial crisis in the deficit countries and subsequently the Great Recession at the global level. As the global imbalances developed, there was a rapid build-up of foreign ownership of assets in the deficit countries, particularly the United States, to finance their chronic current account deficits. These countries became increasingly indebted and their over-borrowing fostered real estate and financial market bubbles that eventually burst and led to a severe financial crisis. Conversely, the surplus countries piled up international reserves, the benefits of which were offset by high fiscal costs and opportunity costs for failure to invest in high-return assets. In other words, although the accumulated foreign reserves could offer insurance against external shocks, the excessive reserves entailed large

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welfare losses due to the central banks’ holding of safe yet low-yielding foreign assets instead of allowing them to be available for the public to invest in assets with much greater returns. Figure 8.1 traces the current account positions across key countries and regions as a percentage of world GDP from 1993 to 2011. The imbalances began in the aftermath of the 1997 Asian crises and enlarged over time despite an immediate decline after the eruption of the financial crises in the developed countries in 2008.1 Apparently, the United States has been the centre of global current account deficits due to its sizable share, followed closely by some European economies. The current account deficits of the United States, averaged out over the last decade, accounted for 1.3 per cent of world GDP. Its peak in 2005 was over 6 per cent of the country’s GDP; equivalent to 1.6 per cent of world GDP. On the surplus side, global imbalances are contributed to by emerging and developing Asia, other than Japan and the Middle East.2 The surpluses came from a remarkable turnaround in developing Asia’s current account in 1998 (after the 1997 Asian financial and currency crisis), which was consistent with the beginning of the imbalances. Since then the current account surpluses of these economies have accelerated and moved closely in parallel to the U.S. current account deficits in absolute terms. Figure 8.1 shows clearly that since 1998 developing Asia’s current account surpluses relative to global surpluses have grown in line with the increases in current account deficits in developed countries, with the United States bearing the most part of the deficits. This asserts that Asia’s contribution to the recent global imbalances was crtical, and that the countries of Asia, together with the United States, have a great role to play in helping rebalance the world economy. We will focus here on the current account positions for selected major economies in Asia, comprising China, India, South Korea, Singapore, and the Association of Southeast Asian Nations (ASEAN) economies. Over the past decade, the aggregate size of these selected economies accounted for more than 85 per cent of incomes of the whole of Asia. Figures 8.2 and 8.3 show that the current accounts of the group of countries affected by the 1997 Asian crisis — particularly Indonesia, South Korea, Malaysia, the Philippines and Thailand — turned sharply from persistent deficits before the crisis to large surpluses in the late 1990s. However, such a drastic improvement in their current accounts slowed down, and since 2003 the surpluses shifted to China. In fact China’s

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2000

1999

1994

1993

Sources: IMF, World Economic Outlook database, October 2012.

-2.5%

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1995

1.0%

1996

1.5%

1997

2.0%

United States Europe Japan Developing Asia NIEs Middle East and Russia Africa Lan America and the Caribbean

1998

2.5%

2005

2004

2003

2002

2001

FIGURE 8.1 Global Current Account Balances (% of world GDP)

2006

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2007

-2.5%

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

178 Paitoon Wiboonchutikula, Bangorn Tubtimtong, and Nuchit Pruektanakul

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2011

2010

2009

2008

4/10/15 8:12 AM Singapore

Indonesia Malaysia Thailand South Korea The Philippines

Source IMF, World Economic Outlook database, October 2012.

-10.0%

0.0%

10.0%

20.0%

30.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

-10.0%

0.0%

10.0%

20.0%

30.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

India

China

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

FIGURE 8.2 Current Account Balances of Selected Asian Countries (% of GDP)

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

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Paitoon Wiboonchutikula, Bangorn Tubtimtong, and Nuchit Pruektanakul

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-1.5%

-1.0%

-0.5%

0.0%

0.5%

1.0%

-2.0%

2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990

Source: IMF, World Economic Outlook database, October 2012.

-2.0%

-1.5%

-1.0%

0.0%

-0.5%

0.5%

1.0%

1.5%

2.0%

India

2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990

Singapore 1.5%

-2.0%

-1.5%

-1.0%

-0.5%

0.0%

0.5%

2.0%

-5.0%

-4.0%

-3.0%

-2.0%

0.0%

-1.0%

1.0%

2.0%

3.0%

4.0%

1.0%

1.5%

2.0%

Indonesia Malaysia Thailand

South Korea The Philippines

5.0%

China

2011 2010 2009 2008 2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

FIGURE 8.3 Current Account Balances of Selected Asian Countries (% of region’s GDP)

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current account surpluses accelerated from around 2 per cent of GDP in the early 2000s to over 10 per cent of GDP (equivalent 4.5 per cent of the region’s GDP) in the late 2000s. This suggests that over the past decade the overall current account surpluses in Asia owed much to China’s current account position rather than the rest of Asia as a group. This is because that whilst countries such as Singapore, Hong Kong and Taiwan had persistently large current account surpluses, other countries such as India and Vietnam often had deficits. Therefore, on balance, the overall current account surplus for countries in Asia other than China, was much less than the surplus of China alone. Asia’s large current account surpluses come mostly from surpluses in the trade account. They are attributable mainly to the success of their export-orientation policies that started in the 1980s. Before the 1997 crisis the high export growth of these countries was accompanied by high import growth of raw materials and machinery and equipment used in manufacturing. After the crisis, exports continued to grow rapidly, but import growth slowed due to the reduced growth of domestic consumption and investment, resulting in persistent surpluses in trade balances. Figure 8.4 presents both exports and imports of goods and services together with their shares in GDP for individual Asian economies. The current account positions for almost all of these countries were in line with the trade balances, implying that current account surpluses came mostly from surpluses in the trade balances. The figures also show that the Asian countries had a relatively high degree of export openness measured by export shares in GDP. Continuing from the late 1980s the export shares in GDP of the city states of Singapore and Hong Kong were the highest in the region (200 per cent). The shares of the rest of Asia were all greater than 50 per cent. The large economy of China saw its export share in GDP increase from 23 per cent in 2001 to 40 per cent in the late 2000s. In recent years the export growth of all Asian countries has slowed down due to the Great Recession following the financial crisis in the developed countries. Nevertheless, the surpluses in both trade and current accounts have not been eradicated, and the global imbalances remain. The contraction of the markets in the developed countries and the world economy reduced part of the imbalances, but not all. This implies that the export-led growth policy in Asia is still viable, albeit not as effective as in the past. Despite the recent slowdown in the export growth of Asia, Asian countries continue to rely on exports as their engine of growth and

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182

Paitoon Wiboonchutikula, Bangorn Tubtimtong, and Nuchit Pruektanakul FIGURE 8.4 Share of Exports and Imports in GDP for Selected Asian Countries China

15.0%

50.0%

Exports Imports Current account

10.0%

40.0%

20.0%

10.0%

30.0%

150.0%

Malaysia Exports Imports Current account

15.0%

100.0%

5.0%

5.0% 20.0%

0.0% 50.0%

-5.0%

Indonesia

6.0% Exports Imports Current account

4.0%

2010

2008

2006

2004

1990

2002

10.0%

2000

60.0%

0.0% 1998

-15.0% 1996

0.0% 2010

2008

2006

2004

2002

2000

1998

1996

1994

1992

1990

-5.0%

-10.0%

1994

10.0%

1992

0.0%

80.0%

Philippines Exports Imports Current account

50.0% 5.0%

60.0%

40.0%

2.0%

30.0% 0.0%

0.0%

40.0%

-5.0%

20.0%

-10.0%

0.0%

20.0%

-2.0%

40.0%

India Exports Imports Current account

1.0% 0.0%

30.0%

-1.0%

20.0%

-2.0% 10.0% -3.0%

2010

2008

2006

2004

2002

2000

1998

Singapore 30.0%

300.0%

Exports Imports Current account

25.0%

250.0%

20.0%

200.0%

15.0%

150.0%

10.0%

100.0%

5.0%

50.0%

0.0%

0.0%

15.0%

60.0%

South Korea Exports Imports Current account

10.0%

50.0% 40.0%

15.0%

2010

2008

2006

2004

2002

2000

1998

1996

1994

1992

1990

2010

2008

2006

2004

2002

2000

1998

1996

1994

1992

0.0% 1990

-4.0%

1996

1990

2010

2008

2006

2004

2002

2000

1998

1996

1994

1992

1990 2.0%

1994

0.0%

-4.0%

1992

10.0%

100.0%

Thailand Exports Imports Current account

10.0%

80.0%

5.0%

60.0%

30.0%

2010

2008

2006

2004

2002

0.0% 2000

-10.0% 1998

2010

2008

2006

2004

2002

2000

1998

1996

1994

1992

1990

20.0%

1996

0.0%

-5.0%

40.0%

1994

10.0%

0.0% -5.0%

1992

20.0% 0.0%

1990

5.0%

Note: The horizontal axis represents years, while the left-vertical axis represents share of the current account in GDP and the right-vertical axis represents share of exports and imports in GDP. Source: World Bank, World Development Indicators database, October 2012.

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continue to accumulate their international reserves. Figure 8.5 shows the gross international reserves of selected Asian economies from 2001 to 2011. The reserves in each country increased despite the recent global recession. Although the reserves were large in all countries, they were almost eclipsed by China’s huge accumulation of reserves. In 2011 China’s international reserves stood at more than US$3,000 billion, while those in the rest of Asia combined were only US$830 billion. Ito (2012) argues that the huge accumulation of international reserves by Asian countries reflects not only efforts to maintain high export growth to increase incomes and employment, but also a self-insurance against the adverse impacts of sudden reversals of capital inflows at times of systemic shocks. For whatever purpose, each country seems to occasionally intervene in their foreign exchange markets to keep the foreign exchange rates favourable to export competitiveness, and at the same time to allow foreign reserves to increase to safeguard against any sudden needs for foreign borrowing. In summary, all the above evidence shows that besides excessive consumption by the industrial countries, the Asian region has also played a crucial role in contributing to the global current account imbalances over the last decade. The region’s large and prolonged current account surpluses were consistent with the U.S. current account deficits after the 1997 Asian financial and currency crises. Perhaps, due to lessons learned from the crises, in its wake the Asian countries have intensified their use of the export-led growth strategy to strengthen the accumulation of international reserves to insure against external shocks, and forced foreign borrowing. The export-led growth strategy has the benefit of keeping employment high and raising real wages. Owing to the above motivations, policymakers in many countries — particularly in the deficit ones — hold the view that Asian countries use exchange rate policies to favour their exports at the expense of their trading partners.

2.2 Exchange Rate Policies in Asia Export orientation policy has been adopted by East and Southeast Asian countries since the 1980s. Before the 1997 Asian crises, exchange rates were fixed and inflation rates were kept low to support export competitiveness. After the fixed exchange rate regime collapsed in the aftermath of the 1997 crises, most Asian countries abandoned the pegged regime and resorted to

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0

110.1

237.11

33.05

500

306.4

298.0

75.48 175.2

15.69

29.81 75.3

102.82 133.3

55.41

28.01

1,000

831.49

Note: For China, data is available for 2004 onwards. Sources: CEIC database, downloaded December 2012.

Thailand

Singapore

Philippines

Malaysia

Korea

India

Indonesia

China

1,500

2,000

2011

FIGURE 8.5 Gross International Reserves (US$ billion)

2,500

2007

3,000

2005

2001 3,500

3255.8

184 Paitoon Wiboonchutikula, Bangorn Tubtimtong, and Nuchit Pruektanakul

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a wide range of relatively flexible exchange rate systems. The exchange rate arrangements of these countries can roughly be divided into two groups. The first group — Indonesia, South Korea and the Philippines — has officially adopted a relatively flexible exchange rate regime accompanied by the inflation targeting monetary policy framework. However, in practice their exchange rates are not completely determined by supply and demand in the foreign exchange market; they sometimes intervene in the market to prevent an excessive fluctuation of their currencies. The second group — China, India, Malaysia, Singapore and Thailand — officially operate various forms of exchange rate policies broadly known as a managed float system. Their exchange rates are generally allowed to adjust in the foreign exchange market so long as the fluctuations do not violate their overall economic goals. China and Malaysia announced in July 2005 that they had officially shifted from the dollar peg to a new system in which the flexible and market-determined exchange rates of the yuan and ringgit are measured against a basket of currencies. India monitors and manages the exchange rate without a specific pre-announced target or band, coupled with official intervention if and when necessary. Quite differently, Thailand allows its currency to be fairly determined by market forces, despite the adoption of a managed float regime along with the inflation targeting framework, whereas Singapore employs the managed float policy conducive to its primary goal of price stability. On the whole, most Asian countries do not always follow their official announcements of their foreign exchange rate systems. In practice the systems are more diversified than the classification into the above two groups. Table 8.1 shows de facto exchange rate regimes of selected Asian countries provided by the International Monetary Fund (IMF).3 Most of these economies — except for China and Indonesia — are classified as managed floaters, broadly consistent with the official pronouncements. The arrangement of China’s exchange rates, officially based on a currency basket, is defined as a crawling peg instead. Yet, Indonesia is categorized as a managed floater, rather than as having a freely floating arrangement, while both South Korea and the Philippines are in line with their public announcements. Reinhart and Rogoff (2004) emphasize the distinction between the observed and official regimes among these Asian countries. Besides the de facto IMF foreign exchange rate classification, Rajan (2010) finds that many Asian countries managed their currencies against either a single

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Paitoon Wiboonchutikula, Bangorn Tubtimtong, and Nuchit Pruektanakul TABLE 8.1 De facto IMF Exchange Rate Classification of Selected Asian Countries

Country

Regimes (as of 30 April 2008)

China Indonesia India South Korea Malaysia The Philippines Singapore Thailand

Crawling peg Managed floating with no pre-determined path for exchange rate Managed floating with no pre-determined path for exchange rate Independently floating Managed floating with no pre-determined path for exchange rate Independently floating Managed floating with no pre-determined path for exchange rate Managed floating with no pre-determined path for exchange rate

Notes: According to the IMF the currency under crawling pegged exchange rates is adjusted periodically in small amounts at a fixed rate or in response to changes in selective quantitative indicators, such as past inflation differentials vis-à-vis major trading partners, differentials between the inflation target and expected inflation in major trading partners, and so forth. Under the managed float system the monetary authority intervenes directly or indirectly in the exchange rate market without having a specific exchange rate path or target. Motives for managing the rate are mainly judgmental, such as balance of payments position, international reserves, and parallel market developments. The exchange rate is market-determined, with any official foreign exchange market intervention aimed at moderating the rate of change and preventing undue fluctuations in the exchange rate, rather than at establishing a level for it. See: http://www.imf.org/external/np/mfd/er/2006/eng/0706.htm. Sources: IMF data on De Facto Classification of Exchange Rate Arrangements and Monetary Frameworks (IMF, 2008).

currency (i.e., the U.S. dollar) or a basket of major currencies over the period of 1999 to 2009. Despite the currency reform of China and Malaysia in late 2005, China continued to operate a de facto U.S. dollar peg with minor fluctuations, whereas there was a gradual decrease in the influence of the dollar in Malaysia. Meanwhile, Singapore and Thailand appeared to manage their currency vis-à-vis a currency basket in line with the pronouncements. Despite being classified as a country with independently floating exchange rates, the Philippines often exhibited strong management against the dollar. In contrast, there existed relatively greater exchange rate flexibility in Indonesia and India compared with others, while evidence of South Korea’s intervention in foreign exchange markets was not significant. Nevertheless, most studies find that the majority of Asian central banks occasionally intervene in foreign exchange markets to deal with fluctuations that could be harmful to their economies. Indeed, the stockpiles of foreign reserves in these economies might be interpreted as the result of attempts to intervene in foreign exchange markets to prevent the exchange rate from

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real appreciation, which could be harmful to their exports. Jongwanich (2010) finds that several Asian currencies were effectively undervalued in real terms and that they tended to move along the same trends. Figure 8.6 shows various forms of the exchange rate index, namely bilateral exchange rates against U.S. dollar, as well as nominal and real effective exchange rate (NEER and REER) for selected Asian currencies after the crisis. The figures are split up for the latest adoption of China’s and Malaysia’s exchange rate flexibility in July 2005. Apparently, the overall indices had similar trends across countries until the eruption of the ongoing global crisis. During the period from 2000 to early 2005, these currencies tended to move in line with the Chinese yuan, although after that a slight change in the patterns occurs. However, the Malaysian ringgit, Philippine peso, Singapore dollar and Thai baht — both in nominal and real terms — still move in concert with the yuan along the trend of mild exchange rate appreciation, not only against the dollar, but also against their major trading partners. Broadly speaking, the co-movements of the exchange rates in Figure 8.6 tend to support the argument that Asian countries attempted to maintain their export competitiveness by keeping their own currencies in line with each other. The exceptional growth of their foreign reserves was also the result of their intervention in foreign exchange markets. Thus, we may conclude that — except for China — the exchange rate regimes of most Asian countries after the 1997 crisis range from managed floating to freely floating ones. However, despite the adoption of greater exchange rate flexibility, the currencies of most of these countries have been managed regularly and persistently in order to enable the competitiveness of their exports to be in line with each other, resulting in the accumulation of their foreign reserves. Their reserves have been invested mostly in the United States to finance and sustain its huge trade deficits, leading to persistent global imbalances.

