From What is Regional Trade Blocs or Free Trade Agreements?
As trade integration across countries is intensifying, we hear more and more about Free Trade Agreements (FTAs) and Regional Trade Blocs (RTBs). As their name suggests these RTBs/FTAs are arrangements aimed for faster trade liberalisation at regional levels.
Countries are convinced that trade is an engine of growth and they are searching for arrangements that promote trade.
The WTO that contains 162 countries is the most popular one; a truly multilateral forum for trade liberalisation. But the history of WTO led trade liberalisation shows that the organisation is facing difficulty in bringing further trade liberalisation because of conflicting interest among large number of countries.
This has led to interest in trade liberalisation within a limited number of countries that may be regionally close together. These regional trade promoting arrangements advocate more tariff cuts and removal of other restrictions within the group while maintaining restrictions against the rest of the world.
Though many regional trade agreements like the EU, NAFTA and ASEAN were established before or around the time of WTO’s formation, there is mushrooming of RTBs in recent years. Recently formed Trans Pacific Partnership (TPP) shows this increasing affinity towards RTBs. Many RTBs like the TPP would like to make advanced level trade liberalisation and hence they are not satisfied with the slow pace of trade liberalisation within the WTO.
What are Regional Trade Blocs (RTBs)?
Regional Trade Blocs or Regional Trade Agreements (or Free Trade Agreements) are a type of regional intergovernmental arrangement, where the participating countries agree to reduce or eliminate barriers to trade like tariffs and non-tariff barriers. The RTBs are thus historically known for promoting trade within a region by reducing or eliminating tariff among the member countries.
Over the last few decades, international trade liberalisations are taking place in a serious manner through the formation of RTBs. They are getting wide attention because of many important international developments. First, now the world is trying hard to escape from the ongoing great recession phase. Second is the failure of the WTO to take further liberalisation measures on the trade liberalisation front.
The EU, NAFTA, ASEAN, SAFTA etc are all examples for regional integration. The triad of North America, Western Europe, and Asia Pacific have the most successful trade blocs. Recently signed Trans Pacific Partnership is a powerful RTB. Similarly, another one called RCEP is in negotiation round. India has signed an FTA with the ASEAN in 2009. Simultaneously, the country has signed many bilateral FTAs.
Different types of RTBs
All regional trade blocs don’t have the same degree of trade liberalisation. They may differ in terms of the extent of tariff cutting, coverage of goods and services, treatment of cross border investment among them, agreement on movement of labour etc.
The simple form of regional trade bloc is the Free Trade Area. The Free Trade Area is a type of trade bloc, a designated group of countries that have agreed to eliminate tariffs, quotas and preferences on most (if not all)goods and services traded between them.
From the lowest to the highest, regional trade integration may vary from just tariff reduction arrangement to adoption of a single currency. The most common type of regional trade bloc is the free trade agreement where the members abolish tariffs within the region. Following are the main types of regional economic integrations.
Classification of RTBs
Preferential trading union: Here, two or more countries form a trading club or a union and reduce tariffs on imports of each other ie, when they exchange tariff preferences and concessions.
Free trade union or association: Member countries abolish all tariffs within the union, but maintain their individual tariffs against the rest of the world.
Customs union: countries abolish all tariffs within and adopt a common external tariff against the rest of the world.
Common market: in addition to the customs union, unrestricted movement of all factors of production including labour between the member countries. In the case of European Common Market, once a visa is obtained one can get employed in France or Germany or in any other member country with limited restrictions.
Economic union: The Economic Union is the highest form of economic co-operation. In addition to the common market, there is common currency, common fiscal and monetary policies and exchange rate policies etc. European Union is the example for an Economic Union. Under the European Monetary Union, there is only one currency- the Euro.
At present, out of the total regional trade arrangements FTAs are the most common, accounting for nearly 90 per cent.
