## _wp1534 - Section III discusses benefits of further liberalization and regional integration in ASEAN ## Source details **Canonical URL:** [_wp1534 - Section III discusses benefits of further liberalization and regional integration in ASEAN](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2015/_wp1534.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2015/_wp1534.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2015/_wp1534.pdf.json) --- ### Overview and analytical support - Section III discusses benefits of further liberalization and regional integration in ASEAN. - Appendix examines potential capital flows to ASEAN countries using two benchmark open economy models and highlights barriers that typically inhibit cross-border flows and financial integration. - Appendix analysis is used as a stepping stone to discuss policy measures at the national, ASEAN, and regional levels to promote further safe financial development and financial integration. - Discussion linked to ASEAN countries’ commitment to establish the AEC (Section IV). Section V presents brief conclusions. ### Growth, trade integration, and financial integration: main findings and key statistics - Since the turn of the century: - ASEAN-wide economic growth has averaged 5¼ percent per annum (weighted average). - Economies of the individual member countries expanded by 5¾ percent per annum, on average. - Export orientation and trade openness: - Except for Indonesia, Myanmar, and the Philippines, ASEAN countries have sum of imports and exports of goods and services exceeding 100 percent of GDP. - Crisis impact and recovery: - The slump in international trade in 2008–09 caused growth to slow in ASEAN, followed by a pronounced rebound when international trade recovered. - Selected indicators (preserved as reported): - Intra-ASEAN trade value: US$630 billion in 2013. - Intra-ASEAN trade share (excluding Singapore): 23 percent of total ASEAN trade (up from 21 percent in 2000). - Trade openness: several ASEAN countries have imports plus exports of goods and services exceeding 100 percent of GDP (except Indonesia, Myanmar, and the Philippines). ### Intra-ASEAN trade: trends, constraints, and structural shifts - Trends: - Intra-ASEAN trade almost quadrupled since 2000, to US$630 billion in 2013. - Excluding Singapore, intra-ASEAN trade represents 23 percent of total ASEAN trade, up from 21 percent in 2000. - ASEAN intraregional trade remains considerably smaller than the European Union (50 percent of total trade). - Constraints and policy implication: - Recent studies indicate that nontariff measures (NTMs) may be holding back growth of regional trade. - Policy implication: gradual removal of NTMs, consistent with the Strategic Schedule in the AEC 2015 Blueprint, could reinvigorate the creation of the single ASEAN market for goods and services. - Structural shifts: - Regional trade within ASEAN has become increasingly oriented to final consumer goods. - A large and vibrant domestic market and a growing middle class provide potential resilience against global demand shocks. - Intraregional demand is an important driver of ASEAN-5 growth (excluding Indonesia). ### AEC objectives, institutional initiatives, and market infrastructure - AEC four main targets: - (i) fostering a single market and production base with free flow of goods, services, investment, skilled labor, and freer flow of capital within ASEAN; - (ii) developing a highly competitive economic region nurturing fair competition, consumer protection, intellectual property rights, and infrastructure development; - (iii) attaining equitable economic development by strengthening SMEs; - (iv) achieving ever greater integration into the global economy. - AEC Blueprint: - 176 priority actions including nine actions related to free flow of financial services, strengthening ASEAN capital market development and integration, and allowing greater capital mobility. - AEC Scorecard mechanism introduced in 2008 to monitor progress. - Key connectivity and market infrastructure initiatives: - Master Plan on ASEAN Connectivity (2010): (i) Physical Connectivity; (ii) Institutional Connectivity; (iii) People-to-People Connectivity. - Working Committee on Capital Account Liberalization (WC-CAL). - ASEAN Capital Markets Forum (ACMF) for harmonization of laws and market infrastructure. - Working Committee on Payment and Settlement Systems (WC-PSS), endorsed April 2010. - Task Force on the ASEAN Banking Integration Framework (ABIF), endorsed April 2011, aims for ASEAN-wide banking sector liberalization by 2020. - ASEAN Capital Markets Infrastructure (ACMI) Blueprint (2013) and Working Committee on Capital Market Development. ### Policy directions implied by the analysis - Address barriers highlighted in the Appendix that inhibit cross-border flows and financial integration to unlock potential capital flows identified by benchmark open economy models. - Pursue gradual removal of NTMs in line with the AEC 2015 Blueprint Strategic Schedule to deepen the single ASEAN market for goods and services. - Strengthen regional cooperation on capital account liberalization, payment and settlement systems, banking integration, and capital market infrastructure to support safe financial development and integration. - Complement connectivity initiatives with policies addressing cross-border crime, illegal immigration, and environmental degradation. ### Regional surveillance, crisis management, and cooperation arrangements - Institutional