Towards regional monetary cooperation in East Asia: lessons from other parts of the world

INTERNATIONAL JOURNAL OF FINANCE AND ECONOMICS

Int. J. Fin. Econ. 10: 97–116 (2005)

Published online in Wiley InterScience (www.interscience.wiley.com). DOI: 10.1002/ijfe.267

TOWARDS REGIONAL MONETARY COOPERATION IN EASTASIA: LESSONS FROM OTHER PARTS OF THE WORLD

MASAHIRO KAWAIa and SHINJI TAKAGIb,*,y

aUniversity of Tokyo, JapanbOsaka University, Japan

ABSTRACT

This paper discusses regional monetary cooperation for East Asia, by drawing lessons from the European PaymentsUnion, the CFA Franc Zone and the Arab Monetary Fund. Along with the well-known experience of the EuropeanMonetary System, these experiences suggest that effective monetary cooperation should include: (1) a surveillancemechanism; (2) a regional financing facility; (3) a common unit of account; and (4) exchange rate coordination. In EastAsia, the existing mechanisms of regional surveillance must be strengthened, and the liquidity support mechanismunder the Chiang Mai Initiative must evolve into a common pool of foreign exchange reserves. Over the longer term,the region may need to create its own common unit of account and to develop a framework for exchange ratecoordination. Copyright # 2005 John Wiley & Sons, Ltd.

JEL CODE: F02; F33

KEY WORDS: East Asian regional monetary cooperation; European Payments Union; CFA Franc Zone; Arab MonetaryFund; exchange rate coordination; regional surveillance; Chiang Mai Initiative

NON-TECHNICAL SUMMARY

This paper discusses regional monetary cooperation for East Asia, by drawing lessons from the EuropeanPayments Union, the CFA Franc Zone (as it existed largely through 1998) and the Arab Monetary Fund.Along with the well-known experience of the European Monetary System, these experiences suggest that,while monetary cooperation may take different forms, an effective modality must include: (1) a regionalfinancing facility; (2) a surveillance mechanism; (3) a common unit of account; and (4) exchange ratecoordination. To be successful, financial resources must be sufficiently large, with a credible surveillancemechanism, to provide the ‘right’ mix of financing and adjustment, and there must be a commitment to themarket principle that safeguards the progress of regional integration from distortions.

Regional monetary cooperation in East Asia is still in its infancy. Institutions and formal frameworkshave not yet progressed in a way commensurate with the degree of real economic integration. There are alsochallenges that arise from the region’s economic diversity, lack of political leadership, ‘consensus’ cultureand economic openness. Nonetheless, some steps have been taken in the area of liquidity provision throughthe Chiang Mai Initiative (CMI)}bilateral swap arrangements among the ASEANþ 3 countries}and thecreation of several mechanisms for information-sharing, policy dialogue and surveillance. However, theregion has yet to take a more visible step towards the creation of a common unit of account and exchangerate stabilization.

Copyright # 2005 John Wiley & Sons, Ltd.

*Correspondence to: Shinji Takagi, Independent Evaluation Office, International Monetary Fund, 700 19th Street N.W., Washington,DC 20431, USA.yE-mail: [email protected]

In moving forward, monetary cooperation must be strengthened in several respects. First, the liquiditysupport mechanism under the CMI must be multilateralized and evolve into a common pool of foreignexchange reserves. Second, the existing mechanisms for surveillance must be made more effective,particularly if the CMI is to develop into an important financial facility. Surveillance must place greateremphasis on technical discussions and create an environment for serious policy dialogues by taking anappropriate balance between non-interference and peer pressure. Third, the region must create its own unitof account, be it a basket of all 13 regional currencies or a G-3 currency basket consisting of the US dollar,the euro and the yen. Finally, developing a cooperative framework for regional exchange rate stability isanother task. Several proposals have been made, including the US dollar standard, a common G-3 currencybasket system and, over a much longer term, even a monetary union.

As a modality of regional monetary cooperation for East Asia, the asymmetric CFA Franc Zone (centredon a dominant outside power) is unlikely to be a useful guide. While Europe’s more recent, symmetricmodel is appealing, East Asia’s culture may not be compatible with Europe’s legalistic and bureaucraticorientation. It may well be that East Asia needs a more market-based approach, with a greater recourse toincentives and peer pressure. Whatever form it may take, regional monetary cooperation would likely bringabout large benefits to the region, given the potential for dynamic economic growth and the availability oflarge financial resources. Strong political will and a well-defined vision are indispensable for suchendeavours.

1. INTRODUCTION

The crisis of 1997–98 highlighted the need to strengthen regional monetary cooperation in East Asia andprompted a series of monetary cooperation initiatives. This paper reviews these initiatives and considers amodality of regional monetary cooperation in East Asia by drawing lessons from the European PaymentsUnion (EPU) during 1950–58, the CFA Franc Zone during 1960–98 and the Arab Monetary Fund (AMF)during 1977–2001. In drawing lessons, we also appeal to the recent, well-known experience of the EuropeanMonetary System (EMS), where relevant.

The paper is organized as follows. The first three sections contain brief historical and organizationalsketches of the EPU (Section 2), the CFA Franc Zone (Section 3) and the AMF (Section 4). Section 5 thendiscusses rationales for regional monetary cooperation, reviews several recent initiatives in East Asia, andsuggests remaining challenges and tasks. Finally, Section 6 offers concluding remarks.

2. THE EUROPEAN PAYMENTS UNION, 1950–58

2.1. The EPU as a regional arrangement for post-war Europe

The EPU was a system of multilateral clearing, which operated under the framework of the Organizationfor European Economic Cooperation (OEEC) from mid-1950 to end-1958.1 As the first organized vehicle ofeconomic and monetary cooperation in Europe, Triffin (1966) called it ‘the main instrument through whichEuropean countries succeeded in shedding the bilateral straitjacket of the early postwar years and inrestoring, by 1958, trade liberalization and currency convertibility’. There were critics from the beginning,however. The United States Treasury and the International Monetary Fund (IMF) opposed its regionalcharacter as contrary to the principles of non-discrimination and multilateralism and its existence asundermining the authority and responsibilities of the IMF. Eichengreen (1993) has argued that, byfacilitating the clearing of trade with inconvertible currencies within Europe, the EPU unnecessarilydelayed the decision of the member countries to make their currencies convertible for current transactions.Even so, intra-European trade expanded rapidly and the region’s balance of hard currency reserves roseduring the period of the EPU.

M. KAWAI AND S. TAKAGI98

Copyright # 2005 John Wiley & Sons, Ltd. Int. J. Fin. Econ. 10: 97–116 (2005)

The end of World War II found Europe in a state of economic devastation. With the notable exception ofthe Swiss franc, European currencies were inconvertible. To conserve hard currency reserves for essentialimports from the US dollar area, European countries restricted their imports from the rest of Europe to thevalue of their receipts in each trading partner’s currency. Although bilateral trade and payment agreements(numbering over 200 by the end of 1947) did ease the situation for a time, it was evident that bilateralismwas hindering the growth of trade, hence the recovery of European economies. To rectify the situation, aseries of attempts were made from 1947 to multilateralize intra-European trade, but their effectiveness waslimited because they were a ‘superstructure’ imposed on top of bilateral agreements and often involved awrong incentive structure resulting from the tying of Marshall aid to external positions (Diebold, 1952).

To address these concerns, on September 19, 1950, the European Payments Union Agreement was signedby all 18 OEEC countries, with settlements commencing retroactively on July 1, 1950.2 The EPUAgreement included provisions designed to correct or accommodate intra-European payment imbalances.As a basis for determining the mix of adjustment and financing, the Agreement assigned each country andits monetary area a quota that was, for most countries, set equal to 15% of the sum of their payments andreceipts on trade in goods and services with all other EPU members during 1949 (Table 1). Bilateralbalances were calculated on the basis of changes in currency holdings, so that countries whose currencieswere used as media for making international settlements between third parties in fact representedtheir currency areas. Thus, the EPU effectively covered an area much larger than the geographical scope ofthe OEEC.

2.2. The operation of the EPU

The working of the system was clearly defined. First, during any given month, central banks would grantunlimited credit to each other. Second, at the end of the month, the Bank for International Settlements(BIS), acting as the Agent, would convert bilateral balances into EPU units of account (each fixed at

Table 1. European Payments Union: economic size, initial quotas and terminal positions

Contracting parties Economic size (1958) Initial quotasa

[EPU million (%)]Terminal net positionsb

(EPU million)GDP Pop. GDP/Pop.(US$million) (million) (US$)

Austria 5,260 6.99 750 70 (1.8) �61Belgium–Luxembourg 10,910 9.36 1,170 360 (9.1) �1,192Denmark 4,970 4.51 1,100 195 (4.9) �255France 57,740 44.80 1,290 520 (13.2) �2,900Germany 55,220 54.25 1,080 320 (8.1) þ 4,473Greece 3,140 8.17 380 45 (1.1) �317Iceland 400 0.17 2,370 15 (0.4) �43Italy 30,310 49.04 610 205 (5.2) �420Netherlands 9,500 11.19 850 330 (8.3) þ 557Norway 4,010 3.52 1,140 200 (5.0) �342Portugal 2,160 8.72 250 70 (1.8) �177Sweden 11,260 7.41 1,520 260 (6.6) þ 137Switzerland 7,350 5.20 1,410 250 (6.3) þ 20Turkey 5,960 26.25 230 50 (1.3) �469United Kingdom 64,910 51.80 1,250 1,060 (26.9) �1,396

Total 273,100 291.38 940 3,950 (100.0) �2,385

aEffective July 1, 1950. Of the 18 signatory countries, Ireland was included in the monetary area of the United Kingdom, Belgium andLuxembourg were assigned a quota as the Belgium–Luxembourg Economic Union and Trieste was included in the monetary area ofItaly (until reunification in October 1954), making the total number of entities in the Union 15.bCumulative net positions on December 27, 1958.

Sources: OECD, National Accounts of OECD Countries 1950–1968; IMF, International Financial Statistics 1966; OEEC (1951, 1959).

EAST ASIAN MONETARY COOPERATION 99


0.88867088 g of fine gold, or the gold content of one US dollar), and offset the resulting balancesmultilaterally. Third, the Agent would calculate each member’s cumulative net position with the Union as awhole from the beginning of the EPU, thereby determining where each country stood in relation to itsquota. Fourth, a monthly change in a member’s cumulative net position would be settled between themember and the Union partly in gold (or US dollars) and partly in credit, according to the size of the netcumulative position relative to quota.

Debtor quotas were divided into five equal segments, called tranches. A cumulative debtor in the firsttranche settled its position entirely with credit from the Union. Thereafter, it settled increasingly in gold (orUS dollars) as its cumulative position moved into successively higher tranches. Once a debtor quota wasexhausted, the country had to settle entirely in gold, unless it received a special credit at therecommendation of the Managing Board. On the other hand, while creditor quotas were identical in sizeto debtor quotas, the gold/credit ratios required for settlement rose over time at a different pace for creditorand debtor countries. Within the first tranche, cumulative surpluses were settled entirely by extending acredit to the Union. Thereafter, settlements were all made 50% in gold and 50% in credit. If a country rancumulative surpluses in excess of its quota, the Managing Board had to propose to the OEEC Council howsubsequent surpluses would be settled. The risk that the dollar reserves might be exhausted was minimizedin later years by the ‘hardening’ of the EPU. From mid-1954, the monthly settlement of cumulative netbalances was made on a uniform rate of half gold and half credit, for both creditors and debtors. FromAugust 1955, the 50/50 ratio was further changed to 75% gold and 25% credit.

An important purpose of the EPU was to induce countries to remove restrictions on trade in goods andservices within Europe, by making member currencies fully transferable into one another. Thus, along withthe EPU Agreement, a simultaneous OEEC Agreement was signed, establishing procedures for removingrestrictions on current transactions with other OEEC countries. Before the establishment of the EPU, byDecember 15, 1949, member countries had agreed to liberalize 50% of their total imports, where apercentage figure expresses the proportion of private imports not subject to quota restrictions, thecalculation being made on the basis of the value of goods in each category imported in the base year 1948(Tew, 1970). Following the establishment of the EPU, the percentage was raised to 60%, then to 75% fromFebruary 1, 1951, and to 90% from January 14, 1955 (OEEC, 1959).

The EPU Agreement also established a Managing Board, consisting of seven voting members elected toserve for a renewable term of one year. They served as individuals, not as representatives of theirgovernments. In addition, Board meetings were attended by the Chairman of the OEEC PaymentsCommittee, representatives of the OEEC Secretary General and of the BIS, and an observer appointed bythe United States government. The Board made recommendations to the OEEC Council, not directly to thegovernments. As Council decisions were made by a rule of unanimity, this meant that individualgovernments effectively had a veto power on Board decisions.

2.3. Crisis management under the EPU

The EPU Agreement established procedures designed to safeguard the country quotas from beingexhausted. If the quota of a creditor or a debtor was about to be exhausted, the OEEC was to considermeasures to correct the situation. Because the EPU Agreement did not precisely define the powers of theManaging Board, the way in which the Board performed these tasks evolved over time as experiences wereaccumulated. As it turned out, within a very short period of time, the Board established itself as a group ofcompetent and neutral financial experts and began to command respect and acceptance from the membergovernments. Over the life of the EPU, working through the OEEC Council, the Board typically extendedsupplementary credits to deficit countries that had exhausted their quotas, attached conditionality andmonitored the domestic policy developments in the debtor countries. From time to time, the ManagingBoard even proposed that deficit countries temporarily reintroduce trade restrictions.

The German crisis of 1950–51 illustrates how the Board learned to manage a crisis. Given the small initialquota of US$320 million, by the time of the very first meeting of the Managing Board in October 1950,Germany was about to exhaust its quota as a pickup in growth had led to a surge in imports. Acting on the



advice of two experts it had dispatched to Germany, on November 6, the Board agreed that Germany beprovided with a special credit, subject to the adoption of corrective policies. On December 13, given theGerman package of adjustment policies, the OEEC Council approved the Board recommendations and theextension of US$120 million to Germany. By March 1951, a dramatic turnaround in Germany’s positionwas evident. By the end of 1951, Germany completely reversed the cumulative deficit position that hadpeaked at US$457 million in February. In the words of Robert Triffin, this ‘dynamic and successfulhandling of a major crisis endowed the young Managing Board with a prestige and authority far beyond themost optimistic expectations of the promoters of the EPU Agreement’ (as quoted in Kaplan andSchleiminger, 1989).

Taking a long-term perspective, Triffin (1966) called the most significant achievement of the EPU an‘administrative’ one, as demonstrated by the ‘extraordinary degree of cohesion and influence developednearly overnight by its Managing Board’. He then ascribed that level of success achieved by the Board tothe fact that (1) it regularly brought together top national policy-makers, thus allowing national views to beexpressed in a regional forum and regional views to be expressed in national decision-making; and (2) itsdecisions were not binding, as the Board could only issue recommendations to the OEEC Council, allowingeach member to vote ‘without being sure of the concurrence of his government’. It was this combination ofexpertise and political neutrality that commanded the respect of member governments and thus contributedto the effective exercise of multilateral surveillance. With external convertibility restored, the purposes ofthe EPU had largely been fulfilled by 1958. In December of that year, the EPU was dissolved according tothe breakup provisions agreed in the summer of 1955.