From Regionalism in a globalizing world: an Asia-Pacific perspective
From Asia’s Rise in the New World Trade Order
From The world’s free trade areas – and all you need to know about them
International trade is a driving force behind economic growth, and two so-called “mega-regional” trade deals are dominating public debate on the issue: the Trans-Pacific Partnership (TPP) and the Transatlantic Trade and Investment Partnership (TTIP).
But there are around 420 regional trade agreements already in force around the world, according to the World Trade Organization. Although not all are free trade agreements (FTAs), they still shape global trade as we know it.
What exactly are free trade areas?
The OECD defines a free trade area as a group of “countries within which tariffs and non-tariff trade barriers between the members are generally abolished but with no common trade policy toward non-members”.
The free movement of goods and services, both in the sense of geography and price, is the foundation of these trading agreements. However, tariffs are not necessarily completely abolished for all products.
Which are the world’s major free trade areas?
The North American Free Trade Agreement (NAFTA)
Free trade between the three member nations, Canada, the US and Mexico, has been in place since January 1994. Although tariffs weren’t fully abolished until 2008, by 2014 total trilateral merchandise trade exceeded US$1.12 trillion.
According to the US government, trade with Canada and Mexico supports more than 140,000 small and medium-size businesses and over 3 million jobs in the US. Gains in Canada are reportedly even higher, with 4.7 million new jobs added since 1993. The country is also the largest exporter of goods to the US.
However, the Council on Foreign Relations suggests that the impact on Mexico is harder to assess. Per capita income has not risen as fast as expected; nor has it slowed Mexican emigration to the US. However, farm exports to the US have tripled since 1994, and the cost of goods in Mexico has declined. The cost of basic household goods has halved since NAFTA came into force, according to estimates by GEA, a Mexican economic consulting firm.
Association of Southeast Asian Nations Free Trade Area (AFTA)
The AFTA was signed in January 1992 in Singapore. The original members were Brunei, Indonesia, Malaysia, Philippines, Singapore and Thailand. Four countries have subsequently joined: Vietnam, Laos, Myanmar and Cambodia.
The bloc has largely removed all export and import duties on items traded between the nations. It has also entered into agreements with a number of other nations, including China, eliminating tariffs on around 90% of imported goods.
The AFTA nations had a combined GDP of US$2.3 trillion in 2012, and they’re home to 600 million people. The agreement has therefore helped to dramatically reduce the cost of trade for a huge number of businesses and people.
Southern Common Market (MERCOSUR)
Although MERCOSUR was envisaged as a Latin American single market, enabling the free movement of people, goods, capitals and services, this vision is yet to become reality. Internal disputes have slowed progress towards removing tariffs and the free movement of people and goods.
But MERCOSUR is still one of the world’s leading economic blocs, and has a major influence on South American trade and the global economy.
Common Market of Eastern and Southern Africa (COMESA)
Formed in December 1994, the organization aims to develop natural and human resources to benefit the region’s population. Its primary focus, according to the United Nations, is to establish a large economic and unit to overcome barriers to trade.
With 19 member states, and an annual export bill in excess of $80 billion, the organization is a significant market place, both within Africa and globally.
COMESA utlimately aims to remove all barriers to intra-regional trade, starting with preferential tariffs and working towards a tariff-free common market and economic union.
What about the European Union?
The EU is a single market, which is similar to a free trade area in that it has no tariffs, quotas or taxes on trade; but a single market allows the free movement of goods, services, capital and people.
The EU strives to remove non-tariff barriers to trade by applying the same rules and regulations to all of its member states. The region-wide regulations on everything from working hours to packaging are an attempt to create a level playing field. This is not necessarily the case in a free trade area.
The creation of the single market was a slow process. In 1957, the Treaty of Rome established the European Economic Community (EEC) or Common Market. However, it was not until 1986 that the Single European Act was signed. This treaty formed the basis of the single market as we know it, as it aimed to establish the free-flow of trade across EU borders. By 1993 this process was largely complete, although work on a single market for services is still ongoing.
