On Monetary Cooperation in East Asia

On Monetary Cooperation in East Asia In View of Experience with the European Monetary Cooperation Soko Tanaka 1

Experience with European Monetary Cooperation 4 Institutional Components of the EMS Collective Foreign Exchange Rate System: ERM fixed exchange rate system: Central Rates ± 2.25% Band (±15% from 1993 to 1998) Supporting Credit Mechanism Surveillance Mechanism Currency Basket or Basket Currency: ECU 2

European M. Cooperation Why? Smithsonian Band (Central Rate in US$ ±2.25 %) Intra-EC Band Too Wide (±4.5%) Narrowing Band (±2.25%) in 1972 Avoidance of Currency Turmoil or Currency Divide ( Economic Stagnation) inside the region Capital Swings between $ & DM Independence from the US dollar European Single Currency in the future (1980s) 3

3 Steps of Euro. M. Cooperation 1970s: Wreck of Cooperation due to Conflicts of Monetary Policy (Price Stability vs. Growth) 1980s: Convergence of Price Trends from Crawling Peg to Fixed Rate Narrow Band vs. Capital Liberalization EMS Crisis in 1992/93 Widening of Band: ±15% in 1993 Speculation-proof Single Currency 4

East Asian Forex Rate Cooperation Why now? Growing global imbalances: East Asia vs. United States Possible Big Fall of US$ & Currency Turmoil in East Asia Transition to more flexible foreign exchange regime of Chinese yuan (RMB) Background: (1) Rising interdependence of the intra-regional trade and FDI, (2) Developing FTA building in East Asia 5

Framework: ASEAN + 3 Asian Currency Crisis in 1997/98 Chiang Mai Initiative (CMI) Summit Conference, Conferences at Ministerial Level (Trade, Foreign, Finance) Setting: (1) Enlarged fund of CMI + Forex Rate Regime under Finance Minister Conference, (2) Permanent Office for Cooperation 6

Time to Go: Price Stability % Per Annum 10 8 6 4 2 0-2 1990 1991 CHANGE IN CONSUMER PRICES1(ANNUAL) 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Malaysia Singapore Thailand Korea Japan Price Rise in East Asia: Comparable to Middle of 1980s in Europe t 7

Trinity Problem in East Asia Exchange Control Forex Rate Stability + Monetary Policy Independence Room for Maneuver - Monetary Policy Independence + Free Movement of Capital + Relative Forex Rate Stability by Massive Intervention (Japan) 8

Factors to be taken into account for a Forex Rate Cooperation To Avoid Excessive Dependence on US Dollar: 1997/98 Crisis To Reflect Competitiveness of Members To be Flexible about Shocks Crawling Band System with Wide Fluctuation Band 9

DEY Baskets for Reference Rate Currency Basket Composed of US Dollar, Euro and Yen DEY basket No Trade-Weighted Basket (10 most important trade partners): too much dollar weight Ex: Singapore $: USD 24%, E 22%, Y 20%, Others 34% USD about 58% (Malaysia, China and Hong Kong ) Trade Partners: Only USA, EU and Japan 10

Number of Unit and Weight of basket CNYB CNYB And DEY of CNY weight Number of Unit JPY US$/JPY 19.60% 22.19169 USD US$/US$ 18.08% 0.18082 Euro US$/Euro 16.51% 0.14140 HK$ Baht S$ Ringgit. Rupiah Pesos NTD KRW RUB US$/HK$ US$/Baht US$/S$ US$/Ringgit US$/Rupiah US$/Pesos US$/NTD US$/KRW USD/RUB 12.65% 1.67% 2.69% 2.79% 1.53% 1.02% 8.97% 8.62% 2.35% 0.97953 0.60934 0.04441 0.10602 121.06834 0.39627 2.88451 103.40749 0.49085 USD/DEY USD/CNYB 1999/1/1=1 1.1 1.05 1 0.95 0.9 0.85 0.8 Exchange Rate of DEY and CNYB CNYB USD/DEYCNY AUD US$/AUD 2.02% 0.03291 CAD US$/CAD 1.51% 0.02312 Weighted by exchange rate on Jan 1, '99 and trade of '02 11

How to make a currency basket DEY Trade weight of USA, EU and Japan for each country in 1998 (USA + EU + Japan = 100.0%) Previous Year of Start of Cooperation Exchange Rate of $, Euro and Yen on the previous day of Start of Cooperation into DEY Equation (Other methods) Revision of the Baskets: Every Five Years 12

