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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

6. An Asian Currency Unit for Asian Monetary Integration

Masahiro Kawai

In recent years East Asia has seen rapid advances in market-driven economic integration through international trade, investment, and finance. Growing economic integration has strengthened macroeconomic links across East Asia, suggesting that it is increasingly important for the region’s economies to achieve intraregional exchange rate stability. Furthermore, given that East Asia—comprising mainly the ASEAN+3 countries—is expected to become the world’s largest economic bloc by 2020, it is natural to expect this region to eventually have its own globally accepted, international currency.

In reality, however, the region remains characterized by diverse, uncoordinated exchange rate regimes. Japan and the People’s Republic of China (PRC), the two largest economies in East Asia, respectively adopt a pure float and a tightly managed US dollar-based regime. Other economies—except for the small open economies of Hong Kong, China and Brunei Darussalam—adopt intermediate regimes of managed float with the US dollar as the most important anchor currency.

In this paper the author argues that East Asia needs a framework for exchange rate policy coordination. An obvious regional anchor currency that leads this coordination might be the yen or the yuan, given the large size and spillover impacts of Japan and PRC in the region. However, the yen’s power waned in the 1990s and 2000s—due to both Japan’s lost decade following the bursting of asset price bubbles and population aging—though it is fully convertible internationally and still has the potential to play a critical role. With PRC’s strong growth, the yuan’s international role will inevitably rise over time, but the usefulness of the yuan will long remain limited for international settlement, clearance, financing, and liquidity holding due to the lack of full convertibility. These two factors suggest that there is a need for introducing a basket of appropriately weighted East Asian currencies—called the Asian Currency Unit (ACU) where the weights of the yen and the yuan are relatively large—as the region’s common reference. An ACU could facilitate various types of regional exchange rate policy coordination.

An important policy challenge for the region today is to manage large and rapid capital inflows. With the robust economic recovery and the prospect of an imminent tightening of monetary policy, large amounts of capital are already flowing into Asia. To manage even larger capital inflows and maintain macroeconomic and financial sector stability, any economy should allow greater exchange rate flexibility but without damaging the country’s international price competitiveness. The best policy strategy for the region is to allow collective currency appreciation vis-à-vis the US dollar and the euro, while maintaining relatively stable intraregional rates. Such collective exchange rate appreciation of the East Asian currencies would require a coordinated approach to exchange rate regime choice. Here an ACU index should prove useful, as it measures collective changes of East Asian exchange rates against the US dollar and the euro and allows analysis of the divergence of regional currencies from the ACU.

The immediate step for such coordination would be for the region’s authorities to discuss exchange rate issues as part of enhanced regional economic surveillance and policy dialogue, for which an ACU index will be a useful instrument. The next step would be to promote convergence of exchange rate regimes in East Asia in order to achieve some degree of intraregional rate stability; the most realistic option is for emerging East Asian economies to adopt similar managed floating regimes. This can be done through, for example, the adoption of a common SDR-plus currency basket regime based on the SDR (which is a basket of the US dollar, the euro, the pound sterling, and the yen) plus emerging East Asian currencies. Use of the ACU for foreign exchange reserve holding, bond issuance, and bank deposits and loans would further promote the role of the ACU.

More formal mechanisms for intraregional exchange rate stability based on the ACU could be developed in the future by reducing the weights of the US dollar, the euro, and the pound in the SDR-plus basket. But this step would require substantial convergence across economies in the region in terms of political, economic, institutional, and social conditions.