Today, the EU is the world’s largest economy, and the biggest exporter and importer. The EU itself has free trade agreements with other nations, including South Korea, Mexico and South Africa.
What about the TPP and TTIP?
Once fully ratified, the Trans-Pacific Partnership is set to become the world’s largest trade agreement. The TPP already covers 40% of global GDP, and trade between member nations is already significant.
However, by removing tariffs and other barriers to trade, the agreement hopes to further develop economic ties and boost economic growth.
From Determinants of Foreign Direct Investment (FDI)
Foreign direct investment (FDI) is a major component of globalization, together with international trade. Its operation is made possible by movements of factors across countries, in particular, capital. By definition, FDI involves long-term cross-country commitments. According to International Monetary Fund (IMF), FDI entails the establishment of a “lasting interest” by a resident entity of one economy in an enterprise located in another economy (International Monetary Fund, 1993). Lasting interest implies a long-term relationship between the foreign investor and the overseas enterprise where the said investor holds significant influence over management. The IMF defines a direct investment enterprise as one in which a foreign investor holds at least 10% of the ordinary shares or voting power (International Monetary Fund, 1993). The Organization for Economic Cooperation and Development (OECD, 1996, p. 10) classifies enterprises of direct foreign investors into three groups: subsidiaries, in which a nonresident investor holds more than 50% of the ownership; associates, in which a nonresident investor’s shares range between 10 and 50%; and branches, which are unincorporated enterprises owned by a nonresident investor, wholly or jointly. Obviously, such definitions and the resultant measurements leave ambiguities and imprecisions. However, they do help maintain relative consistency in cross-country comparisons.
From 1995 to 2015, the world saw a dramatic increase in FDI. The FDI inflows in 2015 were 8.6 times those in 1995, an increase from about 0.2 trillion USD in 1995 to about 1.8 trillion USD in 2015. While FDI inflows to developed countries increased 8.6-fold, those to developing countries and transitional economies increased 23 times. In 1995, FDI inflows to developing and transitional economies were 17% of the world total, and in 2015 they accounted for 45%. FDI flows to OECD countries peaked in 2007, at about 1.3 trillion USD. Between 2013 and 2014, for the first time, developing countries received more FDI than developed countries (UNCTAD, 2016), though the developed world recaptured the position as the largest FDI recipient in 2015 (see Figure 1).
There is an ever-growing body of literature on FDI. As Markusen (2008) demonstrated, three strands of relevant literature exist:
the international business approach that is oriented toward the rationale of individual firms,
the macroeconomic approach that focuses on aggregate flows of FDI without making a distinction between direct and portfolio investments,
and the international trade theory approach, which increasingly moves closer to the international business approach, combining firm-level FDI analysis with aggregate analysis of capital flows.
Global Financial Safety Net: Regional Reserve Pools and Currency Swap Networks of Central Banks
You can read this post from two perspectives
Geo Strategic (International Financial and Economic Architecture)
Financial and Economic stability / Macro-prudential Policy
Recent Financial Crisis has exposed the fact that global financial liquidity can be in shortage. Since US Dollar is the global currency and is used in more that 40 percent of all financial transactions globally.
Asian Countries faced dollar shortage during 1997-1998 asian financial crisis. Recent Global Financial crisis caused dollar shortage in advanced countries. US Central Bank Federal Reserve responded by setting up currency swap lines with central banks of other countries. These swap lines were made permanent in 2013.
After Asian financial crisis in 1997, many countries in developing world started accumulating FX reserves. There was also a swap agreement (known as Chiang Mai Initiative) which was set up between ASEAN countries in south east Asia.
Nations also go to IMF to get conditional financing which they do not like to do. New Trend is toward regional pooling of financial resources. Latest example is BRICS CRA.
Even advanced economies such as EU have established European Stability Mechanism (ESM).
Chiang Mai Initiative has been revamped as Chiang Mai Initiative Multilateralism (CMIM).
