Building Global and Regional Financial Safety Nets February 2016 Yung Chul Park Korea University
1. Need for Global and Regional Financial Safety Nets: Market Failure Financial markets are highly susceptible to market failures. - Overreaction and herding can trigger the sudden reversal of capital inflows tha t provoke a liquidity crisis even in countries with a rational policy regime. A global central bank would ensure an adequate supply of global liqui dity and stability of the prices of globally traded assets. - It would see to it that liquidity crises do not occur and prevent runs on banks. 2
1. Need for Global and Regional Financial Safety Nets: A Second best arrangement Without a global central bank, a second best alternative is to establish a multilatera l currency swap network capable of supplying international liquidity to countries f acing sharp reversals in capital inflows. The current system of global liquidity provision is fragmented and too small in ter ms of size to deal with global or regional crises. IMF lending facilities Regional reserve pooling arrangements such as the CMIM Federal Reserve dollar and foreign currency swap lines with the five major central banks: ECB, BO E, BOJ, BOC, and SNB China s 31 bilateral swaps with other central banks 3
1. Need for Global and Regional Financial Safety Nets: The weaknesses of the existing system IMF and regional financial arrangements such as the CMIM can play a role They are too small to meet the emergency liquidity need, which has grown more than the size of global financial markets. Global investors could take huge negative positions In crisis liquidity needs may become near-infinite. Only central banks have the resources needed to respond to volatile capital flows. 4
1. Need for Global and Regional Financial Safety Nets: Institutionalizing a global currency swap network It is possible to establish a global swap network with the capacity to meet th e liquidity need and the concerns of central bankers (Truman 2010, 2011, 20 13, and Park and Wyplosz 2015). The network also facilitates coordinated actions among central banks to prevent a contraction i n global liquidity. In addition to the five major central banks participating in the Fed system, o ther central banks could join either because they hold large reserves, or beca use of the fear of sudden stops of capital inflows. The list could include the central banks of China, Australia, and New Zealand, and those of the central banks of emerging economies that are active in international finance. 5
2. Global and Regional Financial Safety Nets: US Fed Table 1. Federal Reserve dollar and foreign currency swap lines Number Country Date 1 ECB and SNB (USD) Dec 2007 2 BOJ, BOE, and BOC (USD) Sep 2008 3 ECB, BOE, BOJ, and SNB (without pre-specified limits, USD) Oct 2008 4 9 other central banks (USD) Oct 2008 (terminated Feb 2010) 5 ECB, BOE, BOJ, and SNB (Foreign Currency) Apr 2009 (terminated Feb 2010) 6 ECB, BOE, BOJ, BOC, and SNB (Reestablishing, USD) May 2010 7 ECB, BOE, BOJ, BOC, and SNB (Foreign Currency) Nov 2011 8 Extension of existing swaps through Feb 2014 Dec 2012 9 Conversion of existing swaps to standing arrangements Oct 2013 10 Testing the operational readiness of the swap arrangements Oct 2014 6
2.1 Global and Regional Financial Safety Nets: Ch ina China has established 31 bilateral currency swaps with other central banks a mounting to (3,016.7 billion RMB) Nine of these swaps are with Asian central banks totaling 1,440 billion RM B Regional arrangements ultimately work best as part of a coordinated global system of support. 7
2.1 Global and Regional Financial Safety Nets: Ch ina Table 2. Bilateral Currency Swap Agreements: Asian countries negotiated by China Number Country Amount Date 1 South Korea 360 Oct 2011 2 Hong Kong 400 Nov 2011 3 Thailand 70 Dec 2011 4 Pakistan 10 Dec 2011 5 Malaysia 180 Feb 2012 6 Mongolia 10 Mar 2012 7 Singapore 300 Mar 2013 8 Indonesia 100 Oct 2013 9 Sri Lanka 10 Sep 2014 Total 1,440 8
3. Creating a Global Currency Swap Arrangement The Five major central banks, PBoC, and 8 or 10 other central banks of the countri es active in international finance plus the IMF could be members of a global swap network. In this framework, based on objective criteria, the IMF would determine a need fo r global liquidity to support the international financial system and recommend that central banks consider providing liquidity to private financial institutions in other countries via their central banks (Truman 2013). 9
4. China in the East Asian Economy China holds the key to financial stability in East Asia: Trade. China as the hub for East Asia s regional trade Table 3. Trade with China in East Asia (Continued) Korea (Millions US D) Total Exports To China Share Total Imports From China Share 2000 172,268 18,455 10.7% 160,481 12,799 8.0% 2005 284,419 61,915 21.8% 261,238 38,648 14.8% 2010 466,384 116,838 25.1% 425,212 71,574 16.8% 2015 526,901 137,140 26.0% 436,548 90,237 20.7% 10
4. China in the East Asian Economy Table 3. Trade with China in East Asia (Continued) Japan (Millions Yen ) Total Exports To China Share Total Imports From China Share 2000 51,654,198 3,274,448 6.3% 40,938,423 5,941,358 14.5% 2005 65,656,544 8,836,853 13.5% 56,949,392 11,975,449 21.0% 2010 67,399,627 13,085,565 19.4% 60,764,957 13,412,960 22.1% 2015 ASEAN 69,294,001 12,072,080 17.4% 72,266,410 17,860,385 24.7% (Millions US Total Exports To China Share Total Imports From China Share D) 2000 410,141 14,179 3.5% 348,960 18,137 5.2% 2005 648,147 52,258 8.1% 576,742 61,136 10.6% 2010 1,048,146 118,470 11.3% 950,009 117,749 12.4% 2015 1,292,400 150,407 11.6% 1,236,216 216,119 17.5% 11
4.1 China as a Major Regional Finance Center Stock Price co-movements between China and other East Asian countries Exchange rate co-movements between East Asian currencies and RMB. - One percent change in the RMB/US dollar exchange rate leads to changes in the US dollar exchange rates of some of East Asian currencies from a low of 0.35 in the Philippines to a high of 0.8 percent change in Malaysia. - Stability of the RMB will ensure stability of many of East Asian currencies. - A crisis in any one of the countries in the region and its contagion could destabilize the RMB. 12
4.2 China as a Major Regional Finance Center (co ntinued) 0,9 0,9 0,8 0,8 0,7 0,7 0,6 0,6 0,5 0,5 0,4 0,4 0,3 0,3 0,2 0,2 0,1 0,1 0 Indonesia Korea Malaysia Philippines Singapore Taiwan Thailand 0 Indonesia Korea Malaysia Philippines Singapore Taiwan Thailand % change in Local Currency/$ wrt 1% change in RMB/$ % change in Local Currency/$ wrt 1% change in RMB/$ % change in Local Currency/$ wrt 1% change in Yen/$ % change in Local Currency/$ wrt 1% change in Euro/$ 13
4.2 China as a Major Regional Finance Center (co ntinued) 0,9 0,8 0,7 0,6 0,5 0,4 China needs to bear responsibility for safegu arding regional financial stability participating in the global currency swap netwo rk to help sustain global financial stability. 0,3 0,2 0,1 0 Indonesia Korea Malaysia Philippines Singapore Taiwan Thailand % change in Local Currency/$ wrt 1% change in RMB/$ % change in Local Currency/$ wrt 1% change in Yen/$ % change in Local Currency/$ wrt 1% change in Euro/$ China may convert the 9 bilateral swaps into an Asian swap network consisting of region s central banks centering on the RMB as the d ominant currency. 14
4.2 China as a Major Regional Finance Center (co ntinued) Multilateralizing the Asian currency swap network by institutionalizing bilat eral currency swaps between non-chinese members of the system Allowing conversion of swap proceeds into other major currencies within th e system to a limited amount The Asian swap network should be designed as part of the coordinated glob al network Eventually integrating it with the CMIM 15