3. A GLOBAL ECONOMY MODEL: THE CAM Our study attempts to discover the potential effects of foreign exchange rate adjustment policies in both the surplus countries in Asia and the deficit countries — particularly the United States — on rebalancing the world economy using the Cambridge-Alphametrics Model (the CAM). Based on the model, we simulate results on trade balances and growth of major surplus countries in China and ASEAN, as well as major deficit

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Paitoon Wiboonchutikula, Bangorn Tubtimtong, and Nuchit Pruektanakul FIGURE 8.6 Patterns of Asian Currencies

Panel A: Bilateral Exchange Rate 2999N1–2005M6 2005M7–2012M12 140

140

130

130

120

120

140 110

140 110

130 100

130 100

120 90 140 110 80 130 100 70 120 90 60 110 1/2000 80 100 70 90 140 60 80 1301/2000

120 90 140 110 80 130 100 70 120 90 60 110 12/2005 80 100 70 90 140 60 80 13012/2005

1/2001

1/2002

1/2003

1/2004

1/2005

12/2006

12/2007

12/2008

12/2009

12/2010

12/2011

Panel B: Nominal Effective Exchange Rate (NEER) 1/2001 1/2002 1/2003 1/2004 1/2005 12/2006 12/2007 12/2008 12/2009 12/2010 2000M1–2005M6 2005M7–2012M12 70 70 120

12/2011

120

60 140 110 1/2000 130 100 120 90 140 110 80 130 100 70 120 90 60 110 1/2000 80 100 70 90 140 60 801/2000 130

1/2001

1/2002

1/2003

1/2004

1/2005

60 140 110 12/2005 130 100 120 90 140 110 80 130 100 70 120 90 60 110 1/2005 80 100 70 90 140 60 80 1301/2005

12/2006

12/2007

12/2008

12/2009

12/2010

12/2011

1/2006

1/2007

1/2008

1/2009

1/2010

1/2011

1/2012

1/2006

1/2007

1/2008

1/2009

1/2010

1/2011

1/2012

60 140 110 Panel C: Real1/2005 Effective Exchange Rate (REER) 1/2005 1/2006 1/2007 1/2008 1/2009 1/2010 1/2004 130 2000M1–2005M6 100 2005M7–2012M12

1/2011

1/2012

1/2010

1/2011

1/2012

1/2008 Thailand 1/2009 1/2010

1/2011

1/2012

1/2011

1/2012

1/2001

1/2002

1/2003

1/2004

1/2005

1/2001

1/2002

1/2003

1/2004

1/2005

70 120

70 120 60 140 110 1/2000 130 100 120 90 140 110 80 130 100 70 120 90 60 110 1/2000 80 100 70 90 60 801/2000

1/2001

1/2002

1/2003

1/2001

1/2002

1/2003

1/2004

1/2001

1/2002

1/2003 Malaysia1/2004

China

1/2005

Indonesia 1/2005 Philippines

70 60 1/2000

120 90 140 110 80 130 100 70 120 90 60 110 1/2005 1/2006 1/2007 80 100 70 90 India 60 801/2005 1/2006 1/2007 Singapore

1/2008

1/2009

Korea

70

China 1/2001

1/2002

1/2003

Malaysia

Indonesia 1/2004

1/2005

Philippines

India 60 1/2005 1/2006

Korea 1/2007

Singapore

1/2008

1/2009

Thailand

1/2010

China

Indonesia

India

Korea

Malaysia

Philippines

Singapore

Thailand

Note: Bilateral exchange rates (U.S. dollars per local currency at the end of month), NEER, and REER are obtained from CEIC database, and rebased with 2005 = 100. A rise in figures means appreciation of the corresponding exchange rates. Source: Authors’ calculations.

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countries in Europe and the United States, under the condition that these countries adjust their exchange rate and macroeconomic policies to balance both their internal sectors (reducing unemployment) and external sectors (reducing the deficits or surpluses). The CAM is a global macro-econometric model originated by Cripps and Godley (1978) at Cambridge University in the late 1970s, based on an extended version of the Keynesian theory. The model has been developed progressively by Alphametrics Co., Ltd. as a tool for investigating global policy issues. It is capable of assessing implications and impacts of alternative policies on countries or country groups by feeding historical data into the model, then modifying variables and equations before undertaking simulations under different scenarios to determine policy outcomes over the medium and long terms.4 The structure of the model is depicted in the flow chart in Figure 8.7. In the model the world is separated into individual countries or blocs of countries. In each country or bloc there are sets of modules or sectors interacting with each other and responding to policy shocks or simulation conditions. The main sectors are private sector demand and income; government sector demand and income; international trade in primary and manufactured goods, energy and services; international factor incomes and payments, transfers; capital flows; external balances; exchange rates; and banking flows and balances. These sectors — also separated into goods, services and financial markets — are in turn interacting with the world economy. The CAM model of the world economy makes use of standard national income accounting identities, stock and flow concepts, and adjustment processes capturing public and private sectors behaviour to ensure consistency at both the global and country levels. For the public sector, government behaviour is assumed to track rules of government revenue and spending aimed at stabilizing the economy. Meanwhile, the central bank is assumed to follow a Taylor-type rule responding to domestic inflation and capacity utilization. For the private sector, consumption or savings depend on real incomes, wealth, interest rates and inflation. According to the model, private investment is partly constrained by financial conditions such as bank lending rates and other interest rates, although investment decisions also rely on the rate of GDP growth. In the model, each economy connects with the rest of the world by international trade, while global financial markets match flows of

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190

Paitoon Wiboonchutikula, Bangorn Tubtimtong, and Nuchit Pruektanakul FIGURE 8.7 Economic Structure and Global Linkages in the CAM

Source: Cripps et al. (2011).

the current account with the capital account and foreign reserves, and determine the valuation of external positions. The current account and external positions are affected by exchange rates and prices. Meanwhile, the affected external balances, in turn, provide feedback leading to further changes of exchange rates and prices. The real exchange rate for each country is defined as a ratio of domestic to world purchasing power of money converted from market exchange rates. It adjusts through time in response to either one or a combination of the following factors: (1) changes in the nominal exchange rate against the dollar, (2) changes of the price of domestic expenditures, and (3) changes of the price of world aggregated expenditures. Accordingly, an increase in value of the rate indicates real exchange rate appreciation against the world currencies.

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The world markets for manufactured goods are assumed to be demand-driven with prices determined by supply. Market shares of manufactured exports of individual countries are affected by movements of relative costs of production in different economies. Such a change in market shares reflects outcomes of competitiveness between international firms and their strategies for locating and sourcing supplies. Meanwhile, world markets for primary commodities, energy products, and services are unified separately. Besides the real exchange rate, fluctuations in world prices have influences on the above markets. Movements of the world prices of primary commodities are modelled by a demand function, whereas the world oil price is addressed endogenously each year so as to bring supply and demand for exports of energy to equilibrium. Based on the above economic structure, economic policies — such as fiscal, monetary, exchange rate, trade and industrial policies — are fed into the model to affect individual sectors and allow them to interact with each other in order to determine output and prices, as well as to study the policy effects on individual economies and across countries. The CAM model employs a historical databank as a main source of annual time-series data covering 130 countries around the world, for the period 1980 to 2012. The databank was collected from the following sources: International trade statistics by commodity, source and destination obtained from the United Nations (UN) Comtrade database. Data on balance of payments, international investment positions, monetary variables and government accounts collected from the International Monetary Fund (IMF). National account aggregates and population statistics from the UN Statistical Division, the Organisation for Economic Co-operation and Development (OECD), Eurostat and UNCTAD. All datasets were compiled and rebased to the base year of 2005, before being fed into the model for estimation and simulation. All the structural parameters in the model were estimated on the EViews6. Panel data of 130 countries from 1980 to 2012 were used for estimation with fixed effects where behavioural variables were determined by reaction functions with autoregressive distributed lag schemes in errorcorrection forms. The estimated parameters were tested for statistical significance before using in all simulations. The policy impacts from our CAM-based simulations were interpreted and analysed by comparing results under alternative scenarios with the baseline projection. Note that the original version of the CAM model has been modified by a few specifications in order to obtain results consistent with the objectives

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Paitoon Wiboonchutikula, Bangorn Tubtimtong, and Nuchit Pruektanakul

of our study. The standard bloc aggregation of the model was rearranged with the purpose of highlighting countries of particular interest from the rest of the world. China, India, Indonesia, Japan, Malaysia, the Philippines, Singapore, Thailand and the United States were taken as individual countries, while European countries were separated into blocs of the eurozone and the rest of Europe. The rest of the developed countries and emerging Asia were separated into two different blocs, with the latter group comprising South Korea, Hong Kong and Taiwan. The rest of the world was classified by geographical areas, consisting of the blocs of Central America, South America, North Africa, other Africa, East Asia, South Asia, West Asia, and the former Soviet Union. In implementing our estimation and simulation, we first projected a baseline scenario for the future period of 2013 to 2022, based on the assumption that current economic structures and patterns remain without significant change of policy regimes. Next, we studied the impact of policy adjustments under alternative scenarios by imposing shocks or policy innovations in China, Indonesia, Malaysia, the Philippines, Singapore, Thailand and the United States. Specifically, we simulated the model by specifying explicit commands consisting of a target function and a list of instruments to obtain policy outcomes differentiated from the baseline results so as to be able to draw policy implications.

4. SCENARIOS OF FOREIGN EXCHANGE RATE AND MACROECONOMIC POLICIES Foreign exchange rate policies in Asia, particularly in China, are one of the most controversial issues in the global economy. China’s increasingly large trade surplus with the United States and enormous reserves accumulation incited the United States and other developed economies to accuse the country of currency manipulation in order to gain an unfair trade advantage. They called for the Chinese yuan to be revalued, or even to allow it to float freely. Geithner (2012) insists that the yuan is still undervalued, although China has begun to adjust the exchange rate and has allowed it be more flexible against the U.S. dollar and other major world currencies such as the euro and yen. Thus, in this section we aim to exam the impact on global external balances of foreign exchange rate adjustments in China and major Southeast Asian countries We will also analyse the effects foreign exchange rate adjustments in combination with macroeconomic policies of both the surplus and the deficit countries have on global imbalances. The results are expected to indicate what both

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the deficit and the surplus countries should do to rebalance the world economy to the benefit of their own growth and stability. The study will be separated into four different scenarios as follows:

4.1 Chinese Yuan Revaluation Combined with Expansionary Macroeconomic Policies Imagine that the Chinese authorities were willing to let the real exchange rate revalue against the world’s currencies in order to deal with mounting international pressures on its foreign exchange rate policy. It is expected that a revaluation in real terms could stimulate imports and undermine exports, thereby worsening China’s trade balance. However, a loss of export competitiveness due to the appreciation might also reduce employment, especially in exporting sectors, lower aggregate demand, output and national income, and eventually result in an economic slowdown in China. That is, the more the yuan revalued, the greater the negative effects would be on the Chinese economy. To avoid these potential negative effects, the authorities need to supplement the revaluation with expansionary policies, either by fiscal or through monetary policy to mitigate the impact.5 Accordingly, the first scenario we set to simulate the results was a 10 per cent real exchange rate revaluation combined with a 10 per cent increase in government expenditures in China.6 The 10 per cent shock of increased government expenditures was based on the average growth rate of China’s government expenditures of around 10 per cent over the past two decades. The scenario examines whether yuan revaluation combined with macroeconomic policy could worsen China’s trade balance and improve the trade balances of other economies, focusing on Asian countries as well as the G-3 economies. It is expected that expansionary macroeconomic policy in addition to yuan appreciation should worsen China’s trade balance through a decrease in exports and a sharp increase in imports. Moreover, a combination of yuan appreciation and policy expansion in China should improve the trade balances of both China’s trading partners and trade competitors. In countries that are China’s trading partners, the combined policies should increase their exports and decrease their imports. In countries that are China’s trade competitors, the combined policies should increase their exports to the third countries as well as to China, and decrease their imports from China. Figures 8.8 and 8.9 show the responses of export and import volumes and the trade balance for Asian countries and developed economies, respectively, to a combination of the 10 per cent real appreciation of the

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1

1

1

2

2

2

3

3

3

4

4

4

6

6

5

6

Singapore

5

Malaysia

5

China

7

7

7

8

8

8

9

10

10

10

Imports

Exports

Trade balance

9

Imports

Exports

Trade balance

9

Imports

Exports

Trade balance

1.5 1.2 0.9 0.6 0.3 0.0 -0.3 -0.6 -0.9 -1.2 -1.5

1.5 1.2 0.9 0.6 0.3 0.0 -0.3 -0.6 -0.9 -1.2 -1.5

1.5 1.2 0.9 0.6 0.3 0.0 -0.3 -0.6 -0.9 -1.2 -1.5

5.0 4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0 -4.0 -5.0

5.0 4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0 -4.0 -5.0

5.0 4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0 -4.0 -5.0 1

1

1

2

2

2

3

3

3

4

4

4

6

5

Thailand

5

6

6

The Philippines

5

Indonesia

7

7

7

8

8

8

9

10

10

10

Imports

Exports

Trade balance

9

Imports

Exports

Trade balance

9

Imports

Exports

Trade balance

5.0 4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0 -4.0 -5.0

5.0 4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0 -4.0 -5.0

5.0 4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0 -4.0 -5.0

Note: The impacts are the result of China’s real exchange rate appreciation by 10 per cent combined with an increase in China’s government spending by 10 per cent. The horizontal axis represents the forecast horizon (years) and the vertical axis represents the deviation from baseline values, where the left axis belongs to the trade balance per GDP (percentage points) and the right axis belongs to export volumes and import volumes (per cent). Source: Authors’ calculations.

1.5 1.2 0.9 0.6 0.3 0.0 -0.3 -0.6 -0.9 -1.2 -1.5

1.5 1.2 0.9 0.6 0.3 0.0 -0.3 -0.6 -0.9 -1.2 -1.5

1.5 1.2 0.9 0.6 0.3 0.0 -0.3 -0.6 -0.9 -1.2 -1.5

FIGURE 8.8 Change of Trade Balance in Asia under Real Revaluation of Chinese Yuan Combined with Expansionary Macroeconomic Policies

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1

1

2

2

3

3

4

4

5

USA

5

6

6

ASEAN-5

7

7

8

8

10

10

Imports

Exports

Trade balance

9

Imports

Exports

Trade balance

9

3.0 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0 -2.5 -3.0

5.0 4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0 -4.0 -5.0

-0.3

-0.2

-0.1

0.0

0.1

0.2

0.3

-0.3

-0.2

-0.1

0.0

0.1

0.2

0.3

1

1

2

2

3

3

4

4

6

5

6

Eurozone

5

Japan

7

7

8

8

10

10

Imports

Exports

Trade balance

9

Imports

Exports

Trade balance

9

3.0 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0 -2.5 -3.0

3.0 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0 -2.5 -3.0

Note: The impacts are the result of Asian real exchange rate appreciation by 10 per cent combined with an increase in Asian government spending by 10 per cent. The horizontal axis represents the forecast horizon (years) and the vertical axis represents the deviation from baseline values, where the left axis belongs to the trade balance per GDP (percentage points) and the right axis belongs to export volumes and import volumes (per cent). Source: Authors’ calculations.

-0.30

-0.20

-0.10

0.00

0.10

0.20

0.30

1.5 1.2 0.9 0.6 0.3 0.0 -0.3 -0.6 -0.9 -1.2 -1.5

FIGURE 8.9 Change of Trade Balance of ASEAN-5 and Developed Countries under Concerted Foreign Exchange Rate Adjustments Combined with Expansionary Macroeconomic Policies in Asia

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yuan and a 10 per cent increase in China’s government expenditure. The Chinese exports initially increase, but fall immediately after a short period of adjustment. The exports rise by 0.8 per cent in the first year, but steadily decline to 2.4 per cent less than the baseline value in the next few years. After that the export reduction dampens out. In contrast, imports sharply rise immediately by 3.4 per cent above the baseline in response to the combined shocks of the real exchange rate appreciation and fiscal expansion, before declining to stabilize at about 0.7 per cent over time. China’s imports increased dramatically because the rise in output and national income generated by the expansionary fiscal policy stimulates domestic consumption of both domestically produced goods and imports of goods and services. Immediately after the policy shock the surge in imports worsens the trade balance as the surplus relative to GDP rapidly falls by 1.43 percentage points compared to the baseline surplus. However, through time the trade surplus reduction effect gradually declines to 0.34 percentage points. The yuan revaluation and fiscal stimulus in China have the effect of boosting trade in major Southeast Asian countries immediately after the policy shocks, before declining gradually over time. Exports in Indonesia, Malaysia, the Philippines, Singapore and Thailand rise by the following percentages above the baseline: 0.6, 1.5, 1.7, 1.5 and 1.4 per cent, respectively. Imports also rise immediately by 0.5, 1.6, 0.7, 1.5 and 1.1 per cent, respectively, in Indonesia, Malaysia, the Philippines, Singapore and Thailand. The results indicate that the real revaluation of the Chinese yuan accompanied by the increase in China’s government spending increases the export competitiveness of major ASEAN countries and enable their trade balance per GDP to improve to a level greater than the baseline by 0.3 percentage points immediately after the shock, but tapering off after a few years. In individual ASEAN countries the trade surpluses relative to GDP increase immediately after China’s simulated policy shocks by 0.25 percentage points, compared to the baseline in Indonesia, 0.54 in Malaysia, 0.15 in the Philippines, 0.20 in Singapore, and 0.35 in Thailand in the first year before dying off in the long term. In addition, the real revaluation of the Chinese yuan combined with its fiscal expansion leads to an increase in trade flows in the developed countries. In the United States, exports immediately hike above the baseline figures by 0.7 per cent and further increase to stabilize at 1 per cent from the medium to the long terms. Imports immediately fall below the baseline

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by 0.1 per cent, but increase to 0.4 per cent in the long term. As a result, in response to the shocks, trade deficit relative to GDP in the United States is reduced by 0.10 percentage points from the baseline value in the first year, and the reduction increases to 0.12 percentage points before dampening out in the long term. In the eurozone, both exports and imports increase immediately after the shocks and further increase to stabilize at 0.8 per cent and 0.5 per cent respectively from the medium to the long terms. As a result, its trade deficit relative to GDP declines little from the baseline in the initial period, but the decline is doubled in the second period before tapering off in the long term. In line with other Asian countries, exports of Japan considerably rise immediately after the shocks, but decline to stay at about 1 per cent after a few years. Imports increase only a little and stay rather constant throughout the future time horizon, leading the trade surplus to GDP to increase above the baseline in the short term and to gradually decline in the long term. The results imply that the increases in China’s government expenditures, in addition to the real appreciation of the yuan, are beneficial to developed economies’ exports, since the fiscal stimulus gives rise to higher domestic consumption and private investment in China, which consequently expands into imports of goods and services abroad. As a result, the corresponding trade balance per GDP in the advanced economies improves throughout the time horizon, with relatively large improvements in the short term, although the effects are reduced over time. To sum up, real appreciation of the Chinese yuan along with fiscal expansion had the effects of stimulating domestic demand as well as imports, leading to a reduction in trade imbalances in both the surplus country China and the deficit United States and Europe. On the other hand, the strengthening of the Chinese yuan in combination with an increased aggregate demand in China spurred the exports of China’s trading partners and trade competitors in both Japan and major ASEAN countries, resulting in an improvement in their trade balances.

4.2 Concerted Foreign Exchange Rate Adjustments with Expansionary Macro Policies in Asia Regional cooperation among Asian economies seeking deeper integration for both trade and capital markets has taken place for decades. The strength of such cooperation has grown increasingly since the 1997

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Asian crisis, especially in financial and monetary frameworks.7 Although the progress has been relatively slow, there have been genuine efforts at cooperation to enhance regional foreign exchange market stability and prevent future financial crises. It is expected that concerted foreign exchange rate appreciation in real terms for China and major ASEAN countries, combined with their expansionary macroeconomic policies, should reduce their trade surplus through a decrease in their exports and an increase in their imports. Furthermore, the policies should improve trade balances in the United States, Europe, and the rest of the Asian countries. Hence, we set the scenario for simulation by imposing a set of real exchange rate shocks equivalent to a 10 per cent appreciation combined with a 10 per cent increase in government expenditures in China and major ASEAN countries. Figure 8.10 shows, that in response to the combined shocks, China’s exports initially increase by 0.8 per cent from the baseline value. It takes almost a year for the concerted real appreciation and expansionary macroeconomic policy to cause exports to decline by 1.3 per cent and further reduce to 2.1 per cent in the medium term. In the long term the effect is dampened out to 0.7 per cent. In contrast, imports increase by 3.7 per cent from the baseline value immediately after the shocks, but the effect decreases steadily to stabilize at 0.9 per cent in a few years. On balance, China’s trade surplus relative to GDP is reduced from the baseline by 1.40 percentage points immediately after the policy shocks, but the impact tapers to 0.32 in the long term. In the group of five major ASEAN countries, exports initially increase, but after over a year of adjusting to the policy shocks, exports begin to decrease steadily up to the medium term by 2 per cent less than the baseline value. The effect is, however, reduced to 1.5 per cent in the long term. In contrast, imports increase by 2.5 per cent above the baseline immediately after the shocks, but the effect is dampened out in a few years. On balance, the trade surplus relative to GDP of the major ASEAN countries declines from the baseline by about 1.10 percentage points in the short term, and the effect is steadily reduced by half in the long term. When comparing the effects of the shocks on individual ASEAN countries, Figure 8.10 shows that the reduction of trade surplus relative to GDP from the baseline is greater in the Philippines, Singapore and Thailand than the rest of the ASEAN countries in the short term, but the effects of shocks converge to a comparable percentage point in all countries over the long term.