Financial and Economic Stability / Macro Prudential Policy
A. Reserve Pools
Chiang Mai Initiative (CMI)
Chiang Mai Initiative Multi-Lateralism (CMIM)
BRICS Contingent Reserve Arrangement (CRA)
European Stability Mechanism (ESM)
B. Currency Swap Lines
Federal Reserve Central Bank US Dollar Swap Lines
PBOC China Central bank RMB Swap Lines
D. Self Insurance
Nation’s Foreign Exchange (FX) Reserves
From The decentralised global monetary system requires an efficient safety net
The global financial safety net as a set of protection mechanisms
The current decentralised system also lacks a central authority that is actively integrated and, above all, contractually bound into the maintenance of the monetary system by providing temporary liquidity, such as the IMF in the Bretton Woods system. Instead, various protection mechanisms have evolved because the current system has not led to greater external stability of national economies and the global economy. The problem of volatile capital flows became particularly clear once again in the course of the financial crisis of 2008 and 2009. For emerging market economies, the warning of a sudden reversal of capital flows has been omnipresent ever since the Asian crisis. However, the last crisis has demonstrated that even for industrialised countries their developed financial markets are a significant contagion mechanism for crisis developments. The following are regarded as key elements of the global financial safety net:11
International reserves. These include official foreign exchange and gold reserves as well as claims on inter-national financial institutions such as the IMF that can be rapidly converted into foreign currency under the countries’ own responsibility. •
Bilateral swap arrangements between central banks. In a currency swap two central banks agree to exchange currency amounts, e.g. US dollars for euros. They agree on a fixed date in the future on which they will reverse the transaction applying the same exchange rate. During the term central banks can make foreign currency loans to private banks. •
IMF programmes and regional financing arrangements (e.g. European Stability Mechanism, Chiang Mai Initiative Multilateralisation Agreement, BRICs CRA, Arab Monetary Fund, Latin American Reserve Fund). They make financial resources available to the members to tackle balance of payments difficulties, manage crises and prevent regional contagion effects. Depending on their design, they may impose conditions and requirements for economic policy measures on the recipient countries. Some regional programmes require a combination with IMF funds.
The most important element of the protection mechanisms: international reserves
International reserves are by far the largest element of the global safety net.12 The lack of predictability and robustness of other elements has led to an over-accumulation of reserves. After the Asian crisis, upper middle income countries in particular built up reserves. While China holds a major portion of the reserves in this group of countries, all other countries also boosted their reserves significantly. As a result of central bank interventions in the foreign exchange market, reserves have decreased since the year 2013.
The renaissance of bilateral swap arrangements
Bilateral swap arrangements were used by the US Treasury as early as in 1936 to supply developing countries with bridging loans. During the Bretton Woods period, the Fed introduced a network of swap lines known as reciprocal currency arrangements to prevent a sudden and substantial withdrawal of gold by official foreign institutions.13 A swap protected foreign central banks from the exchange rate risk when they had obtained excess and unwanted dollar positions. It allowed them to dispense with the temporary conversion of dollars into gold. Between 1973 and 1980, the swap lines were used instead of US currency reserves to finance interventions by the Fed in the foreign exchange market. Gains and losses were shared with the other central bank when the Fed drew on a line. However, the G10 central banks could try to use the swap arrangements to influence the US foreign currency market interventions, so the Fed stopped using them in the mid-1980s. All existing swap lines except those with Canada and Mexico were ended in 1998. After the terror attacks of September 11, 2001, the Fed established swap lines with the European Central Bank and the Bank of England for 30 days and expanded the existing line with the Bank of Canada. Currency swaps were used here for the first time to restore liquidity in financial markets. During the global financial crisis, the Fed then financed the lender-of-last-resort actions of other central banks in industrialised and emerging market economies, with the latter assuming the credit risk. The international reserves of many central banks at the start of the crisis were smaller than the amounts they borrowed under the swap lines. In 2013 the swap arrangements between the six most important central banks were converted into standing arrangements. All these swap arrangements have one thing in common: they signal the central banks’ willingness to cooperate with each other, whether it be in defence of the parities under the Bretton Woods system, to avert speculative attacks on the Fed, or with the aim of providing dollar liquidity during the financial crisis. China has also set up a far-reaching system of swap arrangements, mainly with the aim of pushing ahead with the internationalisation of the renminbi. But from the perspective of these central banks, the agreements with the Bank of England, the Monetary