DEY Baskets Weight of 3 Currencies in basket DEY Number of Units of Each Currency USD EURO JPY USD EURO JPY DEY CNY 32.69% 30.38% 36.93% DEY CNY 0.32687 0.26026 41.81465 DEY Bhat 34.79% 28.87% 36.34% DEY Bhat 0.34794 0.24729 41.14378 DEY KRW 42.70% 28.40% 28.90% DEY KRW 0.42698 0.24327 32.72536 DEY S$ 42.33% 32.85% 24.82% DEY S$ 0.42332 0.28138 28.10228 DEY Ringgit. 41.57% 28.32% 30.11% DEY Ringgit. 0.41572 0.24261 34.08655 DEY Rupiah 27.59% 37.68% 34.73% DEY Rupiah 0.27593 0.32274 39.32284 DEY Pesos 46.40% 23.45% 30.15% DEY Pesos 0.46399 0.20091 34.13360 DEY HK$ 38.50% 35.07% 26.43% DEY HK$ 0.38505 0.30038 29.92360 1 DEY KRW =0.42698$+0.24327E+32.725 1 DEY Baht =0.25354$+0.18020E+29.982 13

Exchange Rate of DEY KRW Exchange Rate of DEY and KRW 1.2 1.1 1 0.9 0.8 0.7 0.6 USD/DEY USD/KRW 1999/1/1=1 USD/DEYKRW KRW 14

DEY Rate - CNY, Baht, KRW, S$ 1.2 1.1 1 0.9 0.8 0.7 0.6 Exchange Rate of DEY and CNY 15 USD/DEY USD/CNY 1999/1/1=1 USD/DEYCNY CNY 1.2 1.1 1 0.9 0.8 0.7 0.6 Exchange Rate of DEY and Baht USD/DEY USD/Baht 1999/1/1=1 USD/DEYBhat Baht Exchange Rate of DEY and KRW USD/DEY USD/KRW 1999/1/1=1 Exchange Rate of DEY and S$ 1.2 1.1 1 0.9 0.8 0.7 0.6 USD/DEYKRW KRW 1.2 1.1 1 0.9 0.8 0.7 0.6 USD/DEY USD/S$ 1999/1/1=1 USD/DEYS$ S$

USD/DEY USD/Pesos 1999/1/1=1 1.2 1.1 1 0.9 0.8 0.7 0.6 1.2 1.1 1 0.9 0.8 0.7 0.6 USD/DEY USD/Ringgit 1999/1/1=1 DEY Rate: Ringgit, Rupiah, Peso, HK$ Exchange Rate of DEY and Ringgit 16 Exchange Rate of DEY and Rupiah USD/DEYRinggit. Ringgit. 1.2 1.1 1 0.9 0.8 0.7 0.6 USD/DEY USD/Rupiah 1999/1/1=1 USD/DEYRupiah Rupiah Exchange Rate of DEY and Pesos USD/DEYPesos Pesos 1.2 1.1 1 0.9 0.8 0.7 0.6 Exchange Rate of DEY and HK$ USD/DEY USD/HK$ 1999/1/1=1 USD/DEYHK$ HK$

USD/DEY, USD/JPY 1999/1/1=1 DEY Rates and Yen Rate 1.2 1.1 Exchange Rate of DEY and JYP(USD) US$/JPY USD/DEYBhat USD/DEYKRW 1 0.9 0.8 17

01/01/1995 USD/DEY 95/1/1=1 1.2 1.1 1 0.9 0.8 0.7 10/28/1995 08/23/1996 06/19/1997 04/15/1998 02/09/1999 12/06/1999 10/01/2000 07/28/2001 05/24/2002 03/20/2003 01/14/2004 DEY Currency Block Exchange Rate of DEY against USD CNY Bhat KRW S$ Ringgit. Rupiah Pesos HK$ 18

USD/DEY USD/N.C 1999/1/1=1 Exchange Rate Of DEY Against USD (From Jan,99 ) Exchange Rate of DEY Against USD 1.1 1.05 1 0.95 0.9 USD/DEYCNY USD/DEYBhat USD/DEYKRW USD/DEYS$ USD/DEYRinggit. USD/DEYRupiah USD/DEYPesos USD/DEYHK$ 0.85 0.8 19

Width of Crawling Bands Jan. 1 1999 April 30 2004: Maximum Fluctuation of Daily Exchange Rate vis-àvis DEY Category 1: Won $ & S$ 13% Category 2: Baht, Yuan, Ringgit 21% Category 3: Rupiah 55%, Peso 34%, but about 20% after 2002 Conclusion: width of the band = ±10% 20