developments: - ASEAN Integration Monitoring Office (AIMO) established in 2010 to enhance monitoring capacity. - Chiang Mai Initiative Multilateralization (CMIM), established March 2010 among ASEAN+3, replaced bilateral swap lines; CMIM Precautionary Line introduced. - ASEAN+3 Macroeconomic Research Office (AMRO) operating in Singapore since 2011. - Cooperation with multilateral institutions: - New Delhi communiqué (May 2013) called for “effective cooperative relationship with the International Monetary Fund (IMF) and other multilateral financial institutions in the areas of surveillance, liquidity support arrangements and capacity development.” - Recent initiatives include information sharing on macroprudential policies and capital flow management measures. - Integration scope: - ASEAN+3 and the Regional Comprehensive Economic Partnership (ASEAN+6). - U.S.-ASEAN Expanded Economic Engagement (E3) initiative (late 2012). ### Degree of financial integration, FDI, and portfolio flows - Financial integration and trade: - Degree of financial integration tends to increase with degree of trade integration; Asian economies’ rapid trade expansion has not been matched by commensurate increase in financial integration. - For ASEAN economies, the main channel of financial integration is through FDI flows. - FDI inflows: trends and magnitudes - FDI flows to ASEAN amounted to a record high of US$125 billion in 2013, up 7 percent from 2012. - At almost 9 percent of world FDI inflows, ASEAN’s share of total global FDI is back to pre-Asian crisis levels. - Singapore continues to receive half of all FDI inflows into ASEAN. - The group of 5 other ASEAN countries now account for about 11 percent of FDI inflows into ASEAN. - Rising FDI from China, Japan, and Korea as well as from the United States, Malaysia, and Singapore. - Cross-border portfolio investment: - Cross-border portfolio investment inflows to ASEAN countries have been on a rising trend, with a strong pickup during 2010–12. - ASEAN-5 economies benefited from developing local currency bond markets, Asian Bond Markets Initiative, and linking of stock markets in Malaysia, Singapore, and Thailand. ### Banking integration and cross-border banking exposure (selected figures) - BIS reporting banks’ cross-border exposure to Asia and ASEAN-5 increased during 2012–13. - Bilateral banking integration is particularly low in ASEAN: - ADB (2013): foreign banks accounted for 18 percent of total commercial bank assets in Malaysia, the Philippines, and Thailand in 2009. - Share of ASEAN-based banks in 2009: Malaysia 8.5 percent; Philippines 0.4 percent; Thailand 3.7 percent. - Singapore plays a dominant role as a global financial center; Malaysian banks have expanded abroad significantly. - Relative to GDP, BIS reporting banks’ cross-border assets trended upward vis-à-vis Malaysia, Thailand, and Indonesia in 2012–13; mostly flat in Singapore and the Philippines. ### Financial integration: recent experience and price measures (2013–2014) - Expectations of a reduction in the U.S. Federal Reserve System’s monetary stimulus (“tapering”) ignited capital outflows from the group of ASEAN-5 countries and many other emerging markets in 2013. - An improvement in global risk appetite in the second quarter of 2014 caused capital flows to improve again. - Price measures indicate increasing but incomplete financial integration: - Cross-border interest rate and bond yield differentials have narrowed but remain substantial even after controlling for exchange rate movements. - Comovements in ASEAN interest rates and bond yields have increased; equity market returns show increased comovement even after controlling for global factors. ### A. ASEAN financial sector liberalization: benefits, risks, and institutional barriers - Potential benefits: - Spur financial sector development and product innovation; boost growth, employment, and financial inclusion. - Facilitate development of larger, deeper, and more liquid markets; lower cost of capital; improve resource allocation and risk diversification; lengthen maturity of financing; improve trading and settlement. - Impose greater discipline on governments, banks, and non-bank corporations; increase resilience to shocks. - Distributional/development considerations: - Less-financially developed economies stand to gain most; in most ASEAN countries the outstanding stock of credit to the private sector remains below 50 percent of GDP. - Risks and vulnerabilities: - Poorly supervised financial innovation can harm macroeconomic stability (poor risk management, overexposure to cyclical activities, weak governance, directed/connected lending). - State-owned banks remain significant in several ASEAN countries; directed credit operations can impose quasi-fiscal liabilities. - Cross-border linkages can exacerbate problems and prove costly in a crisis. - Institutional barriers to a common market: - Fragmentation from national regulations and standards, lack of mutual recognition, inconsistent disclosure requirements. - AEC Blueprint calls for regulatory harmonization and strengthened policy coordination. - Regional stability architecture: - A supranational oversight framework and a single resolution regime with a common backstop (e.g., deposit insurance) may be necessary in a single market for financial services. ### B. Reform initiatives, sequencing, and design choices - Recent steps: - 2013 MOU among Securities Regulators of Malaysia, Singapore, and Thailand to establish framework for cross-border