Authority of Singapore, the Reserve Bank of Australia and the ECB also serve the goal of being able to provide renminbi liquidity in their area of responsibility when needed Swaps represent a powerful and flexible tool of central banks that issue reserve currencies to regulate international capital flows. Central banks are the only institutions capable of changing their balance sheets quickly enough to keep pace with the volatility of international capital flows. Swaps are unsuitable, however, for longer-lasting crises, sovereign debt crises and to finance balance of payments imbalances. That is why they would be the most suitable tool for emerging market economies, as they are more likely to face abrupt changes in capital flows. Nevertheless, so far only the most important central banks that issue reserve currencies have been able to access unlimited swaps. Granting them is determined by the mandate of the central banks and they represent contractual, not institutional agreements. Accordingly, the central banks are able to choose their contractual partners, and there is no central independent authority to supervise swap arrangements. The swap arrangements for central banks in industrial countries that do not issue a reserve currency can therefore be expected to be reinstated in the event of a global shock, while they are less likely to be employed in case of a regional shock. Their use is even less predictable for systemic emerging market economies.
Growth of Global Financial Safety Net
Features of Instruments in the Global Financial Safety net
Use of GFSN in various shock Scenarios
Balance of Payment shock
Banking Sector FX Liquidity shock
Sovereign Debt shock
US Dollar Swap Lines
These six central banks have permanent US Dollar swap lines since 2013.
USA (Fed Reserve),
During the global financial crisis, the Federal Reserve extended swap arrangements to 14 other central banks. The ECB drew very heavily, followed by the BoJ. At one point during the crisis in 2009, outstanding swaps amounted to more than $580 billion and represented about one-quarter of the Fed’s balance sheet. The novel element of this effort was the extension of swaps to four countries outside the usual set of advanced-country central banks: Mexico, Brazil, South Korea and Singapore.16 Mexico previously had a standing swap facility with the Federal Reserve by virtue of geographic proximity and the North American Free Trade Agreement, but the new arrangement expanded the amount that Mexico’s central bank could draw and the Fed’s swaps with Brazil, South Korea and Singapore broke new ground. The swaps in general were credited with preventing a more serious seizing up of interbank lending and financial markets during 2008 to 2009 (Helleiner 2014, 38–45; Prasad 2014, 202–11; IMF 2013a; 2014a, Box 2). The Federal Reserve board of governors considered the “boundary” question at length, torn between opening itself up to additional demands for coverage from emerging markets and creating stigma against those left outside the safety net. Fed officials used economic size and connections to international financial markets as the main criteria for selecting Brazil, Mexico, Singapore and South Korea. Chile, Peru, Indonesia, India, Iceland and likely others also requested swaps but were denied. The governors wanted to deflect requests by additional countries to the IMF, which coordinated its announcement of the SLF with the Fed’s announcement of the additional swaps at the end of October 2008. Governors and staff saw in this tiering a natural division of labour that coincided with the resources and analytical capacity of the Fed and IMF.17 The ECB extended swaps to Hungary, Poland, Sweden, Switzerland and Denmark, in addition to its arrangement with the United States. The BoJ extended swaps as well, notably to South Korea after the Federal Reserve announced its Korean swap. The PBoC began to conclude a set of swap agreements with Asian and non-Asian central banks that would eventually number more than 20 and amount to RMB 2.57 trillion. Only those swaps with the central banks of Hong Kong, Singapore and South Korea are known to have been activated (Zhang 2015, 5). Boosting the role of the renminbi in international trade was the express objective of these swaps, although their establishment also helped to secure market confidence during unsettled times. The proliferation of swaps resulted in a set of star-shaped networks of agreements among central banks that were linked by Fed liquidity (Allen and Moessner 2010). Although a number of the swaps in the network were activated, only those swaps of the Federal Reserve were heavily used during the crisis. The “fortunate four” emerging market countries among the Fed 14 were each covered for amounts up to $30 billion, but only temporarily. When the Fed later declined to renew the swaps, these countries became as vulnerable to liquidity shortfalls as the others. So, when South Korea took the chair of the G20 in 2010, its government proposed that the central bank swaps be multilateralized on a more permanent basis. It argued this would be increasingly necessary to stabilize the global financial system and would be in the interest of swap providers and recipients alike. Specifically, during the preparations for the G20 summit, South Korean officials proposed that the advanced-country central banks provide swaps to the IMF, which would conduct due diligence and provide liquidity to qualifying central banks. In this way, the global community could mobilize enough resources to address even a massive liquidity crunch and central banks would avoid credit risk.
In late 2013, six key-currency central banks made their temporary swap arrangements permanent standing facilities. Each central bank entered into a bilateral arrangement with the five others, comprising a network of 30 such agreements.18 But they prefer to maintain a constructive ambiguity with respect to whether they would re-extend swap arrangements to the other central banks that were covered during the global financial crisis, including Brazil, Mexico,19 South Korea and Singapore (Papadia 2013).
During the global financial crisis of 2008-2009, Federal Reserve extended USD swap lines to several central banks. The financial institutions in these countries faced USD shortages as the normal channels of money markets froze during crisis.
US Dollar Swap amounts extended during 2008-2009 Global Financial Crisis
China RMB Swap Lines
During the 2007-8 global financial crisis, the international monetary system experienced an acute US dollar shortage that severely curtailed global trade and pressured international banking business (McCauley and McGuire, 2009; McGuire and von Peter, 2009). The US authorities, in response to the elevated strain in the global market, have arranged dollar swap lines with major central banks to mitigate the global dollar squeeze (Aizenman and Pasricha, 2010; Aizenman, Jinjarak and Park, 2011). On Thursday, October 31, 2013, the network of central banks comprises the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve, and the Swiss National Bank agreed to convert their bilateral liquidity swap arrangements to standing arrangements until further notice.1 The dollar squeeze critically illustrated the danger of operating a US-centric global financial system. Against this backdrop, China has actively implemented measures of promoting the cross-border use of the Chinese currency, the renminbi (RMB), to reduce its reliance on the US dollar. The aggressive policy move was considered a clear signal of China’s efforts to internationalize RMB (Chen and Cheung, 2011; Cheung, Ma and McCauley, 2011). In 2009, China launched the scheme of cross-border trade settlement in RMB to encourage the denomination and settlement of international trade in its own currencies. One practical issue of settling trade in RMB is the limited availability of the currency outside China. China at that time had strict regulations on circulating the RMB across its border. To facilitate its RMB trade settlement initiative, China signed its first bilateral RMB local currency swap agreement with the Bank of Korea in December 2008, and the second one with Hong Kong in January 2009. Since then, China has signed various swap agreements with economies around the world.2
The 5th and 6th BRICS summits in 2013–2014 marked a watershed in the evolution of the BRICS group with the establishment of the first BRICS institutions. These included the BRICS New Development Bank, the CRA, the BRICS Business Council and the Think Tanks Council. Although this has weakened the ‘political talk shop’ perception of the group, critics have questioned whether these institutions will have a substantive effect. In particular, doubts have been cast upon the effectiveness of the CRA.
The CRA is modest in size in comparison to the IMF and other similar arrangements such as the Chiang Mai Initiative Multilateralization (CMIM). At this stage the BRICS countries have committed $100 billion to the CRA, with China committing $41 billion, Russia, Brazil and India $18 billion each and South Africa $5 billion. The CMIM reportedly has a reserve pool of $240 billion and the IMF resources of $780 billion. It has been noted that with BRICS’s foreign reserves standing at about $5 trillion, a commitment of 16% would take the CRA pool to $800 billion.
From GLOBAL AND REGIONAL FINANCIAL SAFETY NETS: LESSONS FROM EUROPE AND ASIA
ASEAN +3 CMIM
ASEAN + Japan Korea China
The embryo of an Asian regional safety net arrangement has existed since 1977, when the five founding members of the ASEAN signed the ASEAN Swap Arrangement (ASA)5. Following the Asian crisis and after aborted discussion on the creation of an Asian Monetary Fund, Japan launched the New Miyazawa Initiative in October 1998 amounting to about $35 billion, which was targeted at stabilising the foreign exchange markets of Indonesia, the Republic of Korea, Malaysia, the Philippines, and Thailand6. The initiative was particularly valuable in containing instability in Malaysia’s financial sector, since that country had refused an IMF Stand-By Arrangement. The Japanese manoeuvre was deemed somewhat mutinous, since the IMF was very critical of Malaysia’s approach. But it also cemented the idea that Asia could gather enough resources to sandbag itself during a crisis period so long as Asian countries were united and managed to roll out timely and credible support mechanisms. In Asian countries under IMF programmes, the conditionality associated with the loans included severe fiscal cuts, deep structural reforms, and substantial increases in interest rates to stabilise currency markets. The economic and social cost of the adjustment was so high and abrupt that it provoked social unrest in a number of countries. This would reverberate strongly in the months that followed and leave a lasting scar in relations between Asian countries and the IMF7. This experience fuelled both a willingness to self-insure through accelerated reserve accumulation and to strengthen regional arrangements to reduce the reliance on global financial safety nets. Building on this lesson, the CMI was formalised in May 2000 during the ASEAN+3 Finance Ministers Meeting8. It largely built on the original ASA and bilateral swap agreements involving the PRC, Japan, and the Republic of Korea but was grounded in a broader programme that also included developing Asia’s local currency bond market and introduced a regional economic review and policy dialogue to enhance the region’s surveillance mechanism (Kawai and Houser 2007). The initiative included the new ASEAN members, increasing the total number of parties to the arrangement from 5 to 10. Table A.1 in the appendix highlights the evolution of the CMI. The question of cooperation between the CMI and the IMF quickly became quite heated, with a number of countries arguing that strong ties to the Fund would defeat the initial purpose of the initiative (Korea Institute of Finance, 2012), but the ties were kept nonetheless both to mitigate moral hazard (Sussangkarn, 2011) and to ensure some consistency with conditionality attached to the IMF’s own programmes. After the formal creation of the CMI in 2000, the era of Great Moderation that followed to some degree doused further ambitions to strengthen regional arrangements. As a result, when the global financial crisis hit in 2008, the Asian regional financial safety net proved too modest to play a meaningful role.
Indeed, instead of seeking support under CMI, the Bank of Korea and the Monetary Authority of Singapore sought a swap agreement with the US Federal Reserve for some $30 billion each. The Republic of Korea concluded bilateral agreements with Japan and the PRC that were not related to the CMI. Similarly, Indonesia established separate bilateral swap lines with Japan and the PRC to shore up its crisis buffer and did not resort to the CMI for credit support (Sussangkarn, 2011). The plan to consolidate the bilateral swap arrangements and form a single, more solid, and effective reserve pooling mechanism – which had initially been put forward by the finance ministers of the ASEAN+3 in May 2007 in Kyoto – was accelerated and evolved in several iterations before the final version was laid out more than two years later. In December 2009, the CMI was multilateralised and the ASEAN+3 representatives signed the Chiang Mai Initiative Multilateralisation (CMIM) Agreement, which effectively became binding on March 24, 2010 (BSP, 2012). These successive transformations have strengthened the initiative, but it remains largely untested. In addition, other aspects of any credible regional financial arrangement, such as surveillance capacity and coordination of some basic economic policies, remain relatively embryonic.
From GLOBAL AND REGIONAL FINANCIAL SAFETY NETS: LESSONS FROM EUROPE AND ASIA
The history of European financial safety nets cannot be dissociated from the history of European monetary integration. With this perspective in mind, it dates back to the late 1960s and has been an ongoing debate to this day. The history of European political integration at every turn is marked by failed projects or actual mechanisms of financial solidarity, ranging from loose exchange rate arrangements to the project of a full-fledged European Monetary Fund. The advent of the monetary union was precisely designed to reduce the need for financial safety nets within the euro area. But the architectural deficiencies of the euro area and the lack of internal transfers have required the establishment of alternative mutual insurance mechanisms since the onset of the euro crisis in 2010. In 2008, when the global financial crisis hit, Hungary had accumulated important external imbalances and large foreign exchange exposures. It had to seek financial assistance almost immediately and initiated contacts with the IMF. The total absence of coordination with European authorities came as an initial shock because it showed that despite decades of intense economic, political, and monetary integration, EU countries could still come to require international financial assistance. The experience pushed European institutions to unearth a forgotten provision of the Maastricht Treaty to provide financial assistance through the Balance of Payments Assistance Facility9. This created preliminary and at first ad-hoc coordination between the IMF and the European Commission, which was then rediscovering design and monitoring of macroeconomic adjustment programmes. Despite the rapid use of this facility and the emergence of a framework of cooperation with the IMF, contagion from the global financial crisis continued for months and prompted some Eastern European leaders to seek broader and more pre-emptive support10, which failed. However, beyond official sector participation, there was a relatively rapid realisation that cross-border banking and financial retrenchment could become a major source of financial disruption and effectively propagate the crisis further – including back to the core of Europe, as large European banks were heavily exposed to Eastern Europe through vast and dense networks of branches and subsidiaries. In response, in late February 2009, under the leadership of the European Bank for Reconstruction and Development (EBRD), the European Investment Bank (EIB) and the World Bank decided to establish what was known as the Vienna Initiative. This was designed as a joint multilateral and private sector coordination and enforcement mechanism to reduce the risk of banking sector sudden stops. In particular, it compelled cross-border European banks to continue to provide appropriate liquidity to their branches and subsidiaries in Central and Eastern Europe. The formalisation of such an arrangement11 quite early in the crisis has certainly proven the case for coordination of financial institutions in emerging-market economies, especially when a relatively small number of institutions have a disproportionate impact on capital flows. But with the crisis spreading to the euro area, starting with Greece in the fall of 2010, new regional arrangements proved necessary. The lack of instruments forced European officials to first consider bilateral assistance from member states. The idea of involving the IMF was initially violently rejected 9 on intellectual and political grounds12 but proved inevitable. In a number of successive iterations, more solid regional arrangements were designed (Bijlsma and Vallée 2012). Table A.2 in the appendix shows the evolution of European regional financial safety nets.
List of Regional Financial Agreements (RFA)
Bilateral Currency Swaps
IMF SDR Basket
FX Swap Networks
Global Financial Safety Nets (GFSN)
Foreign Exchange Reserves
Regional Financial Agreements (RFA)
Regional Financial Networks (RFN)
Bilateral Currency Swap Agreement (BSA)
RMB (Renminbi also known as Yuan)
International Lender of Last Resort (ILOLR)
Regional Financial Safety Net (RFSN)
Multilateral Financial Safety Net (MFSN)
National Financial Safety Net (NFSN)
Key Sources of Research:
Self-Insurance, Reserve Pooling Arrangements, and Pre-emptive Financing
Regional Reserve Pooling Arrangements
Suman S. Basu Ran Bi
First Draft: 8 February, 2010 This Draft: 7 June, 2010