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Message from ADB's President Contributors Acknowledgements Executive Summary and Recommendations Jeffrey D. Sachs, Masahiro Kawai, Jong-Wha Lee, and Wing Thye Woo Paper Summaries (full papers downloadable) International Monetary Advisory Group Global Financial Crisis, its Impact on India and the Policy Response Nirupam Bajpai To What Extent Should Capital Flows be Regulated? Maria Socorro Gochoco-Bautista The Case for a Further Global Coordinated Fiscal Stimulus Willem Buiter Managing a Multiple Reserve Currency World Barry Eichengreen From the Chiang Mai Initiative to an Asian Monetary Fund Masahiro Kawai An Asian Currency Unit for Asian Monetary Integration Masahiro Kawai The International Monetary System at a Crossroad Felipe Larrain B. Towards a New Global Reserve System Joseph Stiglitz A Realistic Vision of Asian Economic Integration Wing Thye Woo An Asian Monetary Unit? Charles Wyplosz Will US fiscal Deficits Undermine the Role of the Dollar as Global Reserve Currency? If So, Should US Fiscal Policy be geared to Preserving the International Role of the Dollar? Yongding Yu International Monetary Working Group International Reserves and Swap Lines: the Recent Experience Joshua Aizenman, Donghyun Park and Yothin Jinjarak The Future of the Global Reserve System Daniel Gros, Cinzia Alcidi, Anton Brender, and Florence Pisani Renminbi Policy and the Global Currency System Yiping Huang Will the Renminbi Emerge as an International Reserve Currency? Jong-Wha Lee Asia's Sovereign Wealth Funds and Reform of the Global Reserve System Donghyun Park and Andrew Rozanov Reforming International Monetary System Kanhaiya Singh Designing a Regional Surveillance Mechanism for East Asia: Lessons from IMF Surveillance Shinji Takagi

12. International Reserves and Swap Lines: the Recent Experience

Joshua Aizenman, Donghyun Park and Yothin Jinjarak

The global crisis has witnessed an unprecedented rise of swap agreements between central banks of larger economies and their counterparts in smaller economies. This chapter explores whether such swap lines can reduce the need for reserve accumulation. The evidence indicates that there is only limited scope for swaps to substitute for reserves. For one thing, swap lines are extended only to fundamentally sound emerging markets, and to important trade partners. Crucially, sound fundamentals include ample foreign-exchange reserves. The highly selective nature of swap recipients means that only a small minority of developing countries will have access to swap facilities. Moreover, large central banks provide liquidity support only when it is in their self-interest. When market confidence is shattered, as happened in the case of the Republic of Korea during the 4th quarter of 2008, reserves fail to perform their precautionary function, even if the economy has sound fundamentals. The timing of market movements suggests that the Bank of Korea's swap agreements with the US Fed played a pivotal role in calming down market hysteria over a possible dollar shortage.

Although overall there is only limited substitutability between swap lines and reserve accumulation, deepening swap lines and regional reserve pooling arrangements such as the Chiang Mai Initiative may weaken the precautionary motive for reserve accumulation. The Chiang Mai Initiative requires more concrete and specific governance structure and implementation details. Formalizing and institutionalizing swap lines will help transform them from temporary anti-crisis measures to more long-term mechanisms for liquidity support. These measures will make it less likely that Asia will gravitate toward the dollar standard.