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ASEAN and the Heat of Hot Money

November 24, 2010 Leave a comment Go to comments

Elephants Fighting

By Chayut “Peko” Setboonsarng, Intern Scholar, Southeast Asia Program, CSIS

In October, Dr. Prasan Traiatvoraku, the Thai Central Bank governor, expressed his concern over competitive devaluation between the United States and China, given what it could mean for ASEAN countries. “When elephants fight,” he said, “the grass is trampled.”

A large amount of funds are flowing into Asia’s currency markets, causing an unwanted appreciation of local currencies. This makes exports less competitive, an unwelcome development for trade-driven nations. Moreover, these investments are fickle and prone to capital flight as relative interest rates change. They are known to create asset bubbles and financial instability.

Nobel laureate Joseph Stiglitz and Indonesian economist and World Bank Managing Director Sri Mulyani have both recommended the use of capital controls to manage the flow. So far Taiwan, Indonesia, and South Korea have responded with capital controls. Even the Bank of Thailand took the plunge, despite a bitter experience with such controls in 2007. It is likely that Malaysia, Singapore and the Philippines will follow suit. Commercial banks, meanwhile, have resorted to using credit-linked notes to work around controls.

It would be best to turn these inflows into more productive long-term investments. Not all inflows are speculative, but it is not always easy to identify the good from the bad. ASEAN’s central bank governors and finance ministers can start by reinvigorating the spirit of the Chiang Mai Initiative and ASEAN integration. Regional cooperation could be helpful in at least two ways:

  1. Stock exchanges already have trading rooms that monitor currencies and assets for erratic behavior; regional coordination among these trading rooms is a plausible goal. A concerted effort at regional surveillance would help identify speculative from long-term investments. As soon as the Singapore-based ASEAN +3 Macroeconomic and Research Office (AMRO) appoints its first director, financial architecture can be further institutionalized.
  2. The Asian Bond Market Initiative, designed to use the region’s considerable savings to develop local currency denominated bond markets, has been around since 2003, but has been slow to show results.  Developing capital markets around local-currency bonds requires liquid and sound infrastructure – something the Korean market has achieved.  ASEAN bonds are typically rated in the b to BBB range, while Won-denominated assets are in the A, A+ band. In order to attract long-term investment and diminish the inflow of hot money, ASEAN needs to improve its ratings. Under the auspices of ASEAN+3, best practices from South Korea’s successful and stable kimichi bond market should be shared in order to improve financial infrastructure, liquidity, and risk assessment among ASEAN nations.

Interest rates near zero and trading partners’ undervalued currencies can be detrimental, but an agile and coordinated policy response can turn ASEAN’s current predicament to its favor.

Photo by Flickr user shplendid, used under a Creative Commons license.

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