trade of collective investment schemes. - ADB (2013) reform proposals (next ten years): - Nurture globally competitive ASEAN-headquartered banks; provide market access preference to ASEAN banks. - Full banking integration (EU-style “single passport”) considered too ambitious; propose partial banking integration with different timelines. - Two-track approach: phase out most restrictions on wholesale banking while delaying liberalization of cross-border retail banking. - Three-dimensional framework: equal access, equal treatment, equal environment; define minimum conditions for Qualified ASEAN Bank (QAB). - Unanswered questions and risks: - Preferential access could reduce efficiency and create too-big-to-fail problems. - Divergent national timelines may lead to “2+x” or “ASEAN minus x” phased approaches. - Need harmonization across licensing, accounting standards, minimum capital, risk management, prompt corrective action (PCA), resolution methods, restrictions on large exposure, anti-money laundering, and consumer protection. - Institutional clarity required for regional cross-border supervision and resolution; trade-offs between subsidiary and branch models. ### C. Lessons from Europe for ASEAN banking integration - Important differences between ASEAN and the EU: diversity in exchange rate regimes, stages of development, political systems, and cultural contexts. - Key lessons/cautions: - Strong political commitment and clear articulation of benefits for each member state necessary. - Identify contagion, spillover, transition, and operational risks; strong policy frameworks must manage these risks. - Banking integration requires institutional and legislative frameworks specifying minimum entry requirements, permissible activities, cross-border supervision and resolution, and regional institutions to set and enforce standards. - Regulatory harmonization is necessary; divergences in implementation can lead to competitive distortions and regulatory arbitrage. - Regulatory harmonization alone may be insufficient; need robust crisis management and burden-sharing frameworks. - Institutional architecture recommendations: - Consider an ASEAN-wide supervisor for oversight of systemic ASEAN banks, avoiding “nationality dominance.” - Strengthen bank resolution frameworks by adopting best international practice and FSB initiatives; eventual need for a single resolution mechanism and a common deposit guarantee scheme (DGS) with common backstops may arise. ### D. ASEAN capital account liberalization: rationale, risks, and sequencing - Infrastructure and investment needs: - ADB (2012) calculates region needs US$0.6 trillion over the next ten years; ASEAN policymakers have recently raised the figure to about US$1 trillion. - Potential benefits of liberalization: - Removal of capital outflow restrictions could increase intra-regional capital flows due to “home bias.” - Increased ASEAN integration could channel investment goods from capital-abundant sources including China, Japan, Korea, and within ASEAN such as Singapore and Malaysia. - Financial integration can accelerate real convergence by facilitating capital deepening. - Risks and necessary complementarities: - Dangers of improperly sequenced liberalization: original sin, sudden stops. - Policy responses: self-insurance (reserve accumulation), taxation measures to internalize externalities, development of labor insurance markets. - IMF institutional view: benefits acknowledged but risks emphasized; no presumption full liberalization appropriate for all countries at all times. - Policy stance for ASEAN: - Gradualist, sequencing-focused approach with regulatory safeguards. - De jure capital account openness varies widely across ASEAN; use of indices (AREAER, Chinn-Ito, Quinn-Toyoda, Schindler) to compare openness. ### Box 2 highlights: De jure indices, net capital flows, and policy sequencing - De jure indices: - Chinn-Ito index measures multiple exchange rates, restrictions on current account transactions, restrictions on capital account transactions, and repatriation requirements. - Quinn-Toyoda and Schindler indices focus on capital account restrictions. - Indices presented on a zero-to-one range; larger number = higher openness. - Patterns across ASEAN: - Singapore: high degree of financial openness since early 1980s; crisis-era restrictions quickly unwound. - ASEAN-4 (Indonesia, Malaysia, the Philippines, Thailand): few restrictions on nonresident trading of domestic securities; some restrictions on residents’ capital account transactions. - Cambodia: phased liberalization from 2001; second most financially open economy in ASEAN in 2011 per Chinn-Ito, but portfolio inflows remain limited. - CLMV: historically low financial openness; Myanmar’s recent liberalization not yet reflected in Chinn-Ito index shown. - Net capital flows and current account balances (2000–12 averages and selected periods) — table excerpts (percent of GDP) preserved exactly: - Indonesia: -2.5 1.8 -3.3 - Malaysia: -5.6 11.9 3.9 - Philippines: -3.7 1.8 3.5 - Singapore: 12.3 18.9 18.3 - Thailand: -6.4 2.9 -0.6 - Brunei: 43.4 44.1 31.5 - Cambodia: -2.8 -3.8 -8.5 - Lao P.D.R.: -6.6 -16.2 -27.7 - Myanmar: ... -0.4 -5.4 - Vietnam: -6.8 -2.3 5.6 - Drivers and policy space: - Net exports of capital in the 2000s reflected official reserve accumulation for self-insurance after the AFC. - With reserves broadly adequate in most ASEAN countries, scope exists for change in intra- and interregional net capital flows. - AEC