By Soyoung Kim

To strengthen macroeconomic and financial stability in the region, ASEAN+3 countries established a regional financing arrangement called the Chiang Mai Initiative Multilateralization (CMIM) to provide U.S. dollar liquidity through currency swap transactions when members experience balance of payments and/or short-term liquidity difficulties.

With deepening regional trade and financial integration, ASEAN+3 economies have frequently used local currency to settle trade and financial transactions in the region. In this context, is it possible to use local currencies, in addition to the U.S. dollars, in the CMIM? Let’s explore the plausibility of local currency contribution to the CMIM arrangements.

Costs and Benefits of Local Currency Contribution to CMIM

There are potential benefits of local currency contribution to the CMIM arrangement. It is efficient and costless if borrowers need local currencies to settle trade or finance matters when they are faced with balance of payments and/ or short-term liquidity difficulties because they will not need to exchange local currencies to U.S. dollar. At the same time, lenders can decrease the burden of drawing on foreign exchange reserves. Moreover, there are various externalities associated with greater local currency usage too, such as promoting trade and financial integration in the region and weakening over-dependence on the U.S. dollar.

But when borrowers do not need local currencies, local currency contribution is inefficient and costly as local currency has to be exchanged to U.S. dollars. In addition, exchanging local currency for U.S. dollars may increase the instability of local currencies and the possibility of crisis contagion. Therefore, the first issue is to analyze whether ASEAN+3 members need local currency when they are faced with balance of payments and/ or short-term liquidity difficulties.

When local currency is not needed, the costs of local currency contribution to CMIM arrangement can be high if local currencies are unstable. In this regard, the stability of local currencies should be examined. In addition, it is also important to consider several features, such as the level of internationalization of the local currency and liberalization of capital account transactions, when implementing local currency contributions to CMIM arrangements.

Demand for Local Currencies in Foreign Exchange Reserves and the CMIM

The overall demand for foreign exchange reserves is inferred; and four measures suggested in past studies are considered to determine it. These include three months of imports, 100 percent of short-term debts, 20 percent of money supply (M2), and the IMF comprehensive rule which comprises a set of broad factors.

To further infer the demand for local currencies in foreign exchange reserves or the CMIM, we multiply each of the above measures by the likely portion of local currency demand out of total demand. The likely portion is inferred from data on local currency shares of the relevant types of transactions.

The results show substantial demand for local currencies in foreign exchange reserves in the ASEAN+3 region. The demand for local currencies is far larger than the maximum amount of withdrawal from CMIM based on all measures, except for the first measure using three months of imports, which is somewhat out of date. The results suggest demand for introducing local currency contribution to CMIM arrangements.

Net Demand for Local Currencies in the CMIM

The net demand for local currencies in the CMIM is inferred by subtracting estimated actual foreign exchange reserves from the demand for local currencies in foreign exchange reserves. The results show that net demand for local currency in the CMIM is positive. This result suggests there is room for introducing local currency contribution to CMIM arrangements, even after considering the current level of local currency in actual foreign exchange reserves. However, the results should be interpreted with caution because the data used in this analysis, especially the estimates for actual foreign exchange reserves, are not perfect.

Stability of Local Currencies

Another factor that should be examined is the stability of local currencies compared with that of international reserve currencies, such as the Euro, the U.K. pound, Canadian dollar and Swiss franc. According to our analysis, the volatility of any local currency is clearly not larger than that of international reserve currencies. However, this does not necessarily mean that local currencies are as stable as the popular international reserve currencies. ASEAN+3 economies tend to have more rigid exchange rate regimes in place, and that may explain the low volatility of their currencies.

With respect to the exchange market pressure index, instead of simply considering exchange rate movements, the measure also considers the degree of foreign exchange management. In that way, the measure tries to capture the size of the fundamental source of exchange rate instability that each member faces.

Some conservative results from our analysis indicate that the currencies of several ASEAN+3 members (China, Japan, Korea, and Vietnam) are as stable as popular non-U.S. international currencies for various sub-periods. In recent years, the currencies of China, Japan and Korea have been as stable as those of the U.K., Canada and Euro, and even more stable than those of Australia and Switzerland. Similarly, the currencies of other members such as Hong Kong, Myanmar and Vietnam are also as stable as those of Australia and Switzerland.

Internationalization of Local Currencies and Liberalization of Capital Account Transactions

When currencies are more internationalized and members have more liberalized capital account transactions, borrowers are likely to feel more comfortable receiving such local currencies, given that the management and exchange of such currencies are easier. Therefore, the internationalization of the currency and liberalization of capital account transactions are important in implementing local currency contribution to the CMIM arrangement.

Various measures of internationalization of currencies show that the Japanese yen is one of the most popular international currencies in the world with a liberalized capital account. Meanwhile, the level of internationalization of the RMB is almost the same as that of the Swiss franc, but China still has a high degree of capital controls in place. The Singapore dollar, Hong Kong dollar and Korean won are next in terms of the level of internationalization, while the degree of capital controls in these economies is low.

Taking into account stability and internationalization of the currency, and liberalization of capital account transactions, it is suggested that the Japanese yen, the RMB, and Korean won could first be considered as eligible for local currency contribution to the CMIM arrangements. 

* For detailed analysis, please refer to AMRO collaborative research on local currency contribution to the CMIM.

* This article is the fourth part of a blog series that explores the possibility of local currency contribution to the CMIM in the ASEAN+3 region. Read Part 1, Part 2 and Part 3 of the series.