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Note: The impacts are the result of Asian real exchange rate appreciation by 10 per cent combined with an increase in Asian government spending by 10 per cent. The horizontal axis represents the forecast horizon (years) and the vertical axis represents the deviation from baseline values, where the left axis belongs to the trade balance per GDP (percentage points) and the right axis belongs to export volumes and import volumes (per cent). Source: Authors’ calculations.

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While the policy shocks lead to a reduction of trade surplus in GDP in both China and the major ASEAN countries, the trade balances in major developed countries all show an improvement. Figure 8.11 indicates that in the United States the shocks lead its exports to increase by 0.9 per cent from the baseline value in the short term and rise to 1.3 per cent in the long term. However, the policy shocks have a marginal impact on its imports in the short term. Besides, its imports seem to rise by 0.5 per cent over the baseline in the long term. As the shocks initially lead to a small increase in exports with no change in imports, the trade deficit relative to GDP in the United States increase in the first two years, but the deficit does decline steadily by 0.06 percentage points less than the baseline over the horizon. This implies the difficulty of reducing the trade deficit in the United States, and it is not sufficient just to realign the exchange rates between China and major ASEAN countries to fix the problem of global imbalances. Other macroeconomic adjustment policies are indeed needed. In the eurozone, both exports and imports increase in response to the shocks. Exports increase by 0.7 per cent above the baseline, and imports by 0.5 per cent, resulting in the trade deficit in GDP increasing in the short term but declining steadily over time. In Japan, exports initially increase by 2.9 per cent above the baseline, but steadily decline to 1.2 per cent over the long term. Imports increase as little as 0.4 per cent greater than the baseline throughout the horizon. On balance, the trade surplus of Japan relative to GDP initially increases to the level above the baseline by 0.16 percentage points, but the gap declines steadily to 0.09 over the time horizon. In summary, regional exchange rate adjustments combined with expansionary macroeconomic policies of China together with major ASEAN countries end up with reduced trade surplus in not only China but in other Asian countries as well. As a result, the co-realignment helps improve trade balances of the United States and Europe greater than if China initiates the policy shock alone. In other words, if the joint appreciation of these Asian countries was done together with yuan appreciation, it would help narrow the gap between surpluses in Asia and the deficits in the United States and some European countries. Nevertheless, if the global current account imbalances were to be reduced significantly in the long term, it is essential that the foreign exchange rate adjustment policy be reinforced by additional macroeconomic policies in both the deficit and the surplus countries to ensure a more effective result.

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Note: The impacts are the result of Asian real exchange rate appreciation by 10 per cent combined with an increase in Asian government spending by 10 per cent. The horizontal axis represents the forecast horizon (years) and the vertical axis represents the deviation from baseline values, where the left axis belongs to the trade balance per GDP (percentage points) and the right axis belongs to export volumes and import volumes (per cent). Source: Authors’ calculations.

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FIGURE 8.11 Change of Trade Balance of ASEAN-5 and Developed Countries under Concerted Foreign Exchange Rate Adjustments Combined with Expansionary Macroeconomic Policies in Asia

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4.3 Reduced Global Imbalances Combined with Expansionary Macro Policies in Asia and Restrictive Policies in the United States Under this scenario we allowed the real exchange rates of China and major Southeast Asian countries to appreciate significantly enough for both the current account surplus of the Asian countries and the deficits of the United States (the country that bears the major part of the developed countries’ deficits) to decline to the point where the global imbalances were almost eliminated. Since the real appreciation might come at a cost of declining exports and employment, we supplemented the above exchange rate policies with an expansionary fiscal policy in the surplus countries and a policy to reduce government budget deficits in the deficit countries. In implementing the simulation, we let the government expenditures of China and the ASEAN countries increase at different rates. China and Singapore, with greater surpluses than the rest, increased their government expenditures by 12 per cent and 10 per cent respectively. For the rest of the ASEAN countries their government expenditures were set to increase by 8 per cent a year. In the United States the government gradually reduces expenditures from the current average rate of 2 per cent to a near-zero growth rate in ten years. The fiscal policies in all of the above countries are to accompany the real appreciation in China and ASEAN to ensure the targeted reduction of the global imbalances. The results in Figures 8.12 through 8.13 show that at the global level the real GDP growth rates show a small decline immediately after the implementation of the above policies. However, after a short period of adjustments the growth improves and stays at the rate higher than the baseline case throughout the horizon. The decline in the global growth rate in the short-term is accounted for by the reduced growth in China and most ASEAN countries (except for Indonesia). The real revaluation of yuan results in the immediate effects of declined exports, production, and employment. However, with the supplementary fiscal stimulus, both production and employment are able to increase in the long term to more than compensate for their original declines. In the United States the decline in the government budget deficit in combination with its real depreciation vis-à-vis the Asian currencies has insignificant effects on output and employment relative to the baseline in the short term, but over time the trade balance improves and real GDP grows faster than the

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baseline projection. Figure 8.12 shows that the growth is also higher than the baseline for Europe, Africa and other East and Southeast Asian countries. Growth at both the global and individual country levels increases after correcting global imbalances for several reasons related to improved resource allocation efficiency. The real exchange rate realignment across countries reduces distortions on prices of tradable relative to non-tradable goods, and as a result the international trading system becomes freer and individual countries benefit from more efficient resource allocation.8 On the other hand, the reduced need for sterilized reserve accumulation as a result of declined current account surpluses in the surplus countries, sets free assets to be invested in the ones with higher yields than the current low-yield government bonds. Consequently, not only may the cost of excessive reserves holdings be reduced, but incomes could also increase due to improved portfolio allocation efficiency.9 Figures 8.14 and 8.15 show further that as a result of global rebalancing and accommodating fiscal policy, unemployment declines and labour productivity grows at rates higher than the baseline for all regions throughout the horizon. All the results imply that the world benefits from the reduction of global imbalances in the long run. The negative immediate effects of exchange rate adjustments to correct the external imbalances could be mitigated by appropriate macroeconomic policies to accommodate them.

4.4 Reduced Global Imbalances Combined with Increased Domestic Demand in Asia and Increased Savings in the United States Under Scenario 4 we allowed the real exchange rates of China and the major Southeast Asian countries to appreciate to correct the external imbalances of both the surplus and the deficit countries, just as in Scenario 3. However, in this scenario we let the aggregate demand of the private sector increase instead of using the macroeconomic policies as in the previous scenario. In other words, in addition to letting the real exchange rates adjust to achieve reduced global imbalances, we allowed both investment and consumption in the surplus countries and savings in the deficit countries to increase to compensate for the negative effects which are the results of the exchange rate adjustments. In this scenario, in addition to letting the current account balance surplus and the deficit countries adjust their

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currencies to correct the global imbalances, the simulation was carried out with an increase in aggregate demand of 12 per cent, 10 per cent, and 8 per cent a year in China, Singapore, and the rest of the ASEAN countries. In the United States the consumption was set to decline gradually to 2 per cent at the end of the projected period. In the case of the surplus countries, the increased investment and consumption were expected to result in increases of output and employment accommodating the negative effects of the declined exports and increased unemployment in response to the real appreciation. In the deficit countries the increased savings could help improve their external imbalances, which would eventually lead to more stable economies. The results in Figures 8.16–8.20 show that at the global level the real GDP growth path under the above scenario is uniformly higher than the baseline projection. The growth of almost all countries and regions increases to rates higher than the baseline.10 Unemployment rates also decline as a result of employment and labour productivity growth. More importantly, consumption and investment relative to GDP increases in the surplus countries and at the global level. The above results reflect the outcomes of corrections to the global imbalances which lead to domestic demand growing faster than GDP. This implies that sources of growth shift from exports to domestic demand.11 All in all it seems that an increased private aggregate demand in compensation for the declined exports in the process of correcting for the global imbalances could result in higher growth prospects for the world as a whole. The projected growth paths under this scenario are the highest of all the scenarios. The results should provide evidence to motivate both the surplus and the deficit countries to cooperate and adjust their foreign exchange rates to achieve a more balanced world economy. In fact, combining foreign exchange rate policies with appropriate domestic policies, all countries may benefit from steady sustainable long-term growth.

5. CONCLUSION AND POLICY IMPLICATIONS Global imbalances are generally the result of excessive consumption and over investment in deficit countries and under consumption and excessive savings in surplus countries. After the 1997 Asian financial and currency crisis, global imbalances began to emerge, peaking in the run-up to the

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FIGURE 8.17 Impact on GDP Growth by Economy under Reduced Global Imbalances Combined with Increased Domestic Demand (Investment and Consumption) in Asia and Increased Savings in the United States China

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Africa

East and Southeast Asia

Note: The solid and dash lines belong to the baseline and the policy scenario, respectively. The horizontal axis represents the forecast horizon (years) and the vertical axis represents the share of aggregate demand in GDP (per cent). Source: Authors’ calculations.

70

72

74

76

78

80

82

84

86

88

90

70

72

74

76

78

80

82

84

86

88

90

FIGURE 8.20 Impact on Aggregate Demand per Capita by Region under Reduced Global Imbalances Combined with Increased Domestic Demand (Investment and Consumption) in Asia and Increased Savings in the United States

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financial crisis in the OECD countries in 2008. There were persistent current account surpluses in the Asian emerging markets, and deficits in the United States and the eurozone. After the financial crisis in the United States, which spread to other developed countries in 2008, the global imbalances declined, but the trend reversed a few years later. The global imbalances seemed to stay, albeit at a reduced level, in the midst of the Great Recession in the aftermath of the 2008 financial crisis. No country benefits from the global imbalances in the long run. During 1997–2007 the deficit countries, particularly the United States, enjoyed high growth under bubbles in the real estate and financial markets, and the surplus countries experienced spectacular growth under export acceleration. However, the growth under an imbalanced world could not last. After the bubbles burst, not only did the deficit countries suffer from the deep and prolonged recession, but growth of the surplus countries also drastically contracted. Our results show that high growth under the baseline case of bubbles and the imbalanced world is inferior to more smooth growth under the hypothetic case of tapered global imbalances. The global rebalancing could be achieved by realigning exchange rates between the surplus and the deficit countries, combined with domestic policies to mitigate the potential adverse effects from foreign exchange rate adjustments. Aggregate demand in the surplus countries needs to increase to compensate for the reduced exports, and at the same time savings in the deficit countries also need to increase to reduce debts in both the private and the public sectors. However, both the exchange rate adjustments and the appropriate domestic policies would be difficult to implement without cooperation between the deficit and surplus countries. Our simulation results point to long-term payoffs for joint efforts between countries to reduce global imbalances. Under multilateral cooperation the world could attain a higher growth path than muddling through the status quo. In this sense our study implies incentives for both surplus and deficit countries to act jointly to achieve an improved world economy that could be sustained in the long term.

Notes We are grateful for the helpful comments and suggestions made by Suthiphand Chirathivat, Chayodom Sabhasri and participants at the CU/ISEAS International Conference on Global Economic Uncertainties and Southeast Asian Economies,

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held at Chulalongkorn University, Bangkok, on 22–23 August 2013, in which the earlier draft of this paper was presented.   1. From 2008 onwards, a considerable correction in the magnitude of the imbalances was mainly due to a slump in world demand triggered both by the U.S. subprime mortgage crisis in mid-2008 and by the European sovereigndebt crisis in late-2009. Concerns about their prolonged recessions intensified around the world thereafter, leading to the ongoing worldwide economic slowdown and reduced, albeit remaining large, global imbalances.   2. Despite a relatively large amount, the current account surpluses in Japan have normally been stable over the past decade while the surpluses in the Middle East and Russia have primarily reflected the soaring commodity prices, in particular oil prices. In contrast, in most of the rest of emerging Asia, the surpluses originated from surpluses in the trade of goods and services account.   3. The IMF takes into account various sources, including behaviour of bilateral exchange rates and reserves, in order to define the exchange rate arrangements more precisely.   4. For key concepts underlying the CAM model, see Cripps et al. (2011).   5. See Blanchard and Giavazzi (2006), Willenbockel (2006), IMF (2010), and Von Arnim et al. (2013) for policies recommended for global rebalancing.   6. Increased government expenditures can be in the form of the provision of social safety nets, health care, housing facilities, and other financial services to reduce households’ incentives to save for precautionary purposes. In fact, the reduced savings are also helpful for mitigating current account surpluses through increased imports. See additional discussion in, for example, Lee (2010), Morgan (2013), and Chongvilaivan (2013).   7. After recovering from the 1997 Asian financial and currency crises, the ASEAN countries initiated various forms of financial cooperation to safeguard member countries against future financial and foreign exchange rate instability. The cooperation includes the Chiang Mai Initiative, the establishment of the Asian Bond Fund, and the forum on Asian Bond Market Initiative. The cooperation has extended from the original ASEAN members to include China, Japan, and South Korea. See additional discussion on the progress of ASEAN financial and monetary cooperation in Jung (2008).   8. Within the tradable sector, by allowing foreign exchange rates of individual countries to adjust to rebalance the global economy, the issue of undervaluation of the surplus countries or overvaluation of the deficit countries would disappear. The need for any protectionist or subsidization policies will also be greatly reduced. Consequently, the trading system becomes more liberalized. In addition, as argued by Irwin (2012), governments can pursue only two of the following three policies: a fixed exchange rate, an independent macroeconomic policy, and a liberal trade policy. Therefore, as individual countries’ exchange

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rates are allowed to be more flexible and macroeconomic policies are used to supplement and strengthen the impacts of the real exchange rate movements, it should be possible for the international trading system to be made freer.   9. See additional discussion on the impacts of global imbalances in Adams and Park (2009) and Blanchard and Milesi-Ferretti (2010). 10. The results are comparable to the findings by Beaton et al. (2010), which use the Bank of Canada’s Global Economy Model to simulate different scenarios under global imbalances and financial crises. The study simulates the baseline scenario where global imbalances are gradually resolved by assuming increases in U.S. savings rates, fiscal consolidation in advanced countries, and orderly real exchange rate adjustments across countries. The results show that world growth under the above scenario is higher than an alternative one in which countries maintain their pre-crisis behaviour and policies. 11. See Krueger (2010) for a discussion on the need for China and other high savings rate countries to expand their consumption relative to GDP in order to help restore the growth of the global economy after the 2008 crisis. See also Butzen et al. (2010) for the discussion on the need for consumption to grow faster than GDP in the Chinese economy to reflect a successful structural adjustment from relying on exports as the engine of growth to sectors geared for domestic markets.

References Adams, C. and D. Park. “Causes and Consequences of Global Imbalances: Perspectives from Developing Asia”. Asian Development Review 26, no. 1 (2009): 19–47. Beaton, K., C. de Resende, R. Lalonde, and S. Snudden. “Prospects for Global Current Account Rebalancing”. Bank of Canada Discussion Paper no. 4. Ottawa: Bank of Canada, 2010. Bergsten, F. “The US Trade Deficit and China”. In Testimony before the Hearing on US-China Economic Relations Revisited Committee on Finance. United States Senate, 29 March 2006. Blanchard, O. and F. Giavazzi. “Rebalancing Growth in China: A Three-handed Approach”. China and World Economy 14, no. 4 (2006): 1–20. Blanchard, O. and G.M. Milesi-Ferretti. “Global Imbalances: In Midstream?” In Restructuring the World Economy, edited by O. Blanchard and I. SaKong. Washington, DC: International Monetary Fund, 2010. Butzen P., W. Melyn, and W. Vandevyvere. “Rebalancing Global Demand”. National Bank of Belgium Economic Review 2010, no. 2 (2010): 21–38. Chongvilaivan, A. “Global Economic Imbalances and Reform Policy: Evidence

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from Asian Economies”. Paper presented at the CU/ISEAS International Conference in Bangkok, 22–23 August 2013. Cripps, F., A. Izurieta, and A. Singh. “Global Imbalances, Under-consumption and Over-borrowing: The State of the World Economy and Future Policies”. Development and Change 42, no.1 (2011): 228–61. Cripps, F. and W. Godley. “Control of Imports as a Means to Full Employment and the Expansion of World Trade. The UK Case”. Cambridge Journal of Economics 2, no. 3 (1978): 327–34. Hausmann, R., L. Pritchett, and D. Rodrik. “Growth Accelerations”. NBER Working Paper no. 10566. Cambridge, MA: National Bureau of Economic Research, 2004. International Monetary Fund. “Getting the Balance Right: Transitioning out of Sustained Current Account Surpluses”. In IMF World Economic Outlook. Washington, DC: International Monetary Fund, 2010. Irwin, D. Trade Policy Disaster: Lessons from the 1930s. Cambridge, MA: MIT Press, 2012. Ito, T. “Can Asia Overcome the IMF Stigma?” American Economic Review 102, no. 3 (2012): 198–202. Jongwanich, J. “Equilibrium Real Exchange Rate, Misalignment, and Export Performance in Developing Asia”. ADB Working Paper Series no. 151. Manila: Asian Development Bank, 2010. Jung, J.Y. “Regional Financial Cooperation in Asia: Challenges and Path to Development”. BIS Papers no. 42. Basel: Bank for International Settlements, 2008. Krueger, A.O. “Development Prospects in Light of the Global Financial Crisis”. In Annual World Bank Conference on Development Economics 2010, Global: Lessons from East Asia and the Global Financial Crisis, edited by J.Y. Lin and B. Pleskovic. Washington, DC: World Bank, 2010. Lee, J.W. “Asia’s Role in Global Rebalancing”. In Rebalancing the Global Economy: A Primer of Policymaking, edited by S. Claessens, S. Evenett, and B. Hoekman. London: Centre for Economic Policy Research, 2010. Morgan, P.J. “The Role of Macroeconomic Policy in Rebalancing Growth”. Journal of Asian Economics 23, no. 1 (2012): 13–25. Rajan, R.S. “The Evolution and Impact of Asia Exchange Rate Regimes”. ADB Working Paper no. 208. Manila: Asian Development Bank, 2010. Reinhart, C.M. and K.S. Rogoff. “The Modern History of Exchange Rate Arrangements: A Reinterpretation”. Quarterly Journal of Economics 119, no. 1 (2004): 1–48. Von Arnim, R., S. Bannister, and N. Perry. “A Global Model of Recovery and Rebalancing”. Cambridge Journal of Economics 37, no. 4 (2013): 889–920.

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9 MONETARY AND FINANCIAL ARCHITECTURES FOR ASEAN+ Chayodom Sabhasri

1. INTRODUCTION The Asian Development Bank Institute (ADBI) drafted a report on ASEAN 2030, towards the borderless economic community. The objective of ASEAN 2030 is to become Resilient, Inclusive, Competitive, and Harmonious, or, a “RICH” ASEAN. To reach such a goal in 2030, we need to re-evaluate past ASEAN economic performance and policy implementations. ASEAN has gone through two recent economic and financial crises in 1997/8 and 2008/9. The ASEAN economies were hard hit by these crises. ASEAN has also moved in the direction of a borderless region — the process began in 1992; the next milestone will be in 2015, with the Economic Community. Given the significance of strengthening economic linkages, ASEAN+3 has been brought into the discussion. Several measures have been implemented to deal with the economic and financial crises, such as the establishment of the Chiang Mai Initiative Multilateralism, the Asian Bond Market, and the ASEAN Macroeconomic Research Office. To achieve economic stability and growth, more areas of cooperation are needed, such as monetary policy, micro-prudential policy, and macro-

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prudential policy. The objectives of these policies are both crisis prevention and resolution. This chapter argues that some policy areas necessary for RICH to be realized are missing.

2. THE PAST ASEAN CRISES AND RESOLUTION Since its inception in 1992, ASEAN has gradually become highly integrated with the international supply chain and international production networks. The foreign direct investment (FDI) and portfolio investment within ASEAN have increased significantly, not only from the region but also from the rest of the world due to the prosperity of the ASEAN economy. The 1997/98 Asian Financial Crisis (AFC) alerted the countries of East Asia to the need for better management of their macroeconomic policies and financial systems. The AFC was caused by a combination of mismanagement by the authorities and financial liberalization. Poor monetary monitoring procedures, the defence of the fixed exchange rate system with limited international reserves, and the reversal of capital flows were among the causes of the AFC. Due to economic interdependence in the region through financial liberalization, all of the ASEAN economies were hard hit by the AFC. The monetary and macroeconomic policies were to be revised, and regional policy cooperation was designed to prevent any future crisis. As a result, a macroeconomic monitoring and surveillance system was formed at the ASEAN level. ASEAN also worked with the Plus Three countries — the People’s Republic of China, Japan, and the Republic of Korea — to establish the regional financial arrangement as a safety net for both prevention and management of future crises. The steps taken were as follows: 1. The Chiang Mai Initiative (CMI) was set up as the bilateral swap arrangement between the ASEAN+3 countries, with a pool of foreign exchange reserves of 200 million U.S. dollars in 2000. The amount was increased to a billion U.S. dollars in 2005. The CMI was rather inactive as the ASEAN+3 members could rely on financial facilities elsewhere and the arrangement was only on a bilateral basis. 2. In 2007 the ASEAN+3 Finance Ministers’ Meeting proposed the multilateral system of the CMI, or the Chiang Mai Initiative Multilateralization (CMIM) with a 120 billion U.S. dollars reserve fund for the ASEAN+3 region. The agreed amounts of currency swaps up

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to 20 per cent were not subject to International Monetary Fund (IMF) conditionality, so as to rely less on IMF funding. However, the CMIM has a major drawback, as the scale of the swap arrangement does not compare in size to the alternative in the form of the U.S. swap arrangement. Additionally, the system is slow to serve the urgent needs of requesting countries, as the participating countries need to agree to contribute as each incident occurs. 3. The ASEAN+3 countries launched the Asian Bond Markets Initiative (ABMI) in 2003 to promote the use of local-currency bond markets. The fund may be recycled in the region from the wealthier countries to the countries that need it. The Asian Bond Fund (ABF) invested the first sum of a billion U.S. dollars in sovereign and quasi-sovereign bonds issued by eight developing countries. The second investment, with double the initial investment amount, was made in 2004. Due to slow progress in the ABMI, a new road map was introduced in 2008 to promote the issuance of local currency bonds, to facilitate the demand for such bonds, to improve the regulatory framework, and to improve the bond market infrastructure. The 2008/9 Global Financial Crisis (GFC) significantly affected the ASEAN+3 countries, especially Singapore, Malaysia, and Thailand, as exhibited in Tables 9.1 and 9.2. These countries were closely interdependent and integrated to the global economy through trade and investment because of relatively deep trade and investment liberalization. However, in comparison with the AFC, the effects of the GFC on financial sectors were relatively modest because the developing Asian countries had become more cautious in financial sector investment. Additionally, ASEAN+3 policies towards macroeconomic and financial stability appeared to be beneficial. Nevertheless, deepening regional policy cooperation is still imperative to prevent future crises.

3. THE FUTURE OF ASEAN 3.1 Financial Structure in ASEAN and ASEAN+3 There are differences in the financial characters of the ASEAN countries, as measured by the share of private credit, deposits, stock market capitalization, and private bond market capitalization in GDP. As of 2010, Indonesia and the Philippines shared similar attributes as they had rather

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Monetary and Financial Architectures for ASEAN+ TABLE 9.1 Effects of the 2008 Global Financial Crisis Economic

1991–2000

2002–7

2008

2009

2010

10.4 14.4 13.4 16.1 17.1 14.4 17.6

10.7 15.3 15.7 14.8 15.9 15.6 16.8

9.6 6.4 3.8 2.3 4.6 2.5 1.4

–8.7 –4.5 –0.9 –0.2 –1.7 –2.3 –2.4

10.4 16.4 13.6 14.5 14.7 15.5 15.7

China Indonesia Philippines Korea Malaysia Thailand Singapore Source: AKYÜZ (2010).

TABLE 9.2 Real Export of Goods and Services 2004–7 Average

China Indonesia Korea Malaysia Philippines Singapore Thailand

Growth (Y-o-Y)

As % of GDP

Growth (Y-o-Y)

24.1 12.0 12.9 18.9 19.7 13.0 17.5

137.8 131.7 140.5 115.0 147.1 233.6 172.8

–8.6 –9.5 –5.7 –1.3 –1.9 –1.3 –5.5

2008

As % of GDP

2009a

136.5 129.8 152.9 103.6 136.9 234.3 176.4

–15.9 –19.4 –14.3 –24.9 –29.2b –20.2 –12.0

Merchandise exports Average for the first three quarters of 2009. Source: AKYÜZ (2010). a b

low private credit to GDP, stock market capitalization to GDP, and private bond market to GDP. The private credit to GDP ratio in Malaysia, Singapore and Thailand are very similar. The ratios of stock market capitalization to GDP of Malaysia and Singapore are comparable, while the ratio of private bond market to GDP of Singapore and Thailand are almost equal. The Plus Three countries have similar ratios for private credit and stock market capitalization. Korea is an exceptional case, with a higher degree of financial deepening in private bond markets than any other ASEAN+3 country.

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The financial sector in all East Asian countries in Table 9.3, except Japan, has grown drastically. The financial sector as a percentage of GDP in China, Korea and the Philippines grew by 187, 128, and 259 per cent, respectively, while that in Indonesia, Malaysia, Singapore and Thailand increased by double digits. The characteristics of financial deepening among the ASEAN countries are diversified. Indonesia does not have a high ratio of financial deepening (50 per cent is considered a high ratio). Malaysia, Singapore and Thailand depend heavily on private credit and stock markets, while the Philippines relies more on stock markets. An increase in the ratio of financial sectors to GDP implies that financial instability can lead to regional problems. Negative spillovers can pass through portfolio investment. The ASEAN Economic Community will further link the capital and financial markets in ASEAN, as well as deepen economic dependency. What is required is a warning system and preventive measures for regional financial vulnerability and its spillovers.

3.2 ASEAN 2030 In 2012 the Asian Development Bank Institute (ADBI) drafted a report on ASEAN 2030 towards the borderless economic community. The objective of ASEAN 2030 is to become Resilient, Inclusive, Competitive, and Harmonious, or a “RICH” ASEAN. Resilience refers to the capacity to handle external and internal volatilities and shocks of economic crises. Resilience refers to the need for strong regional macroeconomic policy management and strong institutional linkages so that the risks may be assessed. Inclusiveness aims at making economic development equitable, particularly for Cambodia, Myanmar, Laos and Vietnam. Competitiveness refers to the need to prepare a business environment with effective national and regional regulations to support productivity and innovation. And Harmony is about peace and the resolution of common problems, which may be partly derived from environmentally sustainable development. Financial stability and financial integration will lead to higher intensity of trade and investment flows. Greater ASEAN physical, people-to-people, and institutional connectivity will be achieved with strong macroeconomic and financial stability. The objective of the RICH ASEAN can be reached in 2030 with the real and financial market integration in line with those stabilities.

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1990

47.2

38.1

77

17

78.2

72.3

Japan

Korea

Indonesia

Malaysia

Philippines

Singapore

Thailand

Source: Morgan (2013).

Vietnam

74.3

168.2

China

% of GDP

2010

109.7

91.7

96.1

29.4

109.3

24.1

98.4

102.8

120

n/a

26.8

22.9

72.9

41.9

–36.7

108.5

–38.9

61.5

Private credit by deposit money Growth banks

28

93.1

13.4

110.4

7.1

42.1

95.5

1990

19.7

87.1

166.2

78.8

172.6

51

107.4

74.6

81

2010

Stock market capitalization

n/a

211.1

78.5

488.1

56.3

618.3

155.1

–21.9

n/a

Growth

6.5

14.6

18.8

28.3

39.8

2.9

1990

17.9

11.4

1.1

43.5

1.5

63

36.3

21.3

2010

Private bond market capitalization

TABLE 9.3 Financial Structure in Selected East Asian Countries

n/a

175.4

–21.9

n/a

131.4

n/a

122.6

–8.8

634.5

Growth

106.8

185.9

30.4

206.2

45.1

117.5

303.4

77.3

1990

2010

129.3

196.7

273.7

109.3

325.4

76.6

268.7

213.6

222.4

Total

n/a

84.2

47.2

259.5

57.8

69.8

128.7

–29.6

187.7

Growth

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With respect to financial integration, improving regional financial openness will be beneficial to the region. The surpluses of international reserves will be recycled to the deficit ASEAN members through FDI, international loans, and cross-border portfolio investment. A larger financial market implies a plunge in transaction costs due to market competition and efficiency. However, such financial openness leads to the risks of crisis transmission from one country to others. There is a need for macroeconomic and financial stability policies. These include crisis prevention measures, crisis management, and appropriate monetary and fiscal policies for dealing with day-to-day operations. Park and Takagi (2013) referred to the study of Chinn and Ito (2009) on the index of the Openness of the Capital Account in ASEAN countries. Indonesia, the Philippines, Malaysia, and Thailand have high de facto capital account openness, but they are in the intermediate range of de jure openness. Vietnam and Laos need to develop domestic financial markets together with capital account restrictions. Cambodia is still lacking a deep domestic financial system and legal infrastructure to regulate crossborder financial flows. Cambodia must be aware of financial instability and volatility associated with mounting capital flows. According to the AEC Blueprint under free flows of capital, the guidelines for capital liberalization are to ensure that capital liberalization is consistent with the national agenda and readiness of the economies, so as to put in place a safeguard against inherited potential macroeconomic instability and systemic risks and to ensure sharing of benefits from financial liberalization. Nevertheless, the Annual Report on Exchange Arrangements and Exchange Rate Restriction of the IMF reported that the ASEAN countries have some aspects that must be adjusted to facilitate financial integration. These aspects are restrictions on capital flows (mostly tighter on outflows), restrictions on current account–related payment, restrictions on offshore usage of their currencies, and limitations on investors to hedge against currency risks in some countries. Therefore, regulatory reforms are required in order to encourage financial integration.

4. CHALLENGES IN ASEAN FINANCIAL RESOLUTIONS 4.1 Chiang Mai Initiative Multilateralism Since the 2008/9 GFC, the monetary authorities of both developed and developing countries have paid more attention to the swap agreements,

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in particular regional swap arrangements. Aizenman et al. (2011) found evidence that the swaps cannot be a substitute for reserves. The selectivity of swap lines also indicated that only countries with significant trade and financial linkages can expect access to the arrangements, and even then only on a case-by-case basis. The reserve accumulation is still crucial for dealing with financial imbalances. Among the ASEAN+3, the CMI introduced in May 2000 in the wake of the 1997/8 AFC set the objectives to address the short-term liquidity problems and to supplement existing international financial arrangements in the event of a crisis. The original initiative consisted of the extension of the ASEAN Swap Arrangement (ASA) by all ASEAN members to the network of bilateral swap agreements (BSAs) and the repurchase facilities between the ASEAN+3. As of December 2008, the CMI Swap Arrangement amounted to 86 billion U.S. dollars, while the ASA, which was only part of it, had a total sum of only 2 billion U.S dollars. Sussangkarn (2011) supported the stance that it was necessary to move from the bilateral agreements of CMI to the multilateralized system of the CMIM. However, the development process was rather slow as countries had accumulated large amounts of international reserves after the 1997/8 AFC; they seemed to have a self-insurance system and it was felt that such a regional financial safety net could be postponed. The CMI was later transformed into the CMIM in 2007, which became effective in 2010; unfortunately not in time to deal with the 2008/9 GFC. The multilateralization implies that all ASEAN+3 members would combine the reserve pooling arrangement under a single contract when needed. As a result, it is expected to improve efficiency in reserve management. Some Asian countries that suffered from the 2008/9 GFC experienced a reversal of capital flows and sharp currency depreciation. Korea was hit hard by the incident due to its large amount of short-term foreign debt. However, the country used only US$3.7 billion out of the possible CMI Swap Arrangement of US$18.5 billion. Instead, Korea got a swap of $30 billion from the U.S. Federal Reserves. Indonesia also requested a swap from the U.S. Federal Reserves, but was declined. As a result, China and Japan were to provide the needed swap for Indonesia. With the CMI now extended to the form of multilateralization with a single pooled contract, the question remains whether the CMIM will be able to address such needs in the future. Sussangkarn (2011), Siregar and Chabchitrchaidol (2013), and Azis (2013) have discussed the progress of the CMIM. The development of the CMIM has been as follows:

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From

3

Thailand

Source: Aizenman et al. (2011).

Total

86

2

84

9

Sub Total

ASEAN Swap Agreement among 10 countries

0

Vietnam

4

1

2.5

1.5

2

18.5

38

0 3

1

6

16.5

Total

0

10

3

2

Thailand

Myanmar 4

12

16

12

Philippines Singapore

Lao PDR

12

1.5

1

1.5

Malaysia

0

23.5

12

16

14

Indonesia

Cambodia

15.5

1

Singapore

7

2

0.5

Philippines 1

1.5

Malaysia

8

13

4

Korea

2

4

Korea

3

Japan

Indonesia

3

China

Japan

China

To

TABLE 9.4 Swap Arrangements under the CMI (as of December 2008)

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The Finance Ministers and the Central Bank Governors of the ASEAN+3 and the Monetary Authority of Hong Kong, China, initially set the amount of the committed swap arrangement to US$120 billion in collaboration with the IMF. The provision of the facility with the IMF was applied: Only 20 per cent of the CMIM borrowing quota can be taken without linking to the IMF; this is referred to as the IMF de-linked portion. The term condition for the swap arrangement facility was only 90 days, which was not long enough to be a financial safety net during the financial imbalances. Due to the awareness of such limitations, the official meeting of the Finance Ministers and the Central Bank Governors of the ASEAN+3 and the Monetary Authority of Hong Kong, held in Manila in 2012, led to two new adoptions for the CMIM: (1) the CMIM Stability Facility (CMIM-SF) to strengthen the crisis resolution mechanism (CRM), and (2) the CMIM Precautionary Line (CMIM-PL) to provide Crisis Prevention Function (CPF). To strengthen the CRM, CMIM resources were doubled to US$240 billion while keeping the current share of financial contributions and voting power among member countries the same. The IMF-delinked portion was increased to 30 per cent, and is likely to increase to 40 per cent in 2014 subject to review should conditions warrant. The maturity, supporting periods, and monitoring were extended. The length of the maturity period of the IMF-linked portion was extended from 90 days to one year with two renewals, totalling up to three years in the supporting period, while that of the IMF de-linked portion was increased from 90 days to six months with three renewals, totalling up to two years in the supporting period. The monitoring is on a biannual basis. To provide the crisis prevention function (CPF), the crisis prevention facility was introduced. There are five qualification criteria to be considered: (1) external position and market access, (2) fiscal policy, (3) monetary policy, (4) financial soundness and supervision, and (5) data adequacy. The Executive Level Decision Making Body (ELDMB) flexibly applies the five criteria as ex-ante qualification and ex-post conditionality after considering the economic reports by the requesting country and an analysis by the ADB, IMF or the ASEAN+3 Macroeconomic Research Office (AMRO). The CMIM-PL duration of access is six months with three renewals, totalling two years in arrangement period for the IMF de-linked portion, and one year for the IMF-linked portion. There is a restriction on dual drawing from both the CMIM-SF and CMIM-PL. If any CMIM-PL recipient country needs additional support, the CMIM-PL can be replaced with the CMIM-SF.

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As suggested by Sussangkarn (2011), the effective size of the CMIM may be increased by attaching additional bilateral swaps from willing countries in the group. The CMIM that deals with short-term financial and economic shocks will be evaluated when the facility is actually utilized. The facility has not yet been challenged, but whether the current facility may prevent and resolve a crisis may be discussed. There are some concerns on the management and implementation of the CMIM in practice. Firstly, there is no rational basis explaining the amount of US$240 billion for CMIM resources. According to Aris (2013) the amount is roughly equivalent to 5 per cent of the total of ASEAN+3’s international reserves. It is doubtful whether the amount will be adequate in the event of a financial crisis. From past experience, the international reserves can be quickly depleted and, together with the systemic risk involved, the demand for reserves in the region will rise at the same time. Unavoidably, the IMF-linked funds will still play the crucial part. Secondly, there is no clearly detailed procedural system for member countries to follow, which could result in delays in activating the facility. Aris (2013) highlights that it is unclear what information needs to be prepared and what steps need to be taken before contacting the CMIM authority. Thirdly, the effectiveness of the CMIM is based on economic and financial information sharing. Therefore, in addition to the Economic Review and Policy Dialogue, there should be a centre dealing with this information. The information may have been collected by the AMRO, but it needs to be constantly updated. Fourthly, due to the trade and financial linkages, financial crises are increasingly more global or regional. The CMIM may not be an adequate tool to prevent and resolve regional problems. Therefore, the CMIM authority should focus on regional issues while maintaining a close relationship with the ADB and IMF for worldwide issues and implications for the ASEAN+3. The balance must be carried out for the separate roles of the CMIM authority and international financial organizations. Sussangkarn (2011) indicates that the CMIM will be the first line of defence to prevent or mitigate a crisis and that a global financial authority such as the IMF will be needed if the crisis continues into the longer term. The pattern of financial liberalization needs to continue and the financial safety net has to be ready in case of future need. Siregar and

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Chabchitrchaidol (2013) referred to the study by Jamo (2011) that noted that successful and effective regional arrangements must be flexible but credible and capable of effective counter cyclical macroeconomic management as well as crisis prevention management. The monetary policy and macro-prudential policy will complement the financial safety net for macroeconomic and financial stability. The 16th ASEAN+3 Finance Ministers’ and Central Bank Governors’ Meeting in May 2013 reaffirmed the commitment to strengthen the CMIM as the regional financial safety net. It supports the enhancement of the use of local currencies for settlement in trade, investment, and capital transactions and the reduction of capital flow volatility in the region. The use of local currencies under the CMIM is to be explored.

4.2 ASEAN+3 Macroeconomic Research Office (AMRO) AMRO is an independent regional surveillance unit established to monitor regional economic performance and to support CMIM decision-making. The roles of AMRO are to assess macroeconomic and financial vulnerability, prepare reports on the macroeconomic situation and financial soundness of the ASEAN+3 members, provide support for policy recommendations, and ensure compliance of swap requesting parties with the lending covenants under the CMIM agreement (see Sussangkarn 2011). Siregar and Chabchitrchaidol (2013) discussed the challenges of AMRO’s roles. The current AMRO tasks involve the AMRO Regional Economic Monitoring (AREM) report covering cross-country economic outlook and multilateral surveillance, individual and bilateral economic surveillance reports, thematic research reports, and an integrated surveillance process. The study pointed out that the major challenge is the bilateral surveillance work, which focuses mainly on domestic economies and less on the implications of external changes. Closer relationships between AMRO and international organizations such as the ADB and IMF should be strengthened to support the ASEAN+3 decision-making process.

5. STABILITY AND ECONOMIC GROWTH Regional financial integration refers to a situation in which financial markets in the region are closely linked together. International financial liberalization supports the flows of funds across borders and allows

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foreign participation in domestic markets and vice versa. The amount of cross-border flows — including portfolio investment and FDI — depends on several factors, such as the risk-adjusted differential rate of return, the outlook of the fund-receiving country, the opportunity-seeking of the MNCs, and the domestic policy promoting FDI. The most important issue for the policymaker is to keep the balance between financial liberalization and domestic regulation to allow for stable cross-border flows. Efficient financial markets that effectively allocate resources will provide sustainable economic growth not only for the host countries but also the region. The 1997/98 AFC and the 2008/9 GFC are lessons for ASEAN in dealing with unstable capital flows and inefficient financial markets. Macroeconomic policy management and a stable financial system are needed to ensure improved competitiveness and productivity leading to eventual prosperity for the region. In the past the central bank played two main roles: to stabilize price levels and to stabilize financial institutions and markets. Due to the recent crises, financial instability led to the collapse of the financial system and the real economy. The cost of the financial crisis was compounded due to financial liberalization. Systematic risk therefore occurred across borders. After the crises the central banks have tended to pay greater attention to financial stability. Sawangngoenyung et al. (2012) posit that there are no explicit definitions of financial stability or financial instability. Financial instability is more often defined than financial stability because of the complexity of institutions, markets and products. Financial instability can be defined as an investment that mainly relies on uncertain external finance. It also refers to a financial crisis that involves a large number of stakeholders in a country and which entails serious adverse effects on the macro economy. Financial instability happens when problems in a financial system occur which impair financial intermediation resulting in an impact on the real sector. On the other hand, financial stability requires (1) the financial system and institutions to be stable so that market participants can meet their contractual obligations, and (2) for the financial market to be stable with prices determined by fundamental value without short-term volatility. Financial stability can also mean that the financial market is functioning well so that prices, the allocation of financial resources, and controllable financial risks support sustainable economic growth. According to Kawai

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M. and Morgan (2012), the European Central Bank (ECB) defined financial stability as a financial system where financial intermediaries and the market infrastructure are capable of withstanding shocks and where the system is able to reduce disruptions in the financial intermediation process that could impair the allocation of savings to investment opportunities. “The ECB defined three conditions associated with financial stability, namely, (1) the financial system should be able to efficiently and smoothly transfer resources from savers to investors, (2) financial risks should be assessed and priced reasonably accurately and should also be relatively well managed, and (3) the financial system should be in such a condition that it can comfortably absorb financial and real economic surprises and shocks” (quoted in Kawai and Morgan 2012).

6. MACRO-PRUDENTIAL POLICY AND MONETARY POLICY The GFC 2008/9 proved that financial imbalances caused severe economic impacts on the real sector. The micro-prudential policy could no longer be the only policy that a country could rely on. Micro-prudential policy claims that, due to manageable portfolio diversification, the failure of one financial institution will not spread to other institutions. Macro-prudential policy can supplement micro-prudential policy for financial stability as it can deal with the systemic crises that spill over to other areas. Sawangngoenyung et al. (2012) discuss the differences between microprudential and macro-prudential policies. A micro-prudential policy is set to oversee one specific financial institution to ensure that it has sufficient buffering to ensure its security, whereas macro-prudential policy considers the financial system as a whole. Micro prudential describes the financialdistress test on an institution by assuming that the risks are exogenous. Macro prudential assumes that the risks are endogenous. The former is described as a bottom-up approach due to the independent behaviour of individual institutions and the latter is top-down, depending on collective behaviour. According to the same report, the new financial environment exposes risks through two channels, namely pro-cyclicality and interconnectedness. For pro-cyclicality, a business boom makes risky loans seem less risky, resulting in higher loan extensions. On the other hand, a business slowdown makes risky loans seem risker, causing higher provision and a reduction in lending. Thus, a micro-prudential policy could intensify the business

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Chayodom Sabhasri TABLE 9.5 Distinction between Macro-Prudential and Micro-Prudential Policy Macro-Prudential Policy

Micro-Prudential Policy

Objective

Limiting financial systemwide distress

Limiting distress of individual institution

Risk Model

Endogenous (depend on collective behaviour)

Exogenous (independent of individual institution behaviour)

Correlations and common exposures across institutions

Important

Irrelevant

Calibration

Top-down

Bottom-up

Source: Borio (2003) as quoted in Sawangngoenyung W., S. Sa-nguanpan, and W. Sabborriboon (2012).

cycle when it reaches the peak or bottom. The interconnectedness can be derived from the use of the same financial tools to assess risk and to run risk management. As a result financial institutions tend to be homogenous in their business practices and portfolio management. Micro-prudential policy does not take care of the problem due to this natural interconnectedness and the risk spreading among the financial institutions. Since micro-prudential policy fails to capture the financial risks due to the pro-cyclicality and interconnectedness, the macro-prudential policy is designed to address the gap. Even though the macro-prudential policy was introduced many years ago, the advanced economies have felt the need to raise awareness of its necessity. The macro-prudential policy aims to stabilize the financial system as a whole. According to the definition by international organizations that deal with financial systems, as quoted in Sawangngoenyung et al. (2012), the macro-prudential policy is defined as “a policy that uses primarily prudential tools to limit systemic or systemwide financial risk, thereby limiting the incidence of disruptions in the provision of key financial services that can have serious consequences for the real economy”. Therefore, macro-prudential policy can fill the lacuna of micro-prudential policy by taking care of the pro-cyclicality and interconnectedness. The macro-prudential policy provides measures to limit system-wide financial risk. Financial imbalances, any sharp swing in prices of financial assets, and the linkage of financial institutions will then be identified and monitored.

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Source: Nacaskul et al. (2012).

Stability mandates

Financial stability

Monetary stability

Crisis mitigation

Intermediary institutions function

Price stability

Monetary functions properly

Limited impacts

Crisis prevention

External price stability

Domestic price stability

FIGURE 9.1 Stability Mandates and Monetary and Financial Stability

Quick recovery

Early warning

No hyperinflation

Low inflation uncertainty

Inflation not high and persistent

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Sustainable economic growth requires both monetary and financial stability. Monetary policy deals with price stability, while financial stability needs a combination of micro-prudential and macro-prudential policy. Monetary policy, of course, helps to stabilize the financial system through interest rate adjustments. According to monetary policy, interest rate changes will affect the cost of funding and the banks’ balance sheets will change investment decisions on risk taking and will send signals on the economic environment from the central bank to the public. Monetary policy then affects decisions on risk-taking behaviour and complements the macro-prudential policy in stabilizing the financial system. Macroprudential policy serves to prevent crises and monetary policy reacts to imbalances in the real and financial sectors.

6.1 East Asian Monetary Policy Several countries left the fixed-exchange rate system to the managed floating exchange rate system, with some level of capital management. A monetary policy with either an implicit or explicit inflation-targeting framework or a flexible inflation-targeting framework has been selected to implement price stability. Nevertheless, there is still a lack of policy cooperation for crisis prevention. Greater cooperation for crisis prevention is necessary, and this is possible through macro prudential cooperation. TABLE 9.6 ASEAN+3 Monetary Policies

Country China, Singapore, Vietnam Indonesia, Korea, New Zealand, Philippines, Thailand Japan, Malaysia, India

Monetary Policy Framework

Monetary Policy Objectives

Price Stability

Monetary Stability

Soft peg

yes

yes

Inflation targeting

yes

no

Implicit

yes

no

Source: Adapted from Pongsaparn et al. (2012) who cited the IMF’s Annual Report of Exchange Arrangements and Exchange Restrictions 2011.

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The People’s Bank of China

Bank of Japan

The Bank of Korea

Bank of Indonesia

Bank Negara Malaysia

Bangko Sentral Ng Pilipinas (BSP)

Monetary Authority of Singapore

Bank of Thailand

China

Japan

Korea

Indonesia

Malaysia

Philippines

Singapore

Thailand

Source: Adapted from Genberg and He (2009).

Central Bank

Jurisdiction

Price stability

Price stability

Price stability

Price stability and exchange rate stability

Price stability and exchange rate stability

Price stability

Price stability

Value of the currency

Policy Objective

Setting the monetary policy direction which is consistent with the nation’s economic conditions, with the ultimate objective of maintaining price stability and sustainable economic growth.

The Bank of Japan Law states that the Bank’s monetary policy should be “aimed at, through the pursuit of price stability, contributing to the sound development of the national economy.” Like other central banks, the Bank of Korea takes price stability as the most important objective of its monetary policy. The Bank of Korea Act, which came into effect in April 1998 following its revision at the end of 1997, stipulates price stability as the purpose of the Bank of Korea. … Bank Indonesia has one single objective of achieving and maintaining stability of the Rupiah value. The stability of the value against goods and services and the other [sic] is the stability of the exchange rate of the Rupiah against other currencies. To issue currency and keep reserves safeguarding the value of the currency; To promote monetary stability and a sound financial structure; To influence the credit situation to the advantage of the country. The primary objective of BSP’s monetary policy is to promote a low and stable inflation conducive to a balanced and sustainable economic growth. The primary objective of monetary policy in Singapore is to promote price stability as a sound basis for sustainable economic growth.

The objective of the monetary policy is to maintain the stability of the value of the currency and thereby promote economic growth.

… as stated on the Central Bank’s Official Website

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6.2 Macro Prudential Policies in ASEAN and ASEAN+3 The measures of Asian macro-prudential policy focus on two main objectives: manage aggregate risk over time (pro-cyclically), and manage aggregate risk at every point in time (systemic oversight). Managing aggregate risk over time consists of countercyclical provisioning, loan-tovalue ratio, debt-service-to-income ratio, tighter lending criteria, credit limits, tighter supervision, capital requirements, and exposure limits on lending to specific sectors. Managing aggregate risk at every point in time consists of capital surcharges for systemically important banks, liquidity and funding requirements, loan-to-deposit requirements, and foreign exchange exposure limits. The common tools to have been used by ASEAN+3 countries are loan-to-value ratio, tighter lending criteria, and liquidity and funding requirements. Unlike other ASEAN+3 countries, Japan and Indonesia have applied only a few tools of macro-prudential policy. The tools used by a few countries are countercyclical provisioning by China, debt-service-to-income ratio by China and Korea, credit limited by China, capital requirements by Malaysia, capital surcharge for systemically important banks by China and the Philippines, loan-to-deposit requirements by China and Korea, and foreign exchange–exposure limits by China and the Philippines. Unlike Japan and Indonesia, China, Korea, Malaysia, the Philippines and Singapore actively utilize the macro-prudential policy. Thailand only applies the commonly used tools. There are at least two possible models of the management of macroprudential policies in ASEAN: full integration and partial integration. Malaysia and Thailand employ partial integration, and the macroprudential policies involve several parties. Singaporean macro-prudential policy is quite exceptional as the central bank plays an important role in the degree of institutional integration and ownership of the policy mandates. From the European Union’s experiences in dealing with the financial crisis, the full cooperation of the monetary policy such as a single currency and a system central bank has proven to be inefficient. However, the monetary policy in the region will be aligned. The ASEAN and the Plus Three members share the common objective of monetary policy for price stability. However, there is a lack of cooperation among countries for the macro-prudential policy, which is an important tool in crisis prevention. The cooperation may range from the exchange of information, an early warning system for financial crisis, and system development for crisis prevention.

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x x

Loan-to-value ratio

Debt-service-toincome ratio

x x x

Liquidity and funding requirements

Loan-to-deposit requirements

FX exposure limits

Source: Morgan (2013).

Manage aggregate risk at every point in time (systemic oversight)

Capital surcharges for systemically important banks x

x

x

x

Malaysia

x

x

x

x

x

X

X

Indonesia

Exposure limits on lending to specific sectors

x

x

x

x

Korea

x

x

x

Japan

Capital requirements

Tighter supervision

x

x

x

China

Countercyclical provisioning

Tools

Manage aggregate Tighter lending risk over time (pro- criteria cyclically) Credit limits

Objectives

TABLE 9.8 Macro-Prudential Policy Measures in Asia

x

x

x

x

x

x

Philippines

x

x

x

x

x

Singapore

x

x

x

Thailand

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Chayodom Sabhasri TABLE 9.9 Stylized Models for Macro-Prudential Policies

Features of the Model

Full Integration

Partial Integration

Degree of institutional integration of central bank and supervisory agencies

Full at the Central Bank

Partial

Ownership of macroprudential mandates

Central Bank

Committee related to Central Bank, independent committee, Central Bank

Role of MoF/Treasury/ government

Active (No)

Passive

Separation of policy decisions and controls over instruments

Active (No)

In some areas

Existence of separate body coordinating across policies

Active (No)

No

Examples of countries

Singapore

Malaysia and Thailand

Source: Adopted from Nier et al. (2011) cited in Sawangngoenyung et al. (2012).

7. CONCLUDING REMARKS ASEAN 2030 has set the clear target of being RICH, which is defined as Resilient, Inclusive, Competitive, and Harmonious. These factors imply that ASEAN 2030 will be supported by sustainable economic growth with macroeconomic and financial stability. However, with respect to the sustainable growth and stability of the ASEAN economy, we need to take into account the Plus Three countries that have close economic linkages with ASEAN through trade and investment liberalization. The linkages of the ASEAN+3 have been progressing rapidly towards regional economic integration. The international production network is an example of the linkage with the regional economy. In addition, the cooperation of ASEAN+6, or the Regional Comprehensive Economic Partnership, is also moving towards the reality of a borderless economy. Our analysis of the experiences of the past financial crises has left us with the lessons of financial cooperation. The evidence has shown that financial cooperation among only ASEAN members would have had minimal impact in providing measures to prevent and resolve the effects

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of the 1997/8 AFC. Financial cooperation among the Plus Three has been established in several forms to prevent and resolve the crisis. These forms of financial cooperation include CMI/CMIM, AMRO, ABMI, ABF, and several others. However, this chapter focuses mainly on the analysis of the CMI/CMIM and AMRO as part of the prevention and resolution for financial crises. The 2008/9 GFC has not fully tested the ASEAN+3’s financial cooperation and resolution. It is doubtful though whether this form of financial cooperation was quite ready to address the problems. The CMI did not function as designed. Korea, instead of relying on the bilateral swap facility of the CMI, turned to the bilateral swap with the U.S. Federal Reserve. With respect to the financial structure in ASEAN, the evidence shows that the values of financial assets to GDP have progressively increased. The AEC blueprint also stresses that financial and capital market integration will be the key fundamental to the success of the RICH objectives. The surveillance system must be provided to monitor the systemic risk across borders. The CMI/CMIM faces several challenges: the size of the fund, the procedural process, the effectiveness of information sharing and flows, and the scope of the measures to deal with systemic risk beyond the ASEAN+3 region. The AMRO is also challenged in its management as well as its efficiency in providing information and policy recommendations to support decision-making on the CMIM facility. To achieve the ASEAN goal of RICH in 2030, macroeconomic and financial stability are the key challenges. Sound macroeconomic performance and financial stability will support the growth of the business sector in investment and trade across countries. Most importantly, the monetary policies of ASEAN members and the Plus Three countries must be coordinated so as to ensure exchange rate stability and stable flows of capital. Nevertheless, there is still a lack of the monetary and exchange rate policy coordination. The challenges to European Monetary Integration provide examples of the difficulty of such cooperation. Nevertheless, instead of monetary and exchange rate coordination, micro-prudential and macro-prudential policies can supplement national monetary and exchange rate policy coordination. In dealing with the systematic risk and interconnectedness in the region, both micro-prudential and macro-prudential policies must be brought up at the ASEAN+3 Finance Ministers and Central Bank Governors’ Meetings. AMRO should coordinate with the national authorities of each

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ASEAN+3 member to monitor key indicators as a preventive measure. However, AMRO needs to be strengthened by more capable staff and sufficient funding. Overall, in dealing with the changes to the global financial landscape and economic uncertainty, ASEAN 2030 can be realized by ASEAN coordinating with the broader region. Macroeconomic stability and financial stability are core to sustainable growth in the region. The crisis prevention and resolution plans must not rely just on the CMIM facility and the work of AMRO, but other areas of policy coordination need also to be taken into account. With the lack of explicit monetary and exchange rate policy coordination, the coordination of micro-prudential and macroprudential policies can supplement the current crisis prevention and resolution plans.

References Aizenman, J, Y. Jinjarak, and D. Park. “Evaluating Asia Swap Arrangement”. ADBI Working Paper Series no. 297. Asian Development Bank Institution, 2011. Akyuz, Y. “The Global Economic Crisis and the Asian Developing Countries: Impacts, Policy Responses, and the Medium Term Prospects”. TWN Global Economy Series 27 (2010). Kawai, M. and P.J. Morgan. “Central Banking for Financial Stability in Asia”. Public Policy Review 8, no. 3 (2012): 215–46. Lee, C.L. and S. Takagi. “Deepening Association of Southeast Asian Nation’s Financial Markets”. ADBI Working Paper no. 414. Asian Development Bank Institute, 2013. Morgan, P.J. “Monetary Policy Frameworks in Asia: Experience, Lessons, and Issues”. Paper presented at the Singapore Economic Review Conference, 6–8 August 2013. Nacaskul, P., K. Janjaroen, and S. Suwanik. “Economic Rationales for Central Banking: Historical Evolution, Policy Space, Institutional Integrity, and Paradigm Challenges”. Mimeographed. Bank of Thailand, 2012. Nier, E., J. Osinski, L. Jacome, and P. Madrid. “Toward Effective Macro Prudential Policy Frameworks: An Assessment of Stylized Institutional Models”. IMF Working Paper WP/11/250. International Monetary Fund, 2011. Pacific Economic Outlook: Monetary Policy Regimes in the Pacific Region. Japan Committee for Pacific Economic Outlook, 2013. Park Y.C. and S. Tagaki. “Managing Capital Flows in an Economic Community: The Case of ASEAN Capital Account Liberalization”. ADBI Working Paper no. 378. Asian Development Bank Institute, 2013.

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Pongsaparn, R., P. Ketruangroch, and D. Hirunwong. “Monetary Policy Conduct in Review: The Appropriate Choice of Instruments”. Mimeographed. Bank of Thailand, 2012. Sawangngoenyung W., S. Sa-nguanpan, and W. Sabborriboon. “Financial Systemic Stability: Challenging Aspects of Central Banks”. Mimeographed. Bank of Thailand, 2012. Siregar, R and A. Chabchitrchaidol. “Enhancing the Effectiveness of CMIM and AMRO: Elected Immediate Challenges and Task”. ADBI Working Paper no. 403. Asian Development Bank Institute, 2013. Sussangkarn, C. “Institutional Building for Macroeconomic and Financial Cooperation in East Asia”. Mimeographed. Paper presented at the Japan Society of International Economics, 2011.

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10 GLOBAL UNCERTAINTIES: IMPLICATIONS FOR THE ASEAN COMMUNITY Piti Srisangnam, Sineenat Sermcheep, and Nuanpan Thamanovanish

1. INTRODUCTION The Association of Southeast Asian Nations (ASEAN) is a unique mixture of ten national economies at different stages of social and economic development, ranging from affluent Singapore to underdeveloped members, for example Myanmar, Cambodia and Laos. Embracing a more region-centred growth model, the process of ASEAN Community building has been monitored through various economic stimulus measures as well as the system of Dialogue Partnerships, the ASEAN Regional Forum, the ASEAN+3 process, and the East Asia Summit (ISEAS 2010) to successfully establish the ASEAN Community by 2015. The global uncertainties, however, remain potentially huge risks that will need to be effectively managed. Since the Asian Financial Crisis in 1997, Southeast Asian countries have witnessed social deficits and the collapse of financial sectors. The process of ASEAN Community building has therefore been tested by uncertainties

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arising from internal and external challenges, particularly from advanced economies in the European Union, Japan, and the United States. These phenomena have significant implications on the establishment of ASEAN Vision 2020 and the plans for the ASEAN Community by 2015 (Srisangnam and Thamanovanish 2013). The global uncertainties could thus be identified in terms of financial risks and non-financial risks, which illustrate the interconnectedness of economic and security issues within the region. ASEAN governments together with their counterparts, particularly those of ASEAN+3 countries, have been working closely to drive the region in the right direction.

2. FINANCIAL RISKS Prior to the Asian Financial Crisis in 1997, most Southeast Asian countries had seen the flow of liquidity from European countries, the United States, and Japan injected into the global financial system — especially that of Southeast Asia — in search of higher returns. This short-term capital inflow owned by non-residents leads to the country’s macroeconomic instability and harms the entire economy when the capital starts to flow out. The Global Financial Crisis in 2007 to 2008 deepened the financial turmoil in vulnerable Southeast Asian economies. The average GDP growth rate in ASEAN countries slowed down from 6.5 per cent in 2007 to 1.2 in 2009 due to export-oriented policies and weak macroeconomic management frameworks (SEAISI 2011). Along with the global economic uncertainties generated by macroeconomic difficulties in advanced economies and the further economic slowdown of China, ASEAN is in dire need to restore confidence in the financial market, prevent the emergence of financial crises, and maintain growth. The lessons learnt from the past financial turmoil at the global and regional levels have thus been an impetus for ASEAN to develop several means of financing facilities and the financial markets. Due to the fact that the IMF’s conditionality was too costly and the awareness among ASEAN+3 countries for the need to be more self-financing in case of financial crisis, there has been even greater cooperation in the form of global governance to tackle such challenges in past years (Asian Century Institute 2013). Coordination between the central banks and the ASEAN+3 Ministers Process was implemented after the Asian Financial Crisis, followed by the more cooperative initiatives of ASEAN+3 countries in policy dialogue and information exchange, surveillance and peer review, regional financing

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arrangements, regional capital-market development, capacity building, and research. The forms of financial cooperation consist of the ASEAN Surveillance Process (ASP) in 1999, the Roadmap for Monetary and Financial Integration of ASEAN (RIA-Fin) in 2003, the ASEAN Capital Market Forum (ACMF), and ASEAN Insurance Cooperation, while ASEAN+3 also played an important role in financial cooperation initiatives. ASEAN+3 strategies for financial cooperation include the Chiang Mai Initiatives (CMI; a bilateral currency-swap arrangement among the ten members of ASEAN, China, Japan and Korea), the Asian Bond Market Initiative (ABMI), Chiang Mai Initiative Multilateralism (CMIM; a multilateral currency swap arrangement among the ten members of ASEAN, China, Japan and Korea), the new CMIM road map, the ASEAN+3 research group, and the establishment of the ASEAN+3 Macroeconomic Research Office (AMRO). There are also ASEAN- and international-level forms of financial cooperation that comprise cooperation with the Asia Pacific Group (APG) on Anti-Money Laundering and East Asia Finance Cooperation (EAS) (Sabhasri 2013). The progress of these cooperative initiatives among the ASEAN+3 countries has become prominent for ABMI in increasing the local currency bond market to US$5.5 trillion dollars (67 per cent of the total outstanding amount was made up of government bonds and 33 per cent was made up of corporate bonds) in the third quarter of 2011 from US$3.7 trillion dollars in 2008. Emerging East Asia’s outstanding local bonds amounted to 8 per cent of the world total. The fastest growing countries in this respect are Vietnam, Malaysia, Singapore and Korea. In addition, the 2008 road map for ABMI paved the way to unify issuing authorities for government bonds and simplify corporate bond issuance procedures for securitization, as well as removing barriers for bond issuance by domestic and foreign entities (Sabhasri 2013). Meanwhile, however, a lack of effectiveness of these initiatives still prevails. The size of the CMIM swap — a foreign exchange reserves pool worth US$120 billion at launch on 24 March 2010 and expanded to US$240 billion in 2012 — may not be enough in the case of an ASEAN/ Asian financial crisis (Sussangkarn 2012), while an agency like AMRO will take more time to prove its efficiency and success in monitoring trends of macroeconomic and financial performance (Sabhasri 2013). It is strongly recommended that no IMF conditionality be applied to the programme. More than 80 per cent of leaders in Asia and the Pacific agreed that the CMIM was a milestone for Asian financial cooperation and 75 per cent

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of them thought that AMRO will complement the work of the IMF for regional surveillance. In the case of the AMBI, the physical infrastructure — including trading, clearing, settlement, regulation, supervision and legal underpinnings, and derivatives markets — needs to be improved to better provide financial facilities to the Asian Bond Market (Sabhasri 2013). It is clear that the role of ASEAN+3 is a cornerstone for ASEAN to strengthen the establishment of the ASEAN Economic Community (AEC). The cooperative international macroeconomic policies as well as the more enhanced and integrated cooperation among ASEAN+3 countries will lead to the further development of the region’s financial infrastructure, including effective bond markets, harmonized cross-border regulations of financial transaction, and standardized domestic agency ratings. Although we have the AMRO and the ABMI, the causes of the financial crisis may come from the exchange risk and volatility. ASEAN may have limited resources to deal with the problem alone, and it needs to cooperate in the form of the ASEAN+3 to tackle the exchange risk. More concerns will be the internationalization of an East Asian currency, which could be either the Japanese Yen or Chinese Renminbi (Sabhasri 2013).

3. NON-FINANCIAL RISKS Beyond the ASEAN Economic Community, the interconnectedness of economic and security issues is inalienable. Nevertheless, ASEAN is not a military alliance or a defence pact; it aims to promote peace and stability in the region so that all member countries may attain a status where economic capacity is effectively utilized. It is undeniable that without peace and security, investments are discouraged, economic development is retarded, and lives and livelihoods are disrupted (ISEAS 2010). As ASEAN strives to be a fully integrated ASEAN Community with genuine people-centred, durable peace, and shared prosperity for the region, several issues concerning regional political-security must be meaningfully dealt with.

3.1 Development Gap in ASEAN The various huge disparities between the ten member countries are a major hindrance to ASEAN regional integration. The wide development gap in ASEAN remains the region’s most significant challenge, especially

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when ASEAN is striving for a free flow of goods, services, investment, and capital. Reducing the development gap will thus bring considerable benefits to ASEAN economies and further enhance its competitiveness in a highly liberalized market. The Initiative for ASEAN Integration (IAI) was launched in 2002 as a device to narrow the development gap with the assistance of ASEAN’s older members towards the less-economically advanced members (ASEAN Secretariat 2012). The IAI focuses on transport and energy, human resource development, capacity building for regional economic integration, tourism, quality of life, and general development issues (ISEAS 2012).

3.2 Human Rights in ASEAN and Its Position towards Myanmar Despite the principle of non-interference of ASEAN, cases that have a severe impact on neighbouring countries and peoples or affect regional peace and stability permit external intervention in the form of humanitarian action or self-defence. For example, the Philippines crisis in 1986, the land and forest fires in Indonesia, the situation in Myanmar, and the turmoil in Thailand. ASEAN’s role in Myanmar became prominent in fostering national reconciliation, holding the 2010 general election in a free, fair, and inclusive manner, as well as calling on the release of Daw Aung San Suu Kyi and political prisoners as economic embargoes and boycotts were considered ineffective and harmful to the people of Myanmar (ISEAS 2010). ASEAN’s position on human rights is clearly stated in the Joint Communiqué of the July 1993 ASEAN Ministerial Meeting. It stressed that human rights are interrelated and indivisible, comprising civil, political, economic, social, and cultural rights. Such abuses are thus detrimental to ASEAN’s international cooperation and its process of ASEAN Community building. To increase ASEAN’s momentum in human rights, the ASEAN Inter-governmental Commission on Human Rights (AICHR) was established with regard to the promotion and protection of human rights and the implementation of the ASEAN Human Rights Declaration (AHRD) (AICHR 2012).

3.3 Terrorism and Transnational Organized Crime The Bali bombing of 12 October 2002 and the bombing of the Marriott Hotel in Indonesia on 5 August 2003 brought the issue of terrorism in

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Southeast Asia into the world’s spotlight. According to James R. Clapper, the Director of U.S. National Intelligence, terrorism and transnational organized crime networks erode good governance, cripple the rule of law through corruption, hinder economic competitiveness, steal vast amounts of money, and traffic millions of people around the globe (Clapper 2013). ASEAN has been facing a number of difficulties, such as the abuse of narcotics, trafficking in illegal drugs, arms smuggling, money laundering, illegal migration, corruption, human trafficking, cybercrime and terrorism. In an increasingly borderless world, organized crimes are committed across national borders and their detrimental effects impede security and peace worldwide (Clapper 2013). The Asian Financial Crisis in 1997 and public cuts in social spending, especially on education, led to an increase in private schools funded by Islamic radicals as well as institutions that promote the anti-Western and puritanical Wahhabi sect of Islam. Several key Southeast Asian countries are used as bases of operations for radical Islamists, especially Jemaah Islamiyah of Indonesia. This extremist group has close ties with al-Qaeda and its global ideology to purify Islam through jihad. The global jihadist movement has become increasingly decentralized, and Southeast Asian countries now face national uncertainty from this threat. According to Professor Xinsheng Wang, at a talk delivered at Bunche Hall on 13 May 2004, Malaysia, Brunei, Singapore, Indonesia, Southern Thailand and the Southern Philippines are expected to become centres of terrorism (Evans 2004). With crimes expanding in scope and becoming more organized, ASEAN ratified the ASEAN Convention on Counter-Terrorism (ACCT) in 2007 — a rules-based framework to counter, prevent and suppress terrorism and deepen counterterrorism cooperation. However, the convention still lacks enforcement mechanisms. In addition, the ASEAN Regional Forum (ARF) through the 13th ASEAN Senior Officials Meeting on Transnational Crime (SOMTC), held in Vietnam on 19–20 June 2013, endorsed the SOMTC Work Programme 2013–2015. The Work Programme includes policy guidelines and activities on the eight areas of transnational crime — terrorism, drug trafficking, trafficking in persons, arms smuggling, piracy at sea, money laundering, international economic crime and cybercrime. The Work Programme was tabled at the 9th ASEAN Ministerial Meeting on Transnational Crime (AMMTC) held in Vientiane, Laos from 15 to 19 September 2013, for adoption by the ministers.

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3.4 ASEAN and the South China Sea The dispute over the South China Sea is a threat to the stability of the entire Southeast Asian region. It is not limited to the regional claimants, but includes major powers like China, India and the United States. The increased tension among the claimant states — China, Taiwan, the Philippines, Malaysia, Brunei, and Indonesia — have led to regional instability and difficulties in trade. ASEAN took its role to support the peaceful management in settling the dispute. A declaration calling for settlement by peaceful means was issued, followed by the Declaration on the Conduct of Parties in the South China Sea (DOC) in 2002 in which the countries concerned committed to the purpose and principles of the UN Convention on the Law of the Sea (UNCLOS), the Treaty of Amity and Cooperation in Southeast Asia (TAC), the Five Principles of Peaceful Coexistence, and other universally recognized principles of international law as stated in the Joint Statement of the 15th ASEAN-China Summit on the 10th Anniversary of the Declaration on the Conduct of Parties in the South China Sea on 19 November 2012 in Cambodia.

3.5 Proliferation of Weapons of Mass Destruction (WMD) States in Southeast Asia do not possess nuclear weapons. Neither do they depend on nuclear energy (Quilop 2006). But, of the ten member nations comprising ASEAN, all except Brunei and Laos have active plans for adding nuclear power into their electricity-generating mix. Among the member countries, Vietnam is the most ambitious in its plans for nuclear energy. The country had adopted a strategy on peaceful use of nuclear energy until 2020, a national strategy on energy development until 2025, and a vision until 2050. Thailand has plans to develop two nuclear power plants to generate 2,000 MW by 2022. Singapore, which generates the majority of its power from increasingly scarce gas, has a feasibility plan for nuclear power under way. Only Myanmar is alleged to be developing any plans for nuclear weapons. Those allegations are being investigated by the IAEA and are denied by Myanmar’s military leaders (Bower 2010). In order to counter nuclear proliferation at the regional level, ASEAN endorsed two instruments — the Zone of Peace, Freedom and Neutrality (ZOPFAN) and the Nuclear Weapons Free Zone (SEANWFZ) Treaty —

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as reassurance that they will not develop or acquire nuclear weapons or allow the deployment of such weapons on their soil (Nuclear Threat Initiative 2013). At the global level, the non-proliferation regime is underpinned by the Non-Proliferation Treaty (NPT) with monitoring by the International Atomic Energy Agency (IAEA) (Quilop 2006). But a state that is party to the NPT could withdraw from it, such as in the case of North Korea, which can pose a serious threat to the peace and security environment. Despite its engagement in the Six-Party Talks, North Korea’s nuclearrelated activities are considered a threat to the international community. North Korean Foreign Minister Park Ui-chun stated at the ARF in Phnom Penh that its nuclear capability was necessary to safeguard its sovereignty from constant nuclear threat by the United States. However, with North Korea’s regular attendance in the ARF, it is seen that the ARF is the only venue to deal with North Korea. Not only has the ARF increased its significance on regional security issues, but it also has a growing influence as a security mechanism to address concerns like the case of North Korea (Miller 2012).

3.6 Energy While the region has a high demand for energy to support increased economic activities, population growth, greater electrification rates, and expansion of the transport sectors, some ASEAN members still lack adequate access to energy and are becoming increasingly vulnerable to climate change and degradation of the environment (World Energy Outlook 2012). As energy is essential to achieving the region’s growth objectives and securing the well-being of the people, energy security has become a top priority for ASEAN leaders. Steps to address these issues include measures to curb demand, steps to increase and diversify sources of supply, and efforts to accelerate the transformation of energy markets (improve energy investment culture, strengthen regional cooperation in sharing best practices) (Kamel 2013). To address these energy challenges, ASEAN leaders have agreed to accelerate regional collaboration through the Trans-ASEAN Gas Pipeline (TAGP), the ASEAN Power Grid (APG), the Petroleum Security Agreement to enhance oil and gas security in the region, cooperation in the renewable energy sector and related industries, as well as investment in the requisite

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infrastructure for renewable energy development. Further cooperation in the energy sector was aided by the attendance of energy minsters at the East Asia Summit. The Energy Market Integration (EMI) initiative was created to address energy policy issues across EAS members, including trade liberalization, investment environments, energy pricing reform, removal of trade and investment barriers, liberalization of energy markets, and development of energy infrastructure, particularly in the Greater Mekong Sub-region (GMS) (Kamel 2013). Chulalongkorn University, under the auspices of the Faculty of Economics, the ASEAN Studies Center and the Energy Research Institute, came together motivated by the strong belief that the AEC cannot deliver its promise of growth and prosperity unless it is firmly supported by ASEAN Energy Market Integration (AEMI). A belief that the AEC cannot achieve the productive free flow of products, of services, of investments and people, without including also the productive free flow of energy — the very engine of growth. In short, the AEC cannot survive and flourish without AEMI. The objective of this project is to design an “Energy Blue Print” of how AEMI would work within the AEC and an “Energy Road Map” of how and when it would be delivered. The AEMI Project was endorsed by the ASEAN Senior Officials Meeting on Energy (SOME) that took place on 24–25 June 2013 on Bali, Indonesia. The AEMI Group will continue to work closely with the ASEAN Secretariat in coordinating this work and in facilitating the dialogue with policymakers throughout ASEAN.

3.7 Natural Disasters Southeast Asian countries suffer from losses caused by natural disasters such as floods, forest fires and earthquakes every year. Natural disasters are not considered as humanitarian crises alone. Apart from the loss of multiple lives and property damage, the region faces considerable economic losses. In 2011 the costs incurred by inundation and storm surges in Thailand alone were estimated at $45.7 billion, making the 2011 flood one of the five costliest natural disasters in modern history (Gleicher 2012). The sources of economic growth in ASEAN countries are heavily linked with the production networks that use domestic resources to produce final products by multinational enterprises (MNEs) for the purpose of importsubstitution, export-promotion and the elimination of domestic gaps in the value chain of production (Cheewatrakoolpong et al. 2013).