Blueprint guidance and recommended sequencing: - Ensure orderly liberalization consistent with national agenda and readiness. - Allow adequate safeguards against macroeconomic instability and systemic risk; retain right to adopt necessary measures to ensure macroeconomic stability. - Gradualist approach emphasizing preconditions before next liberalization step. - Empirical research: financial depth and institutional quality are most important preconditions for a positive effect of foreign capital inflows on growth. - Safeguards often retained: - Restrictions on offshore use of currencies; restrictions on external lending in domestic currency; limits on hedging foreign currency risk; restrictions on cross-border trading of forwards and derivatives. ### Financial integration, banking links, and risk mitigation - Integration implications: - Duval and others (2014): greater banking and portfolio integration reduces output comovement in general, but during crisis banking integration appears to increase synchronization. - Kalemli-Ozcan and others (2013): global banks pulling funds away during crisis can amplify output comovement for financially integrated economies reliant on foreign capital. - Regional banking integration may reduce impact of shocks from advanced economies by increasing role of regional banks. - Supervisory and regulatory considerations: - Rapid bank expansion can outpace risk management and supervisory monitoring. - ASEAN has not indicated plans for a single supervisory mechanism; harmonization of regulations is the current trend. - Risk mitigation options while harmonization proceeds: - Greater host control over foreign branches (example: Singapore). - Reciprocity arrangements and mutual recognition based on harmonization (e.g., definition of capital). - Singapore’s MAS measures (verbatim themes preserved): - Set high standards for approving foreign entrants with same prudential qualifications as local banks. - Limited number of foreign branches permitted to accept retail deposits. - Program requiring qualified full banks (QFBs) with large retail presence to locally incorporate retail operations. - Working relationships with home supervisors and engagement with parent bank management. ### Macroprudential, capital flow, and macroeconomic policy responses - Policy toolkit: - Macroprudential tools (tighten housing loans, require higher bank capital) when systemic banking risks arise. - Temporary capital flow management measures may be useful when risks are associated with capital flow surges. - Importance of financial market development: mature systems can handle capital flows without being overwhelmed. - Historical experience: - Malaysia and Indonesia in 2013: narrowing/turning deficits in current accounts led investors to sell assets; decisive macroeconomic policy packages later in 2013 (and early 2014 in Indonesia) helped reverse capital flow reversals. - Trade-offs: - Capital account liberalization can lead to loss of policy independence, prompting need to strengthen fiscal policy and structural reforms. - Harmonization of regulatory and supervisory frameworks can accelerate integration, but inadequate coordination could produce conflicting regulation and fragmentation. - Monetary and financial integration without fiscal or political integration is fraught with danger; unlike the euro area, ASEAN does not share a common currency. ### Regional safety nets, surveillance, and IMF collaboration - Regional safety nets: - May 2012 ASEAN+3 meeting adopted proposal to double CMIM size to US$240 billion and introduce a crisis prevention facility; amended CMIM came into being in July 2014 following ratifications. - IMF cooperation: - Ongoing collaboration in surveillance, liquidity support arrangements, and capacity development. - May 2014 ASEAN+3 meeting endorsed “Guidelines for the further cooperation with the International Monetary Fund.” - IMF contributes research, analysis, seminars, and institution-building support (example: joint seminar in January 2014 with AMRO). ### Conclusions and forward-looking considerations - Further ASEAN intraregional integration (trade, FDI, portfolio investment, cross-border banking) could be an important source of growth, employment, more inclusive development, and resilience to shocks. - Financial integration in ASEAN lags behind the rest of the world; important scope remains for further financial sector and capital account liberalization. - Need for a measured, gradual, and evolutionary approach to financial integration; supranational oversight frameworks and strengthened regional macrofinancial surveillance (e.g., AMRO) and financial safety nets (e.g., CMIM) may be necessary. - Ongoing monitoring of financial systems is critical for early detection of vulnerabilities as countries with low credit-to-GDP ratios catch up; strong credit growth can give rise to financial sector vulnerabilities. - The ASEAN/AEC framework allows more advanced economies to move faster with financial integration; removal of protectionist barriers to regional banking integration would be in their interest once adequate safeguards are in place. ### Appendix 1: Potential capital flows to ASEAN — models, calibration, and quantitative highlights - Frameworks used: - Two benchmark open-economy models: (A) frictionless neoclassical growth model without adjustment costs; (B) model with adjustment costs and frictions. - Key model parameters and assumptions (preserved exactly): - Cobb-Douglas production function with capