Mr. Chairman and distinguished participants,
It is a privilege to be associated with the
deliberations on Asian Integration. Singapore very vividly signifies both the
diversity and potential for prosperity of the Asian region. We deeply appreciate
the hospitality and excellent arrangements made by the IMF and MAS for this
High Level Seminar. The discussion paper circulated by the MAS is of high quality
and is a very useful document. This session is devoted to subjects of special
interest to Central Banks, namely "Enhancing Regional Surveillance and
Monetary Co-operation in Asia". I intend focusing on one of the topics
flagged for discussion in this session by the organizers, namely "Is there
scope for co-operation or co-ordination on exchange rate policies over the long
term?"
2. In this brief presentation, I propose
to explore the following areas : First, changing dynamics of exchange rate regimes
in Asia; second, importance of the Asian economies for global prosperity and
stability; third, the Asian dynamics of financial integration, fourth, the scope
for co-operation or co-ordination on exchange rate policies; and finally, some
thoughts specific to the Indian situation.
Changing dynamics of exchange rate regimes in
Asia
3. In the period prior to the 1997 crisis,
many of the Asian economies followed an exchange rate regime of fixed but adjustable
pegs. During the East Asian crisis, it was realized that such pegs were quite
vulnerable to speculative attacks. Several East Asian economies have adopted
different types of exchange rate regimes in the post- crisis period. While some
countries continued with pegged regimes, others moved over to some kind of managed
floats.
4. Thus, it appears that in most economies
of Asia, the weight of experience seems to be tilted in favour of intermediate
regimes, and post-crisis, the choice of the exchange rate regimes generally
reveals a growing preference for relatively more flexible exchange rates than
before. In this regard, given the current state of relatively benign international
financial market conditions, it is possible to speculate that as the comfort
level of forex reserves as self insurance is reached, and institutions and financial
markets in Asian economies acquire further resilience, this shift in preference
might grow stronger and wider. The recent moves by the Chinese and the Malaysian
authorities would only substantiate such a notion.
5. An intermediate managed floating regime
may not sound technically a perfect system but, prima facie, it
has proven to be the most pragmatic which explains its popularity. The built-in
flexibility allows the domestic currency to be responsive to market forces,
while it meets the concern of the authorities for ‘basic stability’ and orderly
movement in forex markets. In contrast to a pure float, this mechanism can prevent
excessive exchange rate volatility that can have adverse impacts on external
trade and investment. In other words, rather than being distracted by a quest
for the ‘perfect system’, perhaps it is wise to focus on improving the working
of any given float regime. The real issue in this regard relates to how much
of a float is envisaged and the nature, magnitudes as well as instruments of
its management. These would depend on several factors, especially the changing
contours between flexibility and volatility in each economy.
6. The recent record of very impressive growth
in Asia has been driven by trade and cross-border investment flows. The rapid
strides achieved by China have provided a powerful stimulus for regional expansion.
But it is the nature of trade flows as much as their impressive scale that is
shaping economic relationships and prospects. While much of this trade involves
production of goods, still ultimately destined for the North American and European
markets, it also reflects an increased division of labour, product specialization
and integration within the region. Together with this, fundamental shifts in
economic relations are also taking place.
7. Many of the intra-Asia trade flows, which
correspond to the international division of labour between Asian countries,
are flows of exports of components and spares but not of finished goods for
their end consumers. A crucial question for some countries in the region is
the level of income that would enable domestic demand to become the main driving
force of growth. As domestic demand, notably household sector demand, becomes
the driver of growth, movement to a more flexible exchange rate policy would
be feasible.
8. Similarly, as the corporates as well as
financial intermediaries, especially banks equip themselves to manage movements
in exchange rate, greater flexibility would be feasible, as forex markets also
would tend to become less volatile. It is also necessary in this regard to recognize
the ‘insurance’ in the form of foreign exchange reserves needed against potentially
volatile capital flows which should be sufficient to take care of fluctuations
in capital flows and ‘liquidity at risk’. It is generally felt that reserves
would act as a circuit breaker for situations when unidirectional expectations
become self-fulfilling. The swap arrangements among the Central Banks such as
the one under Chiang Mai Initiative (CMI) add to the level of ‘insurance’ and
hence to the comfort factor to the Central Banks in dealing with excess volatility
in capital flows.
9. Recently there has been considerable expansion
in global liquidity but this should not dilute the vigil of policy makers in
regard to volatility in capital flows. Very often, it is difficult to assess,
ex ante, whether capital flows are temporary or permanent. It
is prudent for policy makers to assume that they are reversible till they are
proven to be enduring. Impact on real economy of significant reverse movements
over a relatively short period could be destabilizing with attendant serious
welfare implications. We in Asia are acutely aware of these aspects. Recent
sharp upward movements in oil prices in an era of heightened uncertainties is
yet another reason for policy makers in Asia to be vigilant. The hikes in oil
prices tend to have adverse consequences for growth and prices in several of
our economies but they also have significant impact on external sector, encompassing
both current and capital accounts. On current account, the trade deficit will
tend to widen. On capital account, surpluses generated in oil exporting countries
may add to global liquidity and lead to large capital inflows to emerging markets
that are net importers of oil. Hence, a careful assessment of the medium term
sustainability would be imperative.
10. Over the medium to longer term, the exchange
rate regimes and related policies are likely to be influenced by (a) the confidence
in the strength of Asian economies; (b) perceived resilience of their economic
as well as financial systems; (c) growing economic and financial integration
amongst Asian economies; (d) emerging significance of Asian economies in the
global economy; (e) the state of international financial architecture and market
conditions and (f) policy-induced measures for co-operation and co-ordination
amongst Asian economies.
Importance of Asian economies and policies
11. The fact that the Asian economies have
recovered swiftly after the crises of 1997 is an important consideration in
viewing the future external developments. The growth rate of developing Asia,
which had plummeted to 4.2 per cent in 1998, recovered quickly to 6.2 per cent
in 1999, rising further to 6.6 per cent in the year 2000. In the more recent
period, the recovery in the output of the Asian economies has been robust with
developing Asia growing by nearly 8 per cent in 2003 and 2004. It is widely
recognized that the contribution of Asia to global growth has generally been
very impressive in recent years, and may continue to be so, for several years
in future. The current account on the balance of payments has been in surplus
for many if not all Asian economies. The private capital flows to the emerging
Asia have recovered from an outflow of US $ 52 billion in 1998 to an inflow
of US $ 151 billion in 2004. At the same time, the reserve build up in the region
has been significant.
12. In the backdrop of the resilience of
the Asian economies and their ability to bounce back after a deep financial
crisis, there is resurgence of confidence in their future. Strategies in the
form of having mutual swap agreements under the Chiang Mai initiative, to guard
against speculative attacks, could now be enlarged, and could also be supplemented
by greater co-operation and co-ordination in the exchange rate regimes and policies.
13. Indeed, from a longer-term perspective,
we must note that Asia is appropriately poised in terms of abundance in factors
of production – labour and capital – particularly labour, as the demography
is clearly in favour of Asia to sustain a long- term growth. The emergence of
surplus factors of production in Asia combined with financial strength would
impact prices, wages and exchange rates. Asian economies could explore strategies
to evolve a system whereby they could not only prevent and, if necessary, manage
financial crises on their own to the extent possible, but also play a more active
role in co-ordinating policies with other major developed economies. These arrangements
could be consistent with continued and an active role of IMF in international
monetary cooperation.
14. It is useful to recall that the acute
sense of interdependence aroused by the financial "contagion" in 1997
convinced the Asian economies of the importance of economic cooperation, one
that reflected their common interests and priorities as well as strengthened
their voice in the global arena. Among others, this led to two parallel movements
– one in South Asia in the form of the SAARC Initiative and the other in East
Asia reflecting the ASEAN+3 Initiative.
15. The idea of having an integrated financial
system so as to provide viable ‘safety net’ in times of crisis germinated. As
a result, the idea of "ASEAN + 3" Initiative gained prominence. This,
in turn, was reflected in two correlated developments. First, in 2000, ASEAN+3
countries mutually agreed to form a network of bilateral swap agreements to
provide mutual protection from financial emergencies, popularly known as the
Chiang Mai Initiative. More recently, there has been a resurgence in the debate
on the formation of an Asian Monetary Fund and the adoption of an Asian Currency
Unit. Concomitantly, reflecting the parallel developments under the ASEAN+3
Initiative, there has been wider discussion and debate on the formation of a
South Asian Economic Union and a South Asian Development Bank. Second, the Asian
Bond Fund Initiative was launched in 2003 reflecting the effort to develop a
regional bond market for catering to the medium and long term financing needs
of the Asian economies.
Asian dynamics of financial integration
16. It is useful to recognize that, there
are several important factors that are relevant for considering greater financial
integration in Asia. First, the wide diversity in the level of economic development
across the region. Second, the divergent level of financial sector development
across the region. Third, the limited scope of the existing intra-region resource-pooling
mechanism and the lack of institutional frameworks. Fourth, the presence of
asynchronous business cycles amongst the countries in the region. Such divergences
are aptly reflected in the asymmetric transmission of demand and monetary shocks
in the region.
17. There are significant developments that
point to emergence of enabling factors for strengthening of economic integration
in Asia. First, emerging Asia fares quite well in terms of factor mobility and
wage and price flexibility. Second, the trade intensity ratios in emerging Asia,
particularly the ASEAN region, are quite high and are likely to accelerate.
Further, Foreign Direct Investment flows within the region are significant.
Third, tariffs are being brought down rapidly. Fourth, the free trade agreements
are expanding and deepening making the prospects of tariff-free and virtual
trade integration in Asia sooner than later. Fifth, there is a strong commitment
of political leadership in Asia to focus on economic issues. There are regular
and frequent close interactions among Central Bank Governors in Asia which should
strengthen the process of cooperation.
Scope for co-operation and co-ordination
18. The Chiang Mai Initiative is a good starting
point to build on the various existing initiatives. Although under the present
dispensation the CMI is complementary to similar IMF initiatives, it has an
important symbolic value in as much as it can signal the markets a regional
commitment to supporting any member country’s currency that is under speculative
pressures. It also recognizes that establishing swap arrangements does not obviate
the need to address structural and financial sector weaknesses. It may also
be added that while CMI might have contributed to the exchange rate stability
in the region, it has also contributed to closer regional economic and financial
integration and co-operation. It is useful to discuss ways of carrying this
process forward.
19. There are several fora already established
for regional monetary cooperation. The Asian Clearing Union (ACU), which was
established in 1974 at the initiative of the Economic and Social Commission
for Asia and Pacific (ESCAP) has eight member central banks. The main objective
of the ACU is to provide a facility to settle current international transactions
among members on multilateral net settlement basis. The ACU mechanism also provides
for a currency swap type mechanism amongst members for trade transactions. ACU
aims to promote monetary co-operation amongst the members and has also resulted
in closer relations across the banking systems of the member countries. During
the last few years trade settled through ACU mechanism has grown at a rate higher
than that of total international trade of the member countries.
20. Yet another forum for exchange of views
and experiences, including through visits and training programmes, is SAARCFINANCE.
Areas covered in recent months include communication policies and practices
of Central Banks and Real Time Gross Settlement systems.
21. The recent policy shift in China from
a pegged to a flexible exchange rate regime is a significant development in
international finance. This step is a watershed in the financial sector reform
process now underway in China. Going by the available indications, China has
long-term plans for development of deep and liquid markets in financial assets,
which would encompass foreign exchange, bonds, and equities, as also commodities.
Some thoughts on India’s approach
22. It may be useful to recall our experience
with exchange rate management in India. In September 1975, the Government of
India proposed a system of determining the exchange rate based on a basket of
five currencies, with weighting, based essentially though not entirely, on trade
weights. The permissible range for the exchange rate was 2.25 per cent on either
side. The currencies chosen were US Dollar, Pound Sterling, Deutsche Mark, Japanese
Yen and SDR. The weights were revised in 1979, 1983 and 1984, though the currency
composition broadly remained the same with only one change in 1984 when French
Franc replaced SDR. The band, however, was extended from 2.25 to 5.0 per cent
in 1979 and from 5 to 10 per cent in 1986. Soon after the devaluation of the
rupee in July 1991, there was a move in March 1992 to a regime of partial convertibility
(essentially a dual exchange rate). In March 1993 the regime changed to a uniform
exchange rate of the rupee which was market-determined – a system which remains
in place to date. In August 1994, India moved over to current account convertibility.
From the latter part of 1997, India moved to a cautious and well calibrated
move towards capital account convertibility. These developments tested the exchange
rate regime which proved conducive to growth while maintaining stability.
23. India has been actively participating
in the various initiatives in SAARCFINANCE and ACU arrangements. Exchange of
views and co-ordination in policies through both formal and informal mechanisms
have been the main characteristics of co-operation. India’s trade links with
Asia are growing at an unprecedented scale. The stated policy in regard to tariffs
is to bring them on par with those of East Asia as soon as feasible. Policy
on Free Trade Agreements with countries in Asia, including SAPTA point to the
binding forces of greater integration of India into Asia. Launching of negotiations
of Free Trade Agreements between ASEAN and India is of historic significance
for carrying forward Asian Integration.
24. As part of our policy of communication
and to aid researchers and analysts the Reserve Bank of India has been constructing
a five-country and 36-country indices for Nominal Effective Exchange Rate (NEER)
and Real Effective Exchange Rate (REER). We have decided to review the REER
and accordingly we expect a new six-country index to replace the present five-country
one. The new index is likely to include the U.S.A., Eurozone, the U.K., Japan,
China and Hong Kong. The new index would in that case have two new currencies,
both Asian, namely, the Renminbi and the Hong Kong Dollar. The 36-country index
already includes the key Asian countries, but its review is likely to result
in some enhancement of their weights. This reflects an increasing recognition
of the Indian economy’s rapidly growing integration with Asia.
Speech by Dr. Y.V. Reddy, Governor, Reserve
Bank of India at the IMF-MAS High-Level Seminar on Asian Integration held on
September 3, 2005 at Singapore
|