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ASEAN, the European Union, Japan and the United States are the top four sources of FDI inflow to ASEAN members. The second group consists of Australia, Canada, the Cayman Islands, China, India and Korea. These ten sources make up about 80 per cent of total FDI inflows to ASEAN. In 2010 Singapore received nearly half (46.9 per cent) of FDI inflows to ASEAN, while Indonesia, Malaysia, Vietnam and Thailand received 17.6, 12.1, 10.6 and 8.3 per cent, respectively (Cheewatrakoolpong et al. 2013). It can thus be seen that as ASEAN aims to be a global supply chain hub, it may fail to maintain the dynamism of FDI inflow and its competitiveness in the world economy. In response to such phenomena, ASEAN established the Committee on Disaster Management, which includes a response action plan, training, information sharing and communications, partnerships with governments and non-governmental organizations, and public awareness. The member countries, in addition, signed the ASEAN Agreement on Disaster Management and Emergency Response, which covers early warning and preparedness, prevention, mitigation and disaster risk reduction, and regional emergency responses to strengthen regional cooperation (ISEAS 2012). The ARF also acts as a major player in disaster management. This role began during the devastation of Cyclone Nargis in 2008, the worst natural disaster in the recorded history of Myanmar. The ARF began with its first meeting in New Zealand in 1997 to focus not only on the traditional role as neighbour states but also strengthening involvement in security matter. Security issues in Southeast Asia include non-traditional threats and disaster management. ASEAN member states see Myanmar as a state vulnerable to natural disasters. It therefore recognized the need for the exchange of information and experience between the member states to help deal with the natural disasters and manage international humanitarian assistance in the aftermath of disasters (Yustiningrum 2010). The commitment of ASEAN member states following the ARF meeting was formulated into the establishment of the ASEAN Committee on Disaster Management, later changed to the ASEAN Framework on Disaster Management (Yustiningrum 2010). Cyclone Nargis was the catalyst for ASEAN member states to formulate the ASEAN Humanitarian Task Force (AHTF). The AHTF was tasked with strengthening capacity building — including trading expertise and financial support —for Myanmar. However, the AHTF faced obstacles in running

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the financial support. Each member state has different financial capacities and different levels of GDP that made them unable to deliver sustainable financial support. This meant that the AHTF only had a temporary supporting fund for disaster management in Myanmar. Surprisingly, Vietnam, as a small state in the region, was able to deliver a huge amount of support funds for disaster management in post-cyclone-Nargis Myanmar. The AHTF ran for two years in the aftermath of the cyclone, winding up in 2010 (Yustiningrum 2010).

3.8 Communicable Diseases An increase of communicable diseases in Southeast Asia has been in the spotlight since the SARS (Severe Acute Respiratory Syndrome) crisis in 2003. Not only do such occurrences pose risks to human health, they also adversely affect trade, tourism and economic growth. In 2003 the deaths in Asia from SARS reached the highest in the world, while the total economic cost was US$20 billion. China was the most affected country, with 349 deaths and GDP losses of US$14.8 billion. For the United States, whilst no deaths were recorded, GDP losses amounted to US$7 billion. TABLE 10.1 Impact on GDP of SARS Cases

Deaths

Asia China Hong Kong Taiwan Singapore Others

5327 1755 346 238 109

North America Canada US

Impact on 2003 GDP

Per cent

USD billion

349 299 37 33 11

–1.05 –2.63 –0.49 –0.47

–14.8 –4.1 –1.4 –0.4

252 27

44 0

–0.6 –0.07

–4.7 –7.6

Europe

33

1

Others

10

1

8097

775

–0.7

–33

World Total

Source: WHO, Brookings Institute, BMO Nesbitt Burns.

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According to the International Air Transport Association (IATA), Asia-Pacific airlines lost revenue of 39 billion passenger kilometres (RPK), or around 8 per cent of annual traffic. This means the airlines lost US$6 billion in revenues due to SARS. To tackle the challenges posed by SARS, ASEAN, in cooperation with other countries and the World Health Organization (WHO), helped to stop the spread of the disease. The ministers of health of ASEAN and those of China, Japan, and Korea met to work out solutions to the problem, followed by special ASEAN and ASEAN-China summit meetings to implement effective measures to combat the deadly disease. These measures included strict quarantine, thermal screenings at airports, and common protocols for land, sea, and air travel (ISEAS 2012). This marks another successful instance of cooperation between ASEAN and its partners, particularly ASEAN+3 countries, in combatting the deadly disease.

4. CONCLUSION ASEAN+3 has been strengthened in the middle of uncertainty — the 1997 Asian Financial Crisis — and has continued to increase significantly in the era of a highly globalized world. The ASEAN+3 Summit and East Asia Summit (ASEAN+6, or ASEAN Regional Comprehensive Economic Partnership: RCEP) are two approaches to strengthen ties with ASEAN and regional partners. Furthermore, with expansion to include the United States, Russia, Australia, China, India, Japan and New Zealand, it forms an even more inclusive element to enhance regional integration. According to Hitoshi Tanaka, a former Deputy Minister for Foreign Affairs and currently a Senior Fellow at the Japan Center for International Exchange, there must be a two-tiered approach to community building — with the ASEAN+3 Summit at the core and the East Asia Summit playing a supportive role — to create a fitting venue that promotes functional cooperation in the region. Ideally, this venue would advance political security and economic maturity in East Asian Countries, while focusing on strengthening regional integrity as a part of the community-building process.

References ASEAN Intergovernmental Commission on Human Rights (AICHR). A Brief History of the ASEAN Intergovernmental Commission on Human Rights, 2012 (accessed 18 August 2013).

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ASEAN Secretariat. Initiative for ASEAN Integration (IAI) and Narrowing the Development Gap (NDG), 2012. Asian Century Institute. Chiang Mai Initiative: An Asian IMF? 2013 (accessed 18 August 2013). Bower, E.Z. ASEAN Going for Nuclear Power, 2010 (accessed 6 July 2010). Cheewatrakoolpong, K. “Impact of the ASEAN Economic Community on ASEAN Production Networks”. ADBI Working Paper No. 409. Tokyo: Asian Development Bank Institute (ADBI), 2013. Clapper, J.R. “Statement for the Record: Worldwide Threat Assessment of the US Intelligence Community”. Senate Select Committee on Intelligence, 2013. Evans, L. ASEAN and Terrorism in Southeast Asia, 2004 (accessed 18 August 2013). Gleicher, D. Waking Up to the Threat of Natural Disasters, 2012 (accessed 18 August 2013) ISEAS. Know Your ASEAN, 2nd ed. Singapore: Institute of Southeast Asian Studies, 2010. Kamel, N. ASEAN Energy Market Integration. Bangkok: ASEAN Studies Center of Chulalongkorn University, 2013. Miller, J.B. ASEAN & North Korea, 2012 (accessed 18 August 2013). Nuclear Threat Initiative. Southeast Asian Nuclear-Weapon-Free-Zone (SEANWFZ) Treaty (Bangkok Treaty), 2013 (accessed 18 August 2013). Quilop, R.J. Weapons of Mass Destruction: A Challenge to Global and Regional Security. Quezon City, Philippines: 2006. Sabhasri C. “ASEAN Financial Cooperation: Thailand Perspective”. Workshop on Financial Evolution, Regulatory Reform and Cooperation in Asia, IDEAs, FEI & CSS, Seoul National University, 17–18 May 2013. Seoul, Republic of Korea: 2013. Srisangnam P. and Thamanovanish N. “ASEAN Integration and the Role of Thailand through Five Moments”. ASEAN Unity and Maritime Challenges in South China Sea and Asia Pacific. Bangkok: Centre for Asian Strategic Studies-India (CASS-India), New Delhi, in cooperation with the Institute of Security and International Studies (ISIS Thailand), 20 June 2013. Sussangkarn, C. Toward a Functional Chiang Mai Initiative, 2012 (accessed 18 August 2013).

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World Energy Economic Outlook 2012. Paris: IEA Publications, 2012. World Energy Outlook 2012. Paris: IEA Publications, 2012. Yustiningrum, D.O. Myanmar Cyclone Nargis and Regional Involvement, 2010 (accessed 18 August 2013).

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INDEX A aggregate demand per capita by region, impact on, 213 in surplus countries, 214 aggregate output growth effects of, 155 exhibit, coefficients of, 165 agricultural business, Vietnam, 141 AHRD. See ASEAN Human Rights Declaration (AHRD) AHTF. See ASEAN Humanitarian Task Force (AHTF) AICHR. See ASEAN Intergovernmental Commission on Human Rights (AICHR) AMMTC. See ASEAN Ministerial Meeting on Transnational Crime (AMMTC) AMRO. See ASEAN+3 Macroeconomic Research Office (AMRO) AMRO Regional Economic Monitoring (AREM), 229 Annual Report on Exchange Arrangements, 224 Anti-Money Laundering, 244 ANZ. See Australia–New Zealand (ANZ) APG. See ASEAN Power Grid (APG); Asia Pacific Group (APG)

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APTA. See ASEAN Preferential Trading Agreement (APTA) AREM. See AMRO Regional Economic Monitoring (AREM) ARF. See ASEAN Regional Forum (ARF) ASA. See ASEAN Swap Arrangement (ASA) ASEAN. See Association of Southeast Asian Nations (ASEAN) ASEAN+3 financial structure in, 220–22 monetary policies, 234 process, 18–19 strategies, 244 ASEAN-4 current account of, 8 policy rates in, 11 ASEAN 2030, 222–24 ASEAN Agreement on Disaster Management and Emergency Response, 251 ASEAN-China Free Trade Agreement (ACFTA), 107 ASEAN-China Summit, 248, 253 ASEAN Committee on Disaster Management, 251 ASEAN community, implications for, 242–43 financial risks, 243–45 non-financial risks, 245–53

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258 ASEAN Convention on CounterTerrorism (ACCT), 247 ASEAN Economic Blueprint for the AEC, 3–4 ASEAN Economic Community (AEC), 3, 222, 245, 250 ASEAN Economic Community (AEC) Blueprint, 224 ASEAN Economic Community (AEC) Scorecard mechanism, 4 ASEAN Energy Market Integration (AEMI), 250 ASEAN Framework on Disaster Management, 251 ASEAN Free Trade Agreement (AFTA), 3, 107 ASEAN Humanitarian Task Force (AHTF), 251–52 ASEAN Human Rights Declaration (AHRD), 246 ASEAN Inter-governmental Commission on Human Rights (AICHR), 246 ASEAN leaders, 3 ASEAN+3 Macroeconomic Research Office (AMRO), 17, 229, 239–40, 244–45 ASEAN Ministerial Meeting on Transnational Crime (AMMTC), 247 ASEAN+, monetary and financial architectures for, 218–19 ASEAN 2030, 222–24 ASEAN financial resolutions, challenges in, 224–29 crises and resolution, 219–20 financial structure in ASEAN and, 220–22 macro-prudential policy and monetary policy, 231–38 stability and economic growth, 229–31

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Index ASEAN Power Grid (APG), 249 ASEAN Preferential Trading Agreement (APTA), 3 ASEAN Regional Forum (ARF), 247 ASEAN Senior Officials Meeting on Energy (SOME), 250 ASEAN Senior Officials Meeting on Transnational Crime (SOMTC), 247 ASEAN+3 Summit, 253 ASEAN’s Vision 2020, 3 ASEAN Swap Arrangement (ASA), 17, 225 Asia domestic demand in, 205–13 exchange rate policies in, 183–87 expansionary macro policies in, 202–5 foreign exchange rate adjustments with expansionary macro policies in, 197–201 global imbalances and, 176–87 trade balance in, 193–94, 199 Asian Bond Fund (ABF), 220 Asian Bond Market, 245 Asian Bond Markets Initiative (ABMI), 220, 244–45 Asian central banks, 186 Asian countries, business cycles in, 112 Asian currencies, patterns of, 188 Asian Development Bank Institute (ADBI), 218, 222 Asian Dollar Market, 87 Asian economies, 47, 150, 154, 156, 163–68, 170 benefits to, 148 domestic financial reform in, 150 samples, 165 Asian financial crisis (AFC), 2, 219, 242–43, 247, 253 after 1997/98, 6–7, 9, 57 Thailand, 18

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Index Asian foreign exchange rate policies, 174–76 Cambridge-Alphametrics Model (CAM), 187–92 global imbalances and, 176–87 policy implications, 208–14 scenarios of foreign exchange rate and macroeconomic policies, 192–208 Asian macro-prudential policy, 236 Asia Pacific Group (APG), 244 Association of Southeast Asian Nations (ASEAN), 117 countries of, 1, 3 development gap in, 245–46 economies, 2, 24, 49 financial resolutions, challenges in, 224–29 financial structure in, 220–22 free trade agreements (FTAs) between, 3 human rights in, 246 integration, 3–4 macro prudential policies in, 236–38 regional economic integration agenda, 3 and South China Sea, 248 stock markets, 14 Australia–New Zealand (ANZ), 117 B balance of payments (BOP), 62–63, 128–29 Bank Indonesia, 51 certificate by foreign investors, 47–48 banking sectors impact on, 83, 86–87 indicators on, 81 measures to stabilize, 92, 94 Bank of Canada’s Global Economy Model, 216n10

11 GlobalEco_Uncertainties.indd 259

259 Bank of International Settlements’ (BIS), 78 Bank of Japan in 2013, 1, 20 baseline parameter, estimation of, 160–66 bilateral swap agreements (BSAs), 225 bilateral-trade flows, 118 BIS. See Bank of International Settlements’ (BIS) BLP. See Bridging Loan Programme (BLP) bond market, participation in, 47–50 BOP. See balance of payments (BOP) borderless economic community, 218, 222 Bridging Loan Programme (BLP), 91 BSAs. See bilateral swap agreements (BSAs) C CAM. See Cambridge-Alphametrics Model (CAM) Cambodia, 224 Cambridge-Alphametrics Model (CAM), 187–92 of world economy, 176 Capability Development Scheme, 97 capital account openness, coefficients of, 168 capital and financial account, 25, 30 capital controls, 171 effects of, 168 notion of, 158 role of, 155, 165 capital flows, in Vietnam, 137 capital inflows in emerging Asia, composition of, 9 capital liberalization, 224 CDS premium. See credit default swap (CDS) premium Central Bank, 57–59 policy objectives, 235

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260 Central Institute for Economic Management (CIEM), 139 Central Provident Fund (CPF) payroll, 90 CET schemes. See Continuing Education and Training (CET) schemes Chiang Mai Initiative (CMI), 17, 219, 244 Chiang Mai Initiative Multilateralization (CMIM), 17–18, 219, 224–29, 244 adoptions for, 227 China, 225, 252 currency reform of, 186 economy of, 181, 193, 216n11 exchange rates, arrangement of, 185 macro-prudential policy, 236 policy, 32 real exchange rates of, 202, 205 yuan revaluation and fiscal stimulus in, 196 Chinese yuan, 187 revaluation with expansionary macroeconomic policies, 193–97 Chinn-Ito index, 165 CIEM. See Central Institute for Economic Management (CIEM) CIMB. See Commerce International Merchant Bank (CIMB) Clapper, James R., 247 CMI. See Chiang Mai Initiative (CMI) CMIM. See Chiang Mai Initiative Multilateralization (CMIM) CMI Swap Arrangement, 225 coefficient of relative income, 170 Commerce International Merchant Bank (CIMB), 64 Committee on Disaster Management, 251

11 GlobalEco_Uncertainties.indd 260

Index commodity fuel (energy) monthly price index, 36–37 commodity price factors, 31–35 communicable diseases, non-financial risks, 252–53 consumer business centre, 98 consumer-price-index-based inflation, 125 Continuing Education and Training (CET) schemes, 97 conventional control variables, 154 Coordinated Portfolio Investment Survey, 14 core businesses, 136 cost-cutting efforts in banking sector, 87 CPF. See crisis prevention function (CPF) CPF payroll. See Central Provident Fund (CPF) payroll crawling-peg exchange rate system, 128, 133, 145 credit default swap (CDS) premium, 142 crisis prevention function (CPF), 227 CRM, 227 cross-border claims in foreign claims, 46 cross-country trade linkages, patterns of, 113–17 Cyclone Nargis, 251 D Declaration on the Conduct of Parties in the South China Sea (DOC), 248 de-coupling theory, 101–2 de facto exchange rate regimes, 185–86 Dependency Ratio Ceilings, 97 direct bilateral statistics, trade, 113 direct trade linkages, 114–16

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Index dollar money market, 87 domestic banks, foreign ownership in, 39 domestic demand-driven economy, 23 domestic equity market, 83 domestic factors, inflation, 126, 128 domestic financial market, 224 domestic financial reforms, 150, 153, 166, 170 in Asian economies, 150 trends of, 151 Vietnam, 143 domestic macroeconomic policy, 6 domestic shocks, Thailand, 112 domestic structural reform, 153 dong-denominated deposits, 141 double-digit territory, 106 Durbin-Watson F test, 161 E EAS. See East Asia Finance Cooperation (EAS) East Asia, 2 liquidity crisis in, 16–19 regional economies of, 22 East Asia Finance Cooperation (EAS), 244 East Asian crisis (1997), 24 East Asian economic crisis (1997), 30 East Asian financial crisis (1997), 38 East Asian Monetary Policy, 234–35 East Asia Summit, 250, 253 ECB. See European Central Bank (ECB) Economic Blueprint’s Strategic Schedule, 4 Economic Community, 218 Economic Development Board (EDB), 90 economic growth rates in Malaysia and Singapore, 14

11 GlobalEco_Uncertainties.indd 261

261 economic recession, Vietnam, 137 Economic Review and Policy Dialogue, 228 Economic Strategies Committee (ESC), 95 Economic Transformation Plan (ETP), 58 economy of Singapore, 78, 94, 102 of Thailand, 106–7 of Vietnam, 124–25 EDB. See Economic Development Board (EDB) Efficient financial market, 230 ELDMB. See Executive Level Decision Making Body (ELDMB) EMI initiative. See Energy Market Integration (EMI) initiative Employees’ Provident Fund, 65 Employment Pass, 97 employment subsidization programme, 90 “Energy Blue Print”, 250 Energy Market Integration (EMI) initiative, 250 energy, non-financial risks, 249–50 “Energy Road Map”, 250 ESC. See Economic Strategies Committee (ESC) ETP. See Economic Transformation Plan (ETP) European banks, 12, 24 European Central Bank (ECB), 1, 12–13, 17, 231 European Commission, 16 European financial markets, 14 European Monetary Integration, 239 European Union, 83, 117, 236 eurozone equity shock, 14–15 financial crisis in, 13, 16

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262 financial markets, 16 financial system, 2 eurozone banks cross-border claims of, 43, 47 in Indonesia, 47 lending, cross-border lending of, 47 exchange rate index, 187 exchange rate policies, 136, 138 in Asia, 183–87 Exchange Rate Restriction of the IMF, 224 exchange rates adjustment, negative immediate effects of, 205 arrangements, 185 co-movements of, 187 inflexibility of, 134 Vietnam, 129–33 Executive Level Decision Making Body (ELDMB), 227 expansionary fiscal policy, 196, 202 expansionary macroeconomic policies, 198 Chinese yuan revaluation with, 193–97 expansionary macro policies in Asia, 202–5 foreign exchange rate adjustments with, 197–201 export-led growth strategies, 148, 183 export markets, 100–101 export-oriented policies, 175, 181, 183 export sector, Singapore, 94 exports growth in Thailand, 107, 109 external factors, inflation, 126 F FDI. See foreign direct investment (FDI) Federal Reserve, 13 financial crisis in eurozone, 13

11 GlobalEco_Uncertainties.indd 262

Index financial deepening, 157–58, 171 coefficients of, 164 correlation between current account balances and, 155 financial instability, 230 financial liberalization, pattern of, 228–29 financial openness Chinn-Ito Index of, 157, 165 degree of, 156 “financial repression taxes”, 163 financial sector policy, 156 dimensions of, 156–57 financial sector reform coefficient of, 163 core explanatory variables of, 163 database of, 156 effects of, 161 variable, 157 financial sectors impact on, 83, 86–87 measures to stabilize, 92, 94 financial stability, 230, 240 first-round linkage, 114, 116 fiscal consolidation, 65–66 fiscal policy, 59 measures in Singapore, 89–91 Vietnam, 136, 142 Five Principles of Peaceful Coexistence, 248 Fixed Effects model, 161, 163, 168 fixed exchange rate system, defence of, 219 foreign assets to GDP, ratio of, 157 foreign banks’ activities, significance and potential impacts of, 47 foreign claims, cross-border claims in, 46 foreign direct investment (FDI), 25, 30, 58, 83–84, 219 inflows of, 64

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Index foreign exchange market, 131, 140, 183, 185–87 demand-supply in, 129 foreign exchange rate, 208 adjustment policy, 200 of individual countries, 215n8 and macroeconomic policies. See macroeconomic policies, foreign exchange rate and foreign exchange rate adjustments, 176 with expansionary macro policies in Asia, 197–201 foreign investors, Bank Indonesia certificate by, 47–48 foreign ownership in domestic banks, 39 free trade agreements (FTAs), 58, 100–101 between ASEAN, 3 of Thailand, 107 G G-3 economies, end-use demand, 81 generalized impulse response functions (GIRFs), 14 GFC. See global financial crisis (GFC) GIO system. See Global Input-Output (GIO) system GIRFs. See generalized impulse response functions (GIRFs) global banking system, 51 global crisis, 103 to Singapore, 80 global economy, 77 developments of, 78 global equity markets, 83 global financial crisis (GFC), 1, 220, 243 impact of, 78–87, 148, 221 Southeast Asia after, 7–12

11 GlobalEco_Uncertainties.indd 263

263 2007/8, 39 2008/9, 7, 10, 56 Vietnam, 137 global financial market, 189–90 global financial system, 243 global financial turbulence, 22 Global Input-Output (GIO) system, 110 globalization, 102–3 globalized banking sector headwinds and recent debates, 39, 43–45 cross-border lending, 43, 46–47 participation in bond market, 47–50 historical perspectives, 38–42 global jihadist movement, 247 Global Trade Analysis Project (GTAP) model, 110, 113 global vector autoregression (GVAR) model, 13–14, 20 GMS. See Greater Mekong Sub-region (GMS) goods and services, real export of, 221 Goods and Services Tax (GST), 91 government budget balances, 157 Government Transformation Plan (GTP), 58 Great Depression, 77 Greater Mekong Sub-region (GMS), 250 Great Recession, 181 green urban solutions, 98 gross domestic product (GDP) China’s trade surplus relative to, 198 by economy, impact on, 210 export shares in, 181 growth rate of Vietnam, 124 public healthcare expenditure in, 150

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264 ratio of foreign assets to, 157 reduction of trade surplus in, 200 by region, impact on, 209 share of exports and imports in, 182 Thailand, 107–8 trade deficit relative to, 197 gross international reserves, 184 GST. See Goods and Services Tax (GST) GTAP model. See Global Trade Analysis Project (GTAP) model GTP. See Government Transformation Plan (GTP) GVAR model. See global vector autoregression (GVAR) model H heteroskedasticity-robust estimators, 161 heteroskedasticity-robust standarderror procedure, 160 human rights in ASEAN, 246 I IAEA. See International Atomic Energy Agency (IAEA) IAI. See Initiative for ASEAN Integration (IAI) IATA. See International Air Transport Association (IATA) IDE. See Institute of Developing Economies (IDE) IMF. See International Monetary Fund (IMF) imports, Singapore, 81 inadequate domestic demand, 150 independent variables, correlation matrix of, 159 Indonesia, 225 Asian economies, 47

11 GlobalEco_Uncertainties.indd 264

Index banking system, 43 current account performance of, 30 economy of, 22, 24 eurozone banks in, 47 fiscal rule, 36 IMF agreement with, 38 international bank claims to, 43–44 macro-prudential policy, 236 and Philippines, 220–21 inflation economic growth and, 133 re-accelerating, 143 in Vietnam, 125–28 inflationary pressure, 128 “initial condition” hypothesis, 164 Initiative for ASEAN Integration (IAI), 246 Institute of Developing Economies (IDE), 118 interbank exchange rate, 131, 138 inter-industry trade, 112 International Air Transport Association (IATA), 253 International Atomic Energy Agency (IAEA), 249 international bank claims across major lenders, 45 to Indonesia, 43–44 international business cycle, Thailand, 111 international economic integration, Vietnam, 143 International financial liberalization, 229–30 international macroeconomic policies, 174 International Monetary Fund (IMF), 2, 16–18, 185, 191, 220 agreement with Indonesia, 38 de-linked portion, 227 international prices, 133

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Index international production networks, 119 development of, 114 international reserves, surpluses of, 224 international trade statistics, 191 Thailand, 107–8, 110, 118–20 international trading system, 205 intra-ASEAN trade, 3 intra-Asian trade, decline in, 81 intra-industry trade, 112 investment and commodity price factors, 31–35 effects on, 166–71 J Japan, 225 growth of, 57 macro-prudential policy, 236 Japan Center for International Exchange, 253 Japan Credit Rating Agency Ltd. (JCR), 52 JCS. See Jobs Credit Scheme (JCS) Jemaah Islamiyah, 247 Jobs Credit Scheme (JCS), 90 Joint Communiqué, 246 K Keynesian theory, 189 Korea, 225 macro-prudential policy, 236 L labour market, impact on Singapore, 87–88 labour productivity growth by region, impact on, 207, 212 Latin American economies, 47 life cycle permanent income hypothesis, 165

11 GlobalEco_Uncertainties.indd 265

265 Likelihood-Ratio (LR) test, 161 local-currency bond markets, 220 LR test. See Likelihood-Ratio (LR) test M Maastricht Treaty, 36 macroeconomic indicators of Malaysia, 2008–13, 60 macroeconomic instability, Vietnam, 133–37 policy responses to, 140–43 macroeconomic performance, Vietnam, 124–33 macroeconomic policies foreign exchange rate and, 192–93 Chinese yuan revaluation with expansionary macroeconomic policies, 193–97 domestic demand in Asia and savings in United States, 205–13 expansionary macro policies in Asia and restrictive policies in United States, 202–5 foreign exchange rate adjustments with expansionary macro policies in Asia, 197–201 management, 230 Vietnam, 144 macroeconomic stability, 240 macro-prudential policy, 229 in ASEAN and ASEAN+3, 236–38 and monetary policy, 231–35 Malaysia bilateral currency swap agreements with, ASEAN, 19 currency reform of, 186 drivers of growth in, 62 economic growth rates in, 14, 56

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266 economic performance 2008–13, 59–65 employment, sector share in, 70 free trade agreements (FTAs), 71 GDP, sector share in, 69 macro-prudential policy, 236 open economy, 58 policy responses to global uncertainties, 57–59 Malaysian firms, 68 manufacturing sector, 98 of Singapore, 81 MAS Electronic Payment System (MEPS+), 94 MAS Exchange Rate Policy, 92–93 maximum likelihood estimation (MLE), 161, 170 Maybank, 64 MEPS+. See MAS Electronic Payment System (MEPS+) missing-variable regressions, 161 MLE. See maximum likelihood estimation (MLE) monetary authorities, 1 monetary policy, 229 framework, 185 GFC, 10 macro-prudential policy and, 231–38 measures in Singapore, 91–92 Vietnam, 134 month-on-month inflation, Vietnam, 126 multistage production process, 111 Myanmar, 248 ASEAN’s role in, 246 disaster management in, 252 human rights in ASEAN, 246 N National Assembly, 126 national budget (2013), 50

11 GlobalEco_Uncertainties.indd 266

Index national investment equation estimates of, 168 parameter estimates of, 169 National Productivity and Continuing Education Council (NPCEC), 97 National Productivity Fund (NPF), 97 national savings effects on, 166–71 equation, parameter estimates of, 167 natural disaster, non-financial risks, 250–52 NEER. See nominal effective exchange rate (NEER) NEM. See New Economic Model (NEM) net foreign assets, 155 coefficients of, 164 net government spending, coefficients of, 168 New Economic Model (NEM), 58 NFPEs. See non-financial public enterprises (NFPEs) NODX. See non-oil domestic exports (NODX) nominal effective exchange rate (NEER), 187 policy, 92 non-financial public enterprises (NFPEs), 65 non-oil and gas, exports and imports, 32, 34 non-oil domestic exports (NODX), 81–82 Non-Proliferation Treaty (NPT), 249 non-resource-based manufacturing sector, 68 “noodle bowl” of bilateral swap agreements, 19 NPCEC. See National Productivity and Continuing Education Council (NPCEC)

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Index NPF. See National Productivity Fund (NPF) NPT. See Non-Proliferation Treaty (NPT) Nuclear Weapons Free Zone (SEANWFZ) Treaty, 248–49 O ODEP. See old population dependency ratio (ODEP) OECD. See Organisation for Economic Co-operation and Development (OECD) oil and gas, exports and imports, 32, 35 old population dependency ratio (ODEP), 170 coefficients of, 164, 168 OLS. See ordinary least squares (OLS) open-market transactions, repo rate for, 140 OPR. See overnight policy rate (OPR) ordinary least squares (OLS), 165 estimation, 158 Organisation for Economic Cooperation and Development (OECD), 112 output-multiplier effect, 118 overnight policy rate (OPR), 57, 73n1 Oxford Economics Global Model, 118 P payment performance, balance of, 25–31 People’s Republic of China (PRC) and India, 3, 10 Petroleum Security Agreement, 249 Philippines Indonesia and, 220–21 macro-prudential policy, 236 PMETs, 90 policy interest rates in Vietnam, 134–35

11 GlobalEco_Uncertainties.indd 267

267 policymakers, 16, 89, 92, 97, 99 policymaking process, Vietnam, 134 population in Singapore, 95 portfolio allocation efficiency, 205 portfolio investment within ASEAN, 219 price controls, Vietnam, 136 primary commodities, world prices of, 191 private bond market, 221 private consumption’s contribution to growth, 66–68 private investment indicators, 62–63 Productivity and Innovation Credit, 97 property developers, implications for, 87 property market, 83, 87, 91 property tax, 91 public healthcare expenditure in GDP, 150 public healthcare spending, trends of, 152 Q quantitative easing measures (QE3), 50 by central banks, 53–54 R random effect, LR test for, 161 Random Effects model, 161, 165, 168, 170 Rating and Investment Information Inc. (R&I), 51n1 real effective exchange rate (REER), 59, 61, 187 real sector, impact on Singapore, 80–85 REER. See real effective exchange rate (REER) regional economic integration, risks from, 4–7

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268 regional exchange rate adjustments, 200 regional financial integration, 229 regional financial safety net, 229 relative income, 155 repo rate for open-market transactions, 140 Republic of Korea, 18, 172n1 reserve requirement ratio (RRR), 137 Resilience Package, 89–90 Resolution 11, 133, 141–42, 145 resource allocation efficiency, 205 restrictive policies in United States, 202–5 return on equity, 38, 42 R&I. See Rating and Investment Information Inc. (R&I) RICH, 222, 239 RRR. See reserve requirement ratio (RRR) S SARS. See Severe Acute Respiratory Syndrome (SARS) SBV. See State Bank of Vietnam’s (SBV) SEAN Regional Forum (ARF), 249, 251 Security Community, 3 self-insurance system, 225 Severe Acute Respiratory Syndrome (SARS), 252 Singapore, 248 bilateral currency swap agreements with, ASEAN, 19 capital market, 83 dollar money market, 87 Economic Development Board (EDB), 90 economy of, 14, 78, 80, 83, 94, 102 export markets, 100–101 export sector, 94

11 GlobalEco_Uncertainties.indd 268

Index financial and banking sectors, 83, 86–87, 92, 94 financial system, 92 fiscal and monetary policy measures, 78 fiscal policy measures in, 89–91 focusing on sectors of growth, 98–99 foreign direct investment, 83–84 free trade agreements, 100–101 GDP growth rate, 79 global crisis to, 80 global financial crisis impact on, 78–87 government of, 91–92 imports, 81 indicators on banking sector, 81 labour market impact, 87–88 labour productivity by industry, 96 manufacturing sector of, 81 monetary policy measures, 91–92 policy response to 2008 GFC, 87, 89 population in, 95 property market, 83, 87 real sector impact on, 80–85 re-balance growth strategies, 94–101 recession, 78 Straits Times Index and Trends in Currency (SGD) Movement, 86 total factor productivity, 95–97 tourism growth, 83, 85 trade, 81, 83 trade hub, 83 transmission of global crisis to, 80 unemployment rate in, 88 Singaporean macro-prudential policy, 236 Singapore Tourism Board (STB), 100 Skills Programme for Upgrading and Resilience (SPUR), 90

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Index small and medium enterprises (SMEs), 141, 156 social protection policies, effects of, 161 social safety net, 156 core explanatory variables of, 163 expenditure, 150 financial reform and expenditure on, 170 public expenditure on, 153 social safety net spending coefficient of, 163, 170 effects of, 153 Socio-Cultural Community, 3 SOEs. See state-owned enterprises (SOEs) SOMTC Work Programme, 247 sophisticated financial system, 155 South China Sea, ASEAN and, 248 Southeast Asia after global financial crisis (GFC), 7–12 communicable diseases in, 252 economies, 38 manufacturing industries hub in, 114 regional economies of, 22 sovereign bond, holdings of, 47–48 S Pass holders, 97 Special Risk-Sharing Initiative (SRI), 90–91 SPUR. See Skills Programme for Upgrading and Resilience (SPUR) SRI. See Special Risk-Sharing Initiative (SRI) stabilization policy of Thailand, 106 stable financial system, 230 “stages of development” hypothesis, 164 State Bank of Vietnam’s (SBV), 129, 131, 136

11 GlobalEco_Uncertainties.indd 269

269 state-owned enterprises (SOEs), 136 Statistical Review of World Energy 2013, 50 STB. See Singapore Tourism Board (STB) stochastic error term, 160 stock market, 83 stock market capitalization, 221 structural trade balance deficit investment and commodity price factors, 31–35 subsidy policy distortion to trade performance, 32, 36–37 structural VAR approach, 118 stylized models for macro-prudential policies, 238 subsidy breakdowns in 2012, 36 supplementary fiscal stimulus, 202 swap arrangement facility, 227 swap arrangements under CMI (2008), 226 T TAC. See Treaty of Amity and Cooperation in Southeast Asia (TAC) TAGP. See Trans-ASEAN Gas Pipeline (TAGP) Tanaka, Hitoshi, 253 target-based comprehensive policymaking process, 137 Taylor-type rule, 189 terms of trade (TOT), volatility of, 158, 161, 165 terrorism in Southeast Asia, 246–47 TFP. See total factor productivity (TFP) Thailand during AFC, 18 Asian financial crisis (AFC), 18 bilateral currency swap agreements with, ASEAN, 19

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270 dependency/diversification, 118–20 domestic shocks, 112 economy of, 106–7 export growth, 107, 109 free trade agreements (FTAs) of, 107 GDP growth, 107–8 idiosyncratic shock occurring in, 6 international business cycle, 111 international trade, 107–8, 110, 118–20 pattern of trade exposures to, 119 stabilization policy of, 106 total trade linkages measures, 113–18 trade relations, 114 Thailand-Australia FTA, 107 13th ASEAN Summit (2007), 3 Tier-I capital, 78 TOT. See terms of trade (TOT) total factor productivity (TFP), 95–97 total trade linkages, Thailand, 113–18 tourism sector, 99–100 trade exposures to Thailand, pattern of, 119 financing schemes, 91 globalization of, 102 linkages, patterns in, 117–18 policy, Vietnam, 136 Singapore, 81, 83 types of, 112 volatility of, 155 trade balance, 33 in ASEAN-5 and developed countries, 195, 201 in Asia, 193–94, 199 trade hub, 98–99 Singapore, 83 trade openness coefficients of, 166 trade volatility and, 171

11 GlobalEco_Uncertainties.indd 270

Index traditional global banks, 51 Trans-ASEAN Gas Pipeline (TAGP), 249 transnational organized crime, 246–47 transport hub, Singapore, 98–99 Treaty of Amity and Cooperation in Southeast Asia (TAC), 248 U Ui-chun, Park, 249 UNCLOS. See UN Convention on the Law of the Sea (UNCLOS) unconventional monetary policy, 1 UN Convention on the Law of the Sea (UNCLOS), 248 unemployment rates, 208 by region, impact on, 206, 211 in Singapore, 88 United Nations (UN) Comtrade database, 191 United States account deficits of, 177 economies of, 1, 95 financial crisis in, 174 housing market, sub-prime crisis, 77 improving trade balances in, 198 restrictive policies in, 202–5 savings in, 205–13 trade deficits in, 175, 200 US Federal Reserve, 1 V Vietnam, 248 agricultural business in, 141 balance of payments, 128–29 capital flows in, 137 domestic financial reforms, 143 economic downturn and stimulus package implementation, 137–39 economic growth, 124–25

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Index economic recession, 137 exchange rate, 129–33 fiscal policy, 136, 142 fiscal stimulus package in 2009, 138–39 global financial crisis (GFC), 137 gross domestic product (GDP), growth rate of, 124 inflation, 125–28 international economic integration, 143 macroeconomic instability, 133–37 macroeconomic performance, 124–33 macroeconomic policies, 144 macroeconomic stabilization, 144 monetary policy, 134 month-on-month inflation, 126 policy interest rates in, 134–35 policymaking process, 134 price controls in, 136 trade policy in, 136 year-on-year inflation rate, 126–28 VND/USD exchange rate, 129–33 W Wang, Xinsheng, 247 WDI dataset. See World Development Indicators (WDI) dataset

11 GlobalEco_Uncertainties.indd 271

271 weapons of mass destruction (WMD), proliferation of, 248–49 Western financial systems, 78 WHO. See World Health Organization (WHO) WIS. See Workfare Income Supplement (WIS) WMD. See weapons of mass destruction (WMD) Workfare Income Supplement (WIS), 90 Work Permit, 97 World Development Indicators (WDI) dataset, 161 World Health Organization (WHO), 253 World Trade Organization (WTO), 59, 100, 123 Y YDEP. See young population dependency ratio (YDEP) yield-driven marketing approach, 100 young population dependency ratio (YDEP), 170 coefficients of, 164 Z Zone of Peace, Freedom and Neutrality (ZOPFAN), 248–49

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