3. THE CFA FRANC ZONE, 1960–98

3.1. The structure and apparatus of monetary cooperation

The CFA Franc Zone, which came into existence in the early 1960s in its broadly current form, is acommon currency area in central and western Africa. As of 1998, the zone included 14 countries, groupedinto two separate monetary unions, namely, the West African Economic and Monetary Union (UEMOA)and the Central African Economic and Monetary Union (CEMAC). Each monetary union has its owncentral bank: the Central Bank of West African States (BCEAO) and the Bank of Central African States(BEAC). Both currencies are called the CFA franc, although the initials represent different names. Theexchange rate for both monetary unions remained fixed at 50 CFA francs per French franc from October1948 to January 1994, when the CFA franc was devaluated by 50%.3 Since January 1999, with theparticipation of France in European Economic and Monetary Union (EMU), the CFA franc has beenpegged to the euro under an arrangement approved by the EU Council of Ministers.

Since the devaluation of 1994, the members of each union have made progress towards broadening theirregional cooperation to include trade, multilateral surveillance of fiscal policies, and harmonization ofinvestment and business law, with the eventual goal of establishing a common market for goods, servicesand capital (Clement et al., 1996; Fouda and Stasavage, 2000). A new mechanism of policy coordinationand surveillance has been introduced, and the role of market forces has been emphasized in the operation ofthe monetary unions. With the launch of EMU in Europe, the nature of the CFA Franc Zone’s relationshipwith France will likely change in the coming years, possibly in the direction of creating a more independentAfrican entity. In what follows, therefore, we will focus our attention on the CFA Franc Zone largely as itexisted from its earliest days to 1998.

The two principal features of the monetary arrangements in the CFA Franc Zone were: (1) the pooling offoreign exchange reserves, a portion (at least 65%) of which was held with the French Treasury; and (2) theFrench Treasury’s guarantee of convertibility of the CFA franc into French francs at a fixed parity throughthe extension of unlimited and automatic overdraft facilities (Medhora, 1992a,b). Payments and receipts inforeign currencies of each regional central bank were settled through the French Treasury. The French



Treasury paid interest on balances in its Operations Accounts, while the regional central banks paid interestto France on any overdraft balances.

The decision-making apparatus of each central bank was a two-tier system, consisting of a Board ofDirectors}represented by French and local government officials}and local monetary policy committees}located in the participating countries. The Board decided on overall monetary policy and creditallocation on the basis of local inputs, while the local committees executed the decisions at the nationallevel. In the earlier days, France exerted considerable influence on the process of monetary policy-making,in part to minimize the moral hazard aspect of the convertibility guarantee. Over the years, the influence ofFrance declined and the role of the market mechanism rose in monetary policy-making and management.

Until the late 1980s, the monetary mechanism was characterized by several features (Honohan, 1990): (1)an annual monetary programming exercise to determine the planned growth of domestic credit in eachcountry; (2) implementation of the monetary programme through credit ceilings to each government; and(3) administered interest rates. Monetary policy relied on direct instruments; lending and deposit rates werefixed, although they were gradually liberalized to harmonize with those prevailing in international markets.Preferential interest rates were applied to certain central bank credits, notably to crop credit refinancing,which was excluded from national credit ceilings, and to statutory advances. The principal instrument was arediscount ceiling, which was periodically set for each country and, in early years, even for each commercialbank within a country and for large individual borrowers. There were separate ceilings for short-term andlong-term credit (Bhatia, 1985). In the late 1980s, however, reform was initiated to increase the role ofmarket forces to minimize distortions, by replacing direct instruments with market-based ones (Clementet al., 1996; Hernandez-Cata et al., 1998).

Another aspect of monetary policy coordination concerned fiscal discipline in order to safeguard theexchange rate peg. In each region, the banking sector, including the central bank, was authorized to extendcredit to the governments up to 20% of their respective fiscal receipts of the previous year. The ceiling wasincluded in the overall credit ceilings for a member country, and the 20% limit for government borrowingincluded borrowing from virtually all domestic sources. The limit, however, did not cover externalborrowing. For this reason, the system was often criticized for creating a wrong incentive, on the part ofgovernments exceeding the deficit ceiling, to resort to foreign borrowing (Bhatia, 1982).

3.2. Economic characteristics of the CFA Franc Zone countries

The CFA Franc Zone consisted primarily of agricultural and mineral producers. Except for a fewcountries (e.g., Gabon, Congo and Senegal), the share of agriculture in GDP was high, ranging between28% and 55% recently (see Table 2). The countries, however, differed widely in other respects. In terms ofeconomic size, the zone was dominated by Cote d’Ivoire and Senegal}39% and 19%, respectively, ofUEMOA GDP}and Cameroon and Gabon}48% and 26%, respectively, of CEMAC GDP. The percapita GDP of the richest country, Gabon, at US$3180 (in 2000), was almost 20 times larger than that ofthe poorest country, Niger. In 2000, all but two were still classified by the World Bank as being ‘lowincome’ countries, the exceptions being Equatorial Guinea and Gabon. Over the years, the countriesincreased openness to international trade, with the ratio of trade (exports plus imports) to GDP reaching arange of 34–124%.

As predominant producers and exporters of mineral and agricultural products, the countries shared acommon structure of trade, mainly trading with industrial countries. Consequently, and owing additionallyto poor regional transportation facilities, relatively little intra-regional trade took place. During 1970–93,for example, intra-regional trade accounted for 10.7% of total external trade in the UEMOA, 6.5% in theCEMAC, and 8.9% in the total CFA Franc Zone, compared with over 60% for the European Union(Bayoumi and Ostry, 1997). Moreover, these figures may well have overestimated the true importance ofintra-regional trade, as they included the entrepot trade of land-locked countries (Boughton, 1991).Although its share declined significantly over the years (from over 60% in the 1960s), France remained themost important trading partner for almost all CFA franc countries. For the zone as a whole, during 1981–95, France accounted for about 21% of total exports, and 35% of imports (Hadjimichael and Galy, 1997).



Table2.Economic

characteristics

oftheCFA

FrancZonecountries,2000

Countries

Yearjoined

Economic

size

Economic

structure

Tradeopenness

(%ofGDP)

Domesticbankcredit

(%ofGDP)

GDPa

Pop.

GDP/Pop.

Agr

Ind

Ser

(US$million)

(million)

(US$)

(%ofGDP)

(1)WestAfricanEconomic

andMonetary

Union(U

EMOA)

Benin

1962

2,262

6.170

367

37

14

49

44.2

8.4

BurkinaFaso

1962

2,406

11.540

208

31

28

40

38.7

15.4

Cote

d’Ivoire

1962

9,319

16.400

568

28

29

43

74.4

25.8

Guinea-Bissau

1997

221

1.207

180

}}

}55.2

17.7

Mali

1984

2,345

11.350

207

45

17

38

51.2

14.7

Niger

1962

1,861

10.830

172

41

17

42

41.4

8.9

Senegal

1962

4,372

9.520

459

18

26

56

59.2

25.1

Togo

1963

1,281

4.530

283

41

21

38

63.2

22.6

(2)CentralAfricanEconomic

andMonetary

Union(C

EMAC)

Cameroon

1960

8,687

14.880

584

44

19

38

37.4

16.7

CentralAfricanRep

1960

959

3.720

258

55

20

25

34.4

11.5

Chad

1960

1,408

7.890

178

36

15

49

39.1

12.1

Congo,Rep.of

1960

2,689

3.020

890

10

49

41

123.8

10.4

EquatorialGuinea

1985

516

0.454

1,170

}}

}88.2

9.5

Gabon

1960

3,928

1.237

3,180

}}

}105.1

16.2

aTheGDPsforGuinea

Bissau,EquatorialGuinea

andGabonare

gross

nationalincomes.

Sources:WorldBank,WorldBankDevelopmentReport

2002:BuildingInstitutionsforMarkets(2002);IM

F,InternationalFinancialStatistics,March2002.



On the other hand, there was a high degree of diversity in production structure. First, predominantexport products ranged from coffee (Cote d’Ivoire and the Central African Republic), cocoa (Cote d’Ivoire)and cotton (Chad, Mali, Benin and Burkina Faso) to petroleum (Cameroon, Congo, Gabon andEquatorial Guinea), phosphate (Togo) and uranium (Niger). As a result, terms of trade shocks affectedcountries differently. For 1964–87, Bayoumi and Ostry (1997) found that real shocks were large and for themost part uncorrelated across countries. Second, the markets for goods and services, capital and labourwere not well integrated, with limited wage and price flexibility. For this reason, different inflationary andstructural pressures often emerged, creating tensions between the constraints of a common external peg andthe need for country-specific adjustment (Bhatia, 1982; Fouda and Stasavage, 2000). Devarajan (1997)identified a significant divergence in real exchange rates across countries on the eve of the 1994 devaluation,ranging from the undervaluation of 20% for Chad to the overvaluation of 80% for Cameroon.4

3.3. Economic function of the CFA Franc Zone

Because of poor regional integration, most analysts have regarded the CFA Franc Zone as notconstituting an optimum currency area (Boughton, 1993; Monga, 1997). Rather, the economic rationale forthe common currency arrangement lies elsewhere. First, at least in theory, the supranational nature of thecentral bank may have allowed greater political independence, ensuring the generally lower rate of inflationobserved in the CFA Franc Zone countries, compared with non-CFA Sub-Saharan countries. This view,however, is challenged by Fouda (1997), who claims that the growth of monetary aggregates in Cameroonwas systematically influenced by domestic election cycles despite the national credit ceilings during 1960–92.This may in part suggest a weakness in the organizational structure of the central bank, where governmentrepresentatives sat on the Board of Directors. Given the asymmetry in economic size, it is also said that theinfluence of a single regional state was dominant in each central bank (Fouda and Stasavage, 2000).

Second, a common currency arrangement may have allowed the participating countries to share risksthrough the pooling of foreign exchange reserves. Given its diversity in production and exports, there was asubstantial scope for risk-sharing in the CFA Franc Zone, where seasonal patterns of agriculturalproduction differed and the prices of export products were not closely correlated with each other. Thisreserve pooling aspect has been emphasized by Medhora (1992a) as an important benefit of the commoncurrency arrangement. Alternatively, one can view the common currency arrangement as a mechanism ofregional financial intermediation. Given the limited development of intra-regional private banking andprivate capital markets, central banks may well have been the only effective institution capable ofchannelling financial resources from surplus to deficit countries. However, these views are challenged byHonohan (1990), who noted the absence of negative correlation between a country’s export receipts and theallocation of central bank credit in the case of the UEMOA and the fact that the larger and moreprosperous countries consistently claimed a disproportionate share in the regional distribution of credits.

Given these features, it may be more appropriate to characterize the CFA Franc Zone as an exchangerate standard area than as a common currency area. Boughton (1991) and Bayoumi and Ostry (1997) haveemphasized the importance of differentiating the economic effects of the CFA Franc Zone as a commoncurrency area from those of its link with the French franc. While the benefit of the external link to theFrench franc may well have been price stability, given the segmentation of national economies and theabsence of an effective mechanism of policy coordination, the lack of exchange rate policy as an instrumentmay have placed tensions on the member countries. This may explain the lower average growth rate of theCFA franc countries (3.1% during 1964–93) compared with the region’s non-CFA franc countries (3.8%).In this interpretation, the CFA franc countries may have been better off having their own nationalcurrencies and pegging them to the French franc at different parities. At the same time, the credibility of thepeg, hence the chance for price stability, may have been enhanced by the multinational character of theexchange rate arrangement. In the words of Boughton (1993), the monetary union may have been a type ofreputation-enhancing mechanism for individual member countries to increase the credibility of a fixedexchange rate regime.



Finally, while the CFA Franc Zone did not function as a common currency area, it did not behave like aconventional fixed exchange rate regime, either. Rother (1999) showed that money demand in Cote d’Ivoirebehaved differently from other parts of the UEMOA during 1975–96, possibly because of its size andbanking sector problems. Moreover, it appears that, for the UEMOA region as a whole, the constraints of afixed exchange rate were not binding, as indicated by the considerable fluctuations in the French Treasury’sOperations Account and the short-run divergence of inflation rates between France and the UEMOAcountries. Likewise, Savvides (1998) showed that, from the 1960s through the early 1990s, Cameroon, Coted’Ivoire and Gabon were able to pursue independent monetary policy, as reflected by their ability to allowinflation and domestic credit to deviate from the constraints of the exchange rate peg in the presence ofmarket imperfections. The less binding fixed peg may have reflected the automatic access to the overdraftfacilities of the French Treasury.

All in all, we may characterize the CFA Franc Zone in the following way, at least as it existed until 1998.In each region, the central bank served as the intermediary in channelling resources across countries, likelyin a distortionary manner. It is in this sense that the zone functioned as a common currency area. Moregenerally, the zone was a collective peg to the French franc. The lack of financial markets}hence thereliance on quantitative tools}made it easier to maintain the fixed parity, and access to the FrenchTreasury’s overdraft facilities provided each country with some degree of monetary independence. Theabsence of an effective mechanism of monetary policy coordination, and the diversified structure ofproduction and exports, frequently led to a divergence in price inflation and other economic performance,creating tension between the country-specific need for adjustment and the constraints of a collective peg.The CFA Franc Zone nonetheless survived for over 30 years with a single parity, only because of thegenerous provision of French assistance. Seen in this way, it becomes clear that the CFA Franc Zone was arecycling mechanism of French aid and, as expected, contributed little to the promotion of regionaleconomic integration.

4. THE ARAB MONETARY FUND

4.1. The organization and functions of the AMF

The AMF was established by the Economic Council of Arab States in April 1976 and commenced itsoperations in 1977. Currently, its membership includes all 22 members of the League of Arab States. In itsorganizational structure and the mode of operation, the AMF resembles the IMF, in part reflecting the factthat it received IMF technical assistance in drafting its charter. The authorized capital currently stands at600 million Arab accounting dinars (AAD), where one AAD is defined to be equal to three SDRs. Theestablishment of the AMF was a modest culmination of a series of attempts, beginning as early as 1946, tocreate a permanent institution for Arab monetary cooperation, including the ideas of an Arab paymentunion and a unified Arab currency (AMF, 1977b, 1983; Dajani, 1982; Abdul-Rasool, 1982).

According to the Articles of Agreement, the objectives of the AMF include: (1) correction of disequilibriain balance of payments; (2) promotion of exchange rate stability among Arab currencies and the removal ofrestrictions on current payments among member countries; (3) promotion of the use of the Arab dinar unitof account and the creation of a unified Arab currency; (4) establishment of policies and modes of Arabmonetary cooperation to achieve Arab economic integration and to speed the process of economicdevelopment; (5) provision of advice on foreign portfolio investment; (6) promotion of the development ofArab financial markets; (7) coordination of member country policies with respect to international monetaryand economic problems; and (8) settlement of current payments among member countries so as to promotetrade (AMF, 1977a).

The Agreement further states that, to accomplish these objectives, the AMF is to: (1) provide short-termand medium-term credit, subject to conditionality; (2) provide guarantees on member country sovereigndebt; (3) act as intermediary in the issue of member country sovereign loans in international markets; (4)coordinate the monetary policies of member countries and promote cooperation among the monetary



authorities; (5) liberalize and promote intra-regional flows of trade and capital; (6) conductperiodic consultations; (7) conduct research; and (8) provide technical assistance to banking andmonetary institutions.

Despite these stated objectives and activities, however, the work of the AMF for all practical purposescentres on the extension of credit to member countries experiencing balance of payment difficulties, withvarying degrees of conditionality. At present, there exist five credit facilities. First, ‘automatic loans’ areextended up to 75% of a member’s subscription paid in convertible currencies, up to the overall balance ofpayments deficit. Second, ‘ordinary loans’ are provided in support of a financial programme to be agreedupon with the member. Third, ‘extended loans’ are provided when the automatic and ordinary loans arefully used up, subject to the placement of a corrective programme that extends over a minimum period oftwo years. Fourth, ‘compensatory loans’ are provided to support countries experiencing balance ofpayments difficulties arising from a decline in exports or a large increase in agricultural imports due to badharvests. Finally, ‘structural adjustment facilities’ are given to support efforts to reform and modernize thefinancial and banking sector and government finance, with disbursements made in instalments, inaccordance with performance criteria.5

4.2. Role of the AMF for Arab monetary cooperation

According to the Agreement, the overriding objectives of the AMF are to lay ‘the monetary foundationsof Arab economic integration’ and to accelerate ‘the process of economic development in all Arabcountries’. In practice, however, the AMF’s role as a catalyst for Arab monetary integration has beenlimited by various factors. First, trade linkages among the Arab countries are limited, reflecting the relativesimilarity of resource endowments, the lack of a diversified export base in manufactures, high costs oftransportation and restrictive trade policies (El-Erian and Tareq, 1993). As a result, intra-regional tradeaccounts for only a small fraction of total Arab trade. In 1998, for example, the share of intra-regionaltrade accounted for only 8% in exports and 7% in imports; a large share of the small intra-regional tradetook place between countries of its subregions, namely, the Gulf Cooperation Council (GCC) and the ArabMaghreb Union. A recent study by Al-Atrash and Yousef (2000) estimates intra-Arab trade to be about10–15% lower than the level predicted by a gravity model.

Second, there is a great diversity in trade and exchange restrictions and other economic regimes acrossthe Arab countries, which is compounded by political differences and conflicts (Al-Atrash and Yousef,2000). Some countries are market-oriented (e.g., Jordan, Morocco and Tunisia), while others are publicsector-oriented (e.g., Libya and Syria). Some have a liberal trade and exchange regime (e.g., the GCCcountries), while most others have a more restrictive regime. Some are primarily agricultural producers(e.g., Mauritania and Sudan), while others are primarily energy producers. Per capita income also varieswidely across the region. As recently as 2000, two countries (Yemen and Comoros) were classified by theWorld Bank as ‘low income’, while three (Kuwait, Qatar and the UAE) were classified as ‘high income’.

Third, exchange rate arrangements vary from a currency board to free floating, with managed floatingand a peg (official or de facto) to the US dollar being predominant (Table 3). Except for the limited attemptmade among the GCC countries, there is little monetary cooperation. Many currencies are not even tradedin the markets. At the end of 2000, six countries still availed themselves of the transitional arrangementsunder Article VIII of the IMF Articles of Agreement. Severe financial repression, extensive governmentintervention in the financial sector, and the lack of central bank independence in most Arab countries seemto have limited the scope and usefulness of exchange rate coordination as a form of monetary cooperation(El-Erian and Tareq, 1993; Wahba and Mohieldin, 1998).

Finally, the essential character of the AMF as a lending institution has not been helpful in promotingmonetary integration. Because the balance of payment surpluses of Arab oil-producing countries haveresulted mainly from external factors beyond their control, the adjustment role of the AMF has beenlimited. Likewise, the fact that the source of the balance of payment deficits of non-oil Arab countries hasalso been both external and structural has considerably limited the AMF’s adjustment role (Abdul-Rasool,1982). Under these circumstances, the AMF has been more a vehicle of resource transfers than a catalyst of



Table3.Economic

size

andexchangerate

arrangem

ents

ofArabMonetary

Fundmem

bers

Country

(currency)

Economic

size

(2000)

Article

VIIIstatus

(end2000)

Exchangerate

arrangem

ent

(end2000)

GDPa

Pop.

GDP/Pop.

(US$million)

(million)

(US$)

Algeria

53,817

30.399

1,580

Sep

5,1997

Managed

floatingwithnopre-announcedpath

fortheexchangerate

(Algeriandinar)

Bahrain,Kingdom

of

}0.691

}Mar20,1973

Conventionalfixed

peg

totheSDR

withwidemarginsb

(Bahrain

dinar)

Comoros

212

0.558

380

Jun1,1996

Conventionalfixed

peg

totheeuro

(Comorianfranc)

Djibouti

553

0.632

880

Sep

19,1980

Currency

board

arrangem

ent,withapeg

totheUSdollar

(Djiboutifranc)

Egypt

98,333

63.976

1,490

Article

XIV

Pegged

exchangerates(vis-a-vistheUSdollar)

within

horizontalbands

(Egyptianpound)

Iraq

}23.264

}Article

XIV

Managed


fortheexchangerate

(Iraqidinar)

Jordan

8,340

4.887

1,710

Feb

20,1995

Conventionalfixed

peg

totheSDR

c

(Jordandinar)

Kuwait

29,674

1.984

18,030

Apr5,1963

Conventionalfixed

peg

toacurrency

basket

(Kuwaitidinar)

Lebanon

16,584

4.328

4,010

Jul1,1993

Conventionalfixed

peg

(Lebanesepound)

Libya

}5.290

}Article

XIV

Conventionalfixed

peg

totheSDR

c

(Libyandinar)

Mauritania

935

2.665

370

Jul19,1999

Managed


fortheexchangerate

(Mauritanianouguiya)

Morocco

33,364

28.705

1,180

Jan21,1993

Conventionalfixed

peg

toacurrency

basket

(Moroccandirham)

Oman

}2.395

}Jun19,1974

Conventionalfixed

peg

totheUSdollar

(Rialomani)

Qatar

}0.585

}Jun4,1973

Conventionalfixed

peg

totheSDR

withwidemarginsb

(Qatarriyal)

SaudiArabia

139,383

20.723

7,230

Mar22,1961

Conventionalfixed

peg

totheSDR

c

(SaudiArabianriyal)

Somalia

}8.778

}Article

XIV

Independentlyfloating

(Somalishilling)

Sudan

9,599

31.095

310

Article

XIV

Managed


fortheexchangerate

(Sudanesedinar)

SyrianArabRep.

16,485

16.189

940

Article

XIV

Conventionalfixed

peg

totheUSdollar

(Syrianpound)

Tunisia

19,462

9.564

2,100

Jan6,1993

Managed


fortheexchangerate

(Tunisiandinar)

United

ArabEmirates

}2.905

}Feb

13,1974

Conventionalfixed

peg

totheSDR

withwidemarginsb

(UAE

dirham)

Yem

en,Rep.of

8,667

17.507

370

Dec

10,1996

Independentlyfloating

(Yem

enirial)

aTheGDPsforComoros,DjiboutiandSudanare

gross

nationalincomes.

bA

relativelystable

relationship

maintained

withtheUSdollar.

cEffectivelypegged

totheUSdollar.

Sources:IM

F,AnnualReporton

Exchange

Arrangements

andExchange

Restrictions2001;WorldBan

k,World

BankDevelopmentReport2002:BuildingInstitutions

forMarkets(2002).



regional integration through finance and adjustment. For countries with chronic surpluses, there is notmuch reason to increase the resource base of the AMF. Their apprehension, reflected in the conservativelending policies of the Executive Board, has been vindicated by the emergence of payment arrears (Ali,1982; Al-Sagban, 1982).

To summarize, the functioning of the AMF is severely handicapped by its limited resources relative to thelarge deficits incurred by the member states. Coupled with the sense of fraternity and comradeshipjustifiably felt by the Arab borrowers, countries applying for loans find it unacceptable that the AMFshould require of them the kind of information and conditionality that the IMF would do for much largerloans. Consequently, it has been difficult to reach agreement on corrective policies, even if the deficitcountries decide reluctantly to approach the AMF (Al-Sagban, 1982). Given the economic and politicalrealities of the Arab world, and the way in which the AMF is structured, the AMF has remained dormantas a vehicle of Arab monetary cooperation.

5. EAST ASIAN INITIATIVES FOR REGIONAL MONETARY COOPERATION

5.1. Rationales for regional monetary cooperation

Monetary cooperation may take at least three forms (Kenen, 1994; Hamada and Kawai, 1996). First, itcan take the form of information-sharing on economic performance, macroeconomic and structural issues,and policy objectives and choices. This can be formalized as regional policy dialogue and surveillance,which would not only facilitate greater information-sharing but also create peer pressure for better policies.Second, cooperation may take the form of regime-setting, which is a joint exercise to agree on a set of rulesof the game. This type of policy cooperation includes agreements on regional payment settlements, regionalfinancing facilities and associated policy adjustments, mechanisms for intra-regional exchange rate stabilityand frameworks for regional action at the time of a crisis. Finally, the deepest form of cooperation is policyoptimization, which is a joint maximization of a weighted sum of economic welfare of the participatingcountries. Europe provides an example of this, in which monetary policy cooperation conducted at leastsince 1979 eventually culminated as the creation of a currency union in 1999.

Focusing on East Asia, there are at least three rationales for regional monetary cooperation. First, themost important rationale is given by strong regional economic interdependence, which creates externalitiesin various areas. Monetary cooperation that focuses on issues pertinent to monetary and financial spherescannot be sustained without broader economic integration. In this context, the East Asian region has longenjoyed a market-driven integration process through trade, foreign direct investment (FDI) and cross-border financial flows. The degree of regional trade integration in East Asia is high and comparesfavourably with levels seen in the North American Free Trade Area or the European Union (Kawai,2004b). Macroeconomic interdependence has also become stronger, as evidenced by a simultaneouscontraction of economic activity in 1998 and a simultaneous expansion in 1999–2000. Several studies showa high degree of interdependence in the region in terms of both demand and supply shocks (Eichengreenand Bayoumi, 1999; Kawai and Motonishi, 2004).

The second rationale comes from the desire to create a new regional financial architecture to securefinancial stability. The recent financial crisis in East Asia has revealed the limitation of the globalframework to address the issues of crisis prevention, management and resolution. While the internationalcommunity has so far focused its attention on global and national policy reforms, a well-designed regionalframework can also be an important way of enhancing the stability of the international financial system.For one thing, the global achievements have been incomplete and national efforts will take more time tobecome effective. In addition, as contagion from a financial crisis tends to begin with a geographic focus, aregional framework is a logical way to proceed.

Finally, the third rationale for regional monetary cooperation in East Asia comes from the lower costand greater usefulness of discussing regional issues at the regional level. Interdependent economiesfrequently face common policy issues and can form a basis for understanding each other’s views and policy



reactions at a lower transactions cost; they often benefit from taking collective action in monetary andfinancial policies. Regional coordination also promotes deeper integration, which requires a formalizedapproach in various areas, including the harmonization of financial sector regulation and the stabilizationof exchange rates.

5.2. Lessons for East Asia: ingredients of successful regional monetary cooperation

While effective regional monetary cooperation can take various forms (Williamson, 1982), some keyingredients of a successful arrangement are suggested by a brief review of the salient features of the EPU,the CFA Franc Zone (largely as it existed through 1998), the AMF and the well-known EMS (Table 4).First, regional monetary cooperation must contain a surveillance mechanism. Surveillance is useful notonly for crisis prevention but also for facilitating the adoption of a credible adjustment programme once acrisis occurs. This was done in the EPU by having a group of politically neutral technical experts whosedecisions were subject to unanimous approval by political appointees.

Second, there must be a financing arrangement to support the currencies of member countries whennecessary. The mix of financing and adjustment must be ‘right’ in order to deter speculative attacks orcontain crises while minimizing moral hazard. Too much financing}as in the case of French aid in theCFA Franc Zone}creates moral hazard, while too little financing}as in the case of the AMF}leads to aloss of interest in regional cooperation on the part of potential borrowers. Financing must be adequate and,at the same time, must be accompanied by a credible mechanism of mandating policy adjustment, in part tominimize tension across countries and in part to protect the interests of potential creditors.

Third, there must be a unit of account, if monetary cooperation is to be formalized. A regional commonunit of account represents a numeraire in which regional economic transactions and facilities can bedenominated. In addition, it can be a basis on which any deviation of a member currency’s exchange ratefrom the regional average can be measured. This was served by the EPU unit of account in the EPU, theCFA franc in the CFA Franc Zone and the AAD in the AMF. A similar role was played by the Europeancurrency unit (ECU) in the EMS.

Fourth, exchange rate and monetary policy coordination needs to be developed to ensure intra-regionalexchange rate stability. Both the EPU and the CFA Franc Zone operated under a fixed exchange rateregime. The EMS had an exchange rate mechanism to ensure intra-regional exchange rate stability throughtight policy coordination.

Fifth, regional monetary cooperation needs to nurture greater regional economic integration, and theobjective of economic integration must be based on market principles. Without a commitment to marketmechanisms, distortions are bound to occur. In the EPU, the discriminatory aspect of the regionalmechanism was mitigated by the collective efforts of trade and current account liberalization. In the case ofthe CFA Franc Zone and the AMF, reliance on quantitative controls cum liberal external financialassistance and trade restrictions, respectively, have kept the regions fragmented, thus limiting the extent ofeconomic integration.

From these lessons, regional monetary cooperation in East Asia may be envisioned to take threeprogressive steps: (1) information-sharing, policy dialogue and economic surveillance; (2) regional financingarrangements; and (3) coordination of monetary and exchange rate policies. Not surprisingly, initiatives tostrengthen monetary cooperation in East Asia so far have focused on the first two areas.

5.3. Regional policy dialogue and surveillance

Among the several regional mechanisms developed for this purpose, three major initiatives include theASEAN Surveillance Process, ASEANþ 3 Economic Review and Policy Dialogue, and the Executives’Meeting of East Asia-Pacific Central Banks (EMEAP). Several other mechanisms also exist, including theAsia-Pacific Economic Cooperation (APEC) and Asia-Europe Meeting (ASEM), which are bothtransregional policy dialogue processes involving countries beyond the region. Table 5 lists thecompositions of these forums, along with the Manila Framework Group (MFG) and two other centralbank groupings in the Asia-Pacific region.6



Table4.Salientfeaturesofmajorregionalmonetary

cooperationarrangem

ents

Arrangem

ents

Surveillance

FinancingFacility

Commonunitofaccount

Exchange

rate

and

monetary

policy

coordination

EuropeanPayments

Union(EPU)

*ManagingBoard

of

theEPU

*Multilateralsettlements

of

monetary

balances,with

automaticextension

ofcreditswithin

designated

limits

*EPU

unitofaccount

*Form

alpeg

togold

and/or

theUSdollar

CFA

FrancZone

*CentralBoard

ofDirectors

*Monetary

Committees

ofGovernors

attheCentral

BankofWestAfrican

States(BCEAO)andthe

BankofCentralAfrican

States(BEAC)

*Extensionofunlimited

and

automaticoverdraft

facilities

throughtheFrench

Treasury’sOperations

Accounts

*CFA

franc

*CFA

francpegged

tothe

French

franc

ArabMonetary

Fund(A

MF)

*Board

ofGovernors

*Board

ofExecutiveDirectors

*AutomaticLoans

*Ordinary

Loans

*Extended

Loans

*Compensatory

Loans

*StructuralAdjustment

Facility

*Arabaccountingdinar

(AAD)

*Form

alpeg,orinform

al,de

factostabilization,to

the

USdollarorSDR

East

Asia

*ASEAN

Surveillance

Process

*ASEANþ3Economic

ReviewandPolicy

Dialogue

Process

*Executives’MeetingofEast

Asia-PacificCentralBanks

(EMEAP)

*ASEAN

Swap

Arrangem

ent(A

SA)

*ASEANþ3BilateralSwap

Arrangem

ents

(BSA)

*DefactoUSdollar

*Form

alpeg,orinform

al,de

factostabilization,to

the

USdollar

Reference:European

Monetary

System

(EMS)

*ECOFIN

Council

*VeryShort-term

Financing

Facility

(VSTF)

*Short-term

Monetary

Support

Facility

(STMS)

*Medium-term

Financial

Assistance

Facility

(MTFA)

*Europeancurrency

unit(ECU)

*Exchangerate

mechanism

(ERM)



The ASEAN Surveillance Process was established in October 1998 when ASEAN Finance Ministerssigned a Terms of Understanding for regional cooperation. The Process is meant to strengthen policydialogue and policy-making capacity in the monetary, fiscal and financial areas through informationexchanges, peer reviews and policy recommendations at the regional and national levels. It is the firstconcrete attempt by a group of developing countries for such purposes. The Process emphasizes themonitoring of macroeconomic developments, capital flows, exchange rates, and structural and socialpolicies by bringing together the Finance Ministers twice a year.

The ASEANþ 3 Economic Review and Policy Dialogue (ERPD) Process was introduced in May 2000 inorder to strengthen policy dialogue, coordination and collaboration on the financial, monetary and fiscalissues of common interest. Its initial focus has been on issues related to macroeconomic risk management,better corporate governance, monitoring of regional capital flows, strengthening of the banking andfinancial systems, reform of the international financial architecture, and enhancing self-help and supportmechanisms. Steps have been taken for cooperation in monitoring short-term capital flows and developinga regional early warning system to assess regional financial vulnerabilities. The effectiveness of ASEANþ 3ERPD, however, has been limited so far by the lack of a formal institutional structure.

EMEAP, established in February 1991 with the leadership of the Bank of Japan and the Reserve Bank ofAustralia, is the most prominent of the policy dialogue processes organized by Asian central banks. Its

Table 5. Regional forums for finance ministries and central banks

Finance ministries and/or central banks Central banks

ASEAN ASEANþ 3 MFGa APEC ASEMb SEANZA SEACEN EMEAP(10) (13) (14) (21) (25) (20) (11) (11)

Year established 1967.8 1999.4 1997.11 1994.3 1997.9 1956 1966.2 1991.2Japan * * * * * *China * * * * * *Korea * * * * * * *Hong Kong * * * *Taiwan * *Singapore * * * * * * * *Brunei * * * * *Cambodia * *Indonesia * * * * * * * *Laos * *Malaysia * * * * * * * *Myanmar * * *Philippines * * * * * * * *Thailand * * * * * * * *Vietnam * * * *Mongolia * *Macao *Papua New Guinea * *Australia, New Zealand * * * *Nepal, Sri Lanka * *Bangladesh, India, Iran, Pakistan *USA, Canada * *Chile, Mexico, Peru *Russia *EU-15 *aMFG was terminated in December 2004. In addition to the member countries indicated, it also included the IMF, World Bank, ADBand BIS.bASEM includes the European Commission.

Source: Kuroda and Kawai (2002).



major objective is to strengthen the cooperative relationship among its members through exchanges ofinformation and views on economic and financial developments in the region as well as through joint actionfor the promotion of financial market development. Its activities include annual meetings of EMEAPcentral bank governors, semi-annual meetings of the deputy governors, and three working groupsconcerned with payment and settlement systems, financial markets and bank supervision. EMEAP has nosecretariat and the responsibility for organizational matters, along with the meetings themselves, is rotatedamong the participating central banks.

5.4. Regional financing facilities

Despite the region’s high savings and large pool of foreign exchange reserves, the ASEAN SwapArrangement (ASA) was the only meaningful regional financing facility (though limited in size) until May2000, when the so-called Chiang Mai Initiative (CMI) was agreed. The CMI consists of two parts:enhancement of the ASA and creation of bilateral currency swap arrangements among the ASEANþ 3countries.

The ASEAN Swap Arrangement was created in August 1977, when the monetary authorities of theoriginal five ASEAN countries signed a Memorandum of Understanding. The facility initially amounted toUS$100 million, which was subsequently increased to US$200 million in 1978. The objective of the ASAwas to provide immediate short-term swap facilities to any member facing a temporary liquidity shortage ora balance of payments problem. It was activated by Indonesia in 1979, Malaysia in 1980, Thailand in 1980and the Philippines in 1981 (Henning, 2001). In March 2000, ASEAN Finance Ministers decided to extendmembership to the other five countries; in November 2000, all 10 ASEAN countries signed a newMemorandum of Understanding. Now, a member country can use the facility of US$1 billion to obtainmajor international currencies for an amount up to twice their commitment under the facility, for a periodof up to six months.

Bilateral swap arrangements under the CMI are designed to create a new network of swap and repurchasearrangements among Japan, China and Korea as well as between each of these and any one of the ASEANcountries. By the end of December 2003, 16 bilateral swap arrangements (BSAs) had been concluded in linewith certain agreed principles and reached a total of US$36.5 billion, without counting the commitmentsmade under the New Miyazawa Initiative; the amount was US$44 billion, if these commitments wereincluded (see Table 6).7 As of end-2004, all conceivable BSAs have been concluded, and no further BSAnegotiation is under way.

The ASEANþ 3 countries have agreed on a basic framework and main principles of bilateral support,including linkages to the IMF, maturity and interest structure. For example, countries may borrowinternational liquidity collateralized by domestic currencies with government guarantees, rather thanoffering US Treasury bonds as collateral. Any swap will be for a period of 90 days, renewable up to seventimes, at LIBOR plus 150 basis points for the first drawing and first renewal. Thereafter, premiums rise by50 basis points every two renewals, subject to a maximum of 300 basis points. Negotiations on swaparrangements are to be concluded bilaterally, based on the agreed principles.

Furthermore, members requesting liquidity support under the CMI can immediately obtain short-termfinancial assistance for the first 10% of the BSA facility without involving the IMF. The remaining 90% isprovided under an IMF-supported programme. The linkage of disbursements after the first 10% to IMFconditionality is designed to minimize moral hazard and to address the concern that the problems leadingto balance of payment difficulties may be fundamental in nature, rather than driven simply by investors’herd behaviour. In May 2004, the participating countries initiated a review of the IMF linkage and othermain principles.

5.5. Moving forward

In moving forward, East Asia faces at least four challenges (Eichengreen, 2001). The most serious one isits obvious economic diversity, which creates difficulties for any attempt to agree on coordinated policies.Before deeper monetary cooperation is feasible, substantial economic convergence must take place. The



second challenge is the lack of political leadership, partly due to the wide difference in political philosophy,the past history and the resulting lack of mutual trust, and partly due to the absence of a single economicpower that plays a dominant role. Japan has been mired with economic stagnation, while China has yet toachieve its transition to market economy and democracy. The third challenge is the region’s ‘consensus’culture. As a result, cooperation in East Asia has so far been characterized by consensus decision-makingand the presumption of non-intervention in domestic affairs. Although this has nurtured a certain degree ofregional cooperation, it may limit a deeper development of monetary cooperation. The final challengeconcerns the incentive issue arising from the region’s economic openness. While intra-regional trade andinvestment interdependence is rising, East Asia is not self-contained in terms of foreign trade, directinvestment and financial flows.

Against these challenges, monetary cooperation in East Asia must be strengthened further. First, aspreviously agreed, in May 2004, the ASEANþ 3 members began to review the CMI, including its amount,modality and IMF linkage. The total amount covered by the CMI may be enlarged, its bilateral nature maybe modified to become multilateral, and the degree of IMF linkage may be reduced. For such revisions tobe meaningful, it is essential to develop an effective surveillance mechanism and to improve the region’scrisis management capacity. Once these efforts are made, East Asia will have effectively established anAsian Monetary Fund that can contribute to regional financial stability without creating fears of moralhazard. As suggested by the experience of the CFA Franc Zone (Medhora, 1992a), reserve pooling wouldrequire a mechanism of one type or another under which net users of reserves are charged and net providersare compensated. Such a mechanism may involve a formal institutional arrangement, includingstrengthened surveillance designed to minimize moral hazard.

Second, while there are several mechanisms for regional information-sharing, policy dialogue andeconomic surveillance, none is sufficiently effective at this point. To be effective, surveillance must placegreater emphasis on technical discussions and create an environment for serious policy dialogues by takingan appropriate balance between consensus and non-interference, on the one hand, and strong peer pressure,on the other. This becomes particularly important if the CMI develops into an important financial facilitythrough size enlargement, multilateralization of swap arrangements and a weaker IMF linkage. A feasibleoption in this direction may be to set up a technically competent secretariat whose role is to provide high

Table 6. Bilateral swap arrangements under the Chiang Mai Initiative (as of end-2003)

BSAs Currencies Conclusion dates Size

Japan–Korea USD–won July 4, 2001 US$7.0 billiona (1-way)Japan–Thailand USD–baht July 30, 2001 US$3.0 billion (1-way)Japan–Philippines USD–peso August 27, 2001 US$3.0 billion (1-way)Japan–Malaysia USD–ringgit October 5, 2001 US$3.5 billionb (1-way)China–Thailand USD–baht December 6, 2001 US$2.0 billion (1-way)Japan–China Yen–renminbi March 28, 2002 US$3.0 billionc (2-way)China–Korea Renminbi–won June 24, 2002 US$2.0 billionc (2-way)Korea–Thailand USD–won or USD–baht June 25, 2002 US$1.0 billion (2-way)Korea–Malaysia USD–won or USD–ringgit July 26, 2002 US$1.0 billion (2-way)Korea–Philippines USD–won or USD–peso August 9, 2002 US$1.0 billion (2-way)China–Malaysia USD–ringgit October 9, 2002 US$1.5 billion (1-way)Japan–Indonesia USD–rupiah February 17, 2003 US$3.0 billion (1-way)China–Philippines Renminbi–peso August 29, 2003 US$1.0 billionc (1-way)Japan–Singapore USD–Singapore dollar November 10, 2003 US$1.0 billion (1-way)Korea–Indonesia USD–won or USD–rupiah December 24, 2003 US$1.0 billion (1-way)China–Indonesia USD–rupiah December 30, 2003 US$1.0 billion (2-way)

aThe amount includes US$5.0 billion committed (on June 17, 1999) under the New Miyazawa Initiative.bThe amount includes US$2.5 billion committed (on August 18, 1999) under the New Miyazawa Initiative.cThe amounts are US dollar equivalents.

Source: Kawai and Motonishi (2004).



quality economic reviews and assessments, timely identification of emerging issues and vulnerabilities, andrealistic policy options.

Third, a successful case of regional monetary cooperation elsewhere has created its own unit of account.Within the context of ASEANþ 3, the easiest way is to construct a basket of all 13 regional currencies, withweights corresponding to their economic importance. Use of such an Asian Currency Unit (ACU) will nodoubt enhance the perception of Asian regionalism. As another option for the ACU, emerging marketeconomies in East Asia could consider conducting exchange rate management with reference to a G-3currency basket, consisting of the US dollar, the euro and the yen}as noted below. This would allow theACU to be effectively traded in international markets.

Finally, developing a cooperative framework for regional exchange rate stability is another task. Severalproposals have been made, including the US dollar standard (McKinnon, 2001), a common G-3 currencybasket system (Williamson, 2001; Kawai and Takagi, 2005; French and Japanese Staff, Ministries ofFinance, 2001; Kawai, 2002, 2004a; Ogawa and Ito, 2002) and a monetary union. The US dollarstandard, which is a formalization of the pre-crisis de facto dollar peg, is simple and transparent, but it canresult in undesirable fluctuations in effective exchange rates. The G-3 currency basket system has thebenefit of minimizing fluctuations in the region’s effective exchange rates, while allowing each country tochoose a specific margin of fluctuation. One potential problem with this option is its asymmetric treatmentof Japan, which is allowed to maintain monetary policy independence. An Asian Monetary System,along the lines of the European Snake (or the ERM), would require a more concerted, symmetric approachin the spirit of regional cooperation. In a much more distant future, an Asian Monetary Union, along thelines of the euro area, may also develop. This last option is not yet realistic, given the absence of region-wide convergence in economic conditions and structures, political commitments and supportiveinstitutions.

6. CONCLUDING REMARKS

This paper has reviewed the modalities of regional monetary cooperation by reviewing the salient featuresof the European Payments Union, the CFA Franc Zone (as it existed largely through 1998) and the ArabMonetary Fund. While monetary cooperation may take different forms and different degrees ofcommitment and formality, a successful modality must have certain ingredients, including: (1) sufficientlylarge financial resources with a credible surveillance mechanism to provide the ‘right’ mix of financing andadjustment; (2) initiatives for regional monetary policy and exchange rate coordination; and (3) principlesof market-based integration that safeguard the progress of regional integration from distortions.

Regional monetary cooperation in East Asia is still in its infancy. Institutions and formal frameworkshave not yet progressed in a way commensurate with the degree of real economic integration. Nonetheless,some steps have been taken in the area of liquidity provision through the Chiang Mai Initiative and thecreation of several mechanisms for information-sharing, policy dialogue and surveillance. However, theregion has yet to take a more visible step towards the creation of a common unit of account, exchange ratestabilization and macroeconomic policy coordination. Greater convergence of per capita income andeconomic structure and stronger political commitments to regional cooperation will be required beforedeeper regional cooperation becomes a reality. An effective mechanism of surveillance, essential for crisisprevention and management, will also facilitate that process.

As a modality of regional monetary cooperation for East Asia, the asymmetric CFA Franc Zone (centredon a dominant outside power) is unlikely to be a useful guide. While Europe’s more recent, symmetric,model is appealing, East Asia’s culture may not be compatible with Europe’s legalistic and bureaucraticorientation. It may well be that East Asia needs a more market-based approach, with a greater recourse toincentives and peer pressure. Whatever form it may take, regional monetary cooperation would likely bringabout large benefits to the region, given the potential for dynamic economic growth and the availabilityof large financial resources. Strong political will and a well-defined vision are indispensable forsuch endeavours.



ACKNOWLEDGEMENTS

This is a substantially abridged version of the paper presented at the Conference on ‘East Asian Monetaryand Financial Cooperation’ organized by the Hamburg Institute of International Economics, May 29–31,2002. The authors are grateful to Eric Girardin, Ousmane Ouedraogo, Hugh Patrick, conferenceparticipants and two anonymous referees for useful comments, and to Steven Green for editorial assistance.The views and interpretations expressed in this paper are those of the authors alone and do not necessarilyrepresent the views of the International Monetary Fund.

NOTES

1. Unless otherwise noted, factual information in this section comes from OEEC (1951), Diebold (1952) and Kaplan andSchleiminger (1989).

2. For Switzerland, the Agreement became effective on November 1, 1950.3. Prior to the French currency reform of 1958, the fixed parity was 0.5 CFA franc per old French franc.4. Devarajan (1997) further showed that, because the CFA franc was uniformly devalued against the French franc, significant

divergence in real exchange rates remained, ranging from the undervaluation of 66% for Chad to the overvaluation of 68%for Cameroon.

5. In addition, the AMF provides trade credit to Arab exporters and importers through the Arab Trade Financing Programme,designed to promote intra-Arab trade.

6. The Manila Framework Group was created as a compromise in November 1997 when the United States and the IMF objected tothe proposal by Japan to create an Asian Monetary Fund. After seven years of activity, however, it was terminated in December2004. As a notable feature, the MFG included a regional surveillance function designed to serve as a basis for an intensive andhigh-level dialogue among finance ministry and central bank deputies, with support from the IMF, World Bank, AsianDevelopment Bank (ADB) and BIS. The IMF once characterized the MFG as the ‘preeminent forum for Asian regionalsurveillance and peer pressure’. Two other central bank groupings are SEANZA (South East Asia, New Zealand, Australia) andSEACEN (South East Asian Central Banks).

7. The so-called ‘New Miyazawa Initiative’, totalling US$30 billion, was announced by the government of Japan at the IMF/WorldBank Annual Meetings in October 1998 in order to provide assistance to the crisis-affected East Asian countries. Half of thepledged amount was earmarked to short-term capital needs during the process of immediate economic restructuring and reform,while the remainder was allocated to medium-term and long-term reforms for accelerating banking and corporate sectorrestructuring and strengthening social safety nets. The five crisis-affected economies received assistance under this initiative;Vietnam also received yen loans as an extension of the initiative.

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Towards regional monetary cooperation in East Asia: lessons from other parts of the world

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