0.15 0.14 0.13 0.12 0.11 0.1 0.001 0.00095 0.0009 0.00085 0.0008 0.00075 0.0007 DEY/KRW DEY/CNY Exchange Rate Against DEY and Band3(1) Exchange Rate Against DEY and Band3 Exchange Rate Against DEY and Ban3 0.0325 0.03 0.0275 0.025 0.0225 Exchange Rate Against DEY and Band3 Exchange Rate Against DEY and Band3 0.7 0.65 0.6 0.55 0.5 DEY/S$ DEY/Baht 21

0.325 0.3 0.275 0.25 0.225 0.0175 0.015 DEY/Pesos 0.03 0.0275 0.025 0.0225 0.02 DEY/Ringgit Exchange Rate Against DEY and Band3(2) Exchange Rate Against DEY and Band3 Exchange Rate Against DEY and Band3 Exchange Rate Against DEY and Band3 0.00018 0.00016 0.00014 0.00012 0.0001 0.00008 0.11 0.1 DEY/HK$ 0.16 0.15 0.14 0.13 0.12 Exchange Rate Against DEY and Band3 DEY/Rupiah 22

Descriptive Statistics of Exchange Rate of National Currency Against DEY Descriptive Statistics of Exchange Rate of National Currency Against DEY Mean Median Mode Standard deviation Variance Kurtosis Skewness DEY/CNY 0.12745 0.12709 0.11581 0.005955 3.55E-05-0.56078 0.04832 DEY/Baht 0.02556 0.02512 0.02447 0.001227 1.5E-06-0.11460 0.95017 DEY/KRW 0.00087 0.00086 0.00083 3.44E-05 1.19E-09-0.24593 0.67964 DEY/S$ 0.60435 0.60830 0.56571 0.016052 0.000258-0.10656-0.93787 DEY/Ringgit 0.27615 0.27597 0.25396 0.011359 0.000129-0.55373-0.04843 DEY/Rupiah 0.00012 0.00012 0.00011 1.15E-05 1.33E-10 1.28151 0.92312 DEY/Pesos 0.02185 0.02143 0.01726 0.002859 8.17E-06-0.80262 0.35910 DEY/HK$ 0.13595 0.13598 0.12369 0.006029 3.63E-05-0.57698-0.13965 Sample(n)=1947 From Jan, '99 to Apr, '04 Kurtosis <<3 We can assume there are low probability that the distributions of Exchange Rate against DEY were Normal Distribution 23

20 0 Frequency 120 100 80 60 40-0.013045194-0.011260587-0.00947598-0.007691372-0.005906765-0.004122158-0.00233755-0.000552943 0.001231664 0.003016272 0.004800879 0.006585486 0.008370094 0.010154701 0.011939308 Histogram of Deviation (DEY/CNY) Histogram of Deviation (DEY/CNY) Data Section 24

Frequency 1.98653E-05 0.000913673 0.001807481 0.002701289 0.003595097 0.004488904 0.005382712 0.00627652 0.007170328 0.008064136 0.008957944 0.009851751 0.010745559 0.011639367 0.012533175 Data Section Histogram of Modulus of Deviation (DEY/CNY) Histogram of Modulus of Deviation(DEY/CNY) 120 100 80 60 40 20 0 accumulation 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 25

Band X = n x i Std. Dev = ( x X) i n 1 Band1 = CV = 2 ( x X) i n 1 X 2 a = x X i i A i = a i N= 0.9 n Set A 1 <A 2 <A 3 <A N < A n Band A X N 2 = 26

Average of Exchange Rate against DEY, Deviation And Band average of Exchange Rate Standard deviation Coefficient of variation (Band1) average of Exchange Rate Deviation at accumulated 90% Coefficient of variation (Band2) DEY/CNY 0.12745 0.00595 4.67% DEY/CNY 0.12745 0.01056 8.28% DEY/Baht 0.02556 0.00123 4.80% DEY/Baht 0.02556 0.00195 7.64% DEY/KRW 0.00087 0.00003 3.95% DEY/KRW 0.00087 0.00006 6.86% DEY/S$ 0.60435 0.01605 2.66% DEY/S$ 0.60435 0.02614 4.32% DEY/Ringgit 0.27615 0.01136 4.11% DEY/Ringgit 0.27615 0.01978 7.16% DEY/Rupiah 0.00012 0.00001 9.45% DEY/Rupiah 0.00012 0.00002 16.64% DEY/Pesos 0.02185 0.00286 13.08% DEY/Pesos 0.02185 0.00459 21.00% DEY/HK$ 0.13595 0.00603 4.43% DEY/HK$ 0.13595 0.01040 7.65% Sample (n)=1947 From Jan, '99 to Apr, '04 Sample (n)=1947 From Jan, '99 to Apr, '04 27

Exchange Rate Against DEY And Band(1) Sample(n)=1947 From Jan, '99 to Apr, '04 E Emean Band1 Band2 CNY Baht 0.15 0.03 0.14 0.13 0.12 0.11 01.01.99±10% CNY: 0.1087-0.1329 Baht: 0.0247-0.0302 KRW: 0.000750-0.000917 S$: 0.545-0.666 0.0225 DEY/CNY DEY/Baht 0.0275 0.025 0.001 KRW 0.00095 0.0009 0.00085 0.0008 0.00075 DEY/KRW 0.64 S$ 0.62 0.6 0.58 0.56 DEY/S$ 28

Exchange Rate Against DEY And Band(2) Sample(n)=1947 From Jan, '99 to Apr, '04 E Emean Band1 Band2 Ringgit Rupiah 0.325 0.00018 0.3 0.275 0.25 0.225 01.01.99±10% Ringgit: 0.237-0.290 Rupiah: 0.000114-0.000139 Peso: 0.0232-0.0284 HK$: 0.116-0.142 0.00008 DEY/Ringgit DEY/Rupiah 0.00016 0.00014 0.00012 0.0001 0.03 Pesos 0.027 0.024 0.021 0.018 0.015 DEY/Pesos 0.15 HK$ 0.14 0.13 0.12 DEY/HK$ 29

How to Crawl DEY Reference Rate ERM method: Revaluation or Devaluation of Central Rates based on Inflation Gap (17 times 1979-1995) competitiveness of the members When a currency reaches fluctuation margin, check inflation gap against the average of the Members! Intervention (CMI) or Crawling Crawling (devaluation): Cumulative inflation gap 10% 10% devaluation of DEY Peso 1 DEY Peso (New) = 0.9 x 1 DEY Peso (old) = 0.41759$ + 0.18082E + 24.285Y Crawling (revaluation): Same method 30

Width of Band: Widened or Narrowed over time? Stability or Flexibility? Liberalization of Capital Accounts More Flexibility? ERM Wider Band:±15% (08.1993-12.1998): Core Countries inside ±2.25% Band (de facto) since 1996 10% band enough to be flexible for East Asia? Price Stability of the Members 31

Problems of competitiveness Inside East Asia: ±10% Band and Crawling of DEY Rate based on inflation gap Vis-à-vis the rest of the world: (1) Currency Basket: Weighted Average of the 3 Main Currencies Competitiveness vis-à-vis the World Market (2) Big Fall of the US Dollar Japan s Massive Intervention near the PPP Rate (3) Cooperative Intervention of Japan, USA and East Asian Countries 32

Deutsche Mark as an anchor Market chooses an anchor Forex Transaction Cost: proportional to Volatility of Currency Pair traded and inversely proportional to Transaction Turnover (Quality and Quantity) Trade Vehicle Currency or Forex Vehicle Currency? D-Mark as Forex Vehicle on European Spot Markets around 1990 (Trade Invoicing Currency Inertia) Forex Rate Stability of ERM vs. Instability of the US dollar Transaction Turnover Increased in Capital Transactions in Europe Self-reinforcing Effect of Regional International Currency 33

Japanese yen as an anchor? Yen: Volatility + Little International Use Foreign Exchange Rate Stability vis-à-vis East Asian Currencies by DEY Basket Transaction Volume: Increase of Capital Transactions in East Asia in Yen or East Asian Currencies Development of Asian Bond Market Strengthening of Tokyo Financial Market Difficult Competition for the Yen vs. US$ 34

FTA and CU in ASEAN+3 Can trade integration be endogenized? FTA CU: autonomous development? CU has CET (Common External Tariff) and Common Authority to manage CET( WTO Round) CET: possible in East Asia? A Korea = Japan CU as First Step FTA + PESC (Pan-European System of Cumulation of Origin) Pan-ASEAN+3 System of Cumulation of Origin ASEAN+3 FTA 35

Further Development of DEY Basket Single Currency Basket in ASEAN+2 ACU (Asian Currency Unit) of ASEAN+3 36