May 13, 2009AsiaChinaEast AsiaEconomyForeign Affairs

No room in Chiang Mai

China’s geoeconomic move to strengthen its geopolitical power in Asia

This is an archived blog post from The Acorn.

A few days ago, China, Japan, South Korean and the ASEAN states agreed to set up a US$120 billion to manage currency volatility. The Chiang Mai Initiative (CMI) primarily reduces the member countries’ dependency on the International Monetary Fund. It deliberately excludes India.

Here’s an excerpt from an EIU report on the development:

But does it make sense to compare the CMI to the IMF? Given that the meeting of G20 countries in London in early April resulted in pledges to triple the IMFs reserves, from US$250bn to US$750bn, the expansion in the CMI does not initially look too impressive. Moreover, the severity and synchronisation of the global crisis imply a need for a much larger pool of emergency funding. But US$120bn is still a sizeable amount, arguably enough to allow the CMI to deal with crises in several countries (the IMF bail-out of South Korea in 1997-98 cost US$57bn). A lack of IMF conditionality might also encourage countries to make preventative use of the CMI, and thus to act to before external imbalances became unmanageable.

At the same time, however, the global crisis has changed views of the IMFs correct role, and of the effectiveness of free-market policies. The IMF has now conceded that its loans need not always have stringent policy conditions. Its new Flexible Credit Line (FCL) embodies this view, as the FCL is designed to be used as a contingency by countries with sound economic fundamentals. To some eyes, the creation of the FCL obviates the need for a special Asian fund. Why bother setting up an Asian facility when the IMF already has a similar programme, and one that no longer carries the stigma that it used to? But although recent moves by Mexico, Poland and Colombia to tap the FCL should encourage others to do the same, Asian suspicion of IMF lending will persist. In any event, an increase in the absolute pool of funds potentially available to ASEAN + 3 countries is welcome, given the severity of the global crisis and the possibility that crises in other regions will create heavy demand for IMF funds.

At the same time, the CMI may not prove to be quite as hassle-free as potential users may imagine. In part for political reasons, countries that act as suppliers” of foreign exchange—mainly China and Japan—are highly unlikely to impose the sort of formal austerity conditions associated with IMF lending. But they will still expect to see measures taken to ensure that they get their money back when the currency swaps expire. If a recipient” country is in such straits that this looks unlikely, the donor may be reluctant to conduct the swap. Alternatively, reserve-rich countries like China may be tempted tacitly to extract political concessions from recipients in return for access to swaps, complicating the entire process and increasing the potential for diplomatic friction. At first glance, the CMI may help the likes of China and Japan to be seen as coming to the rescue of their neighbours. But if wrongly handled, the scheme could backfire and cause them to be perceived as seeking to exploit the crisis for strategic gain. [EIU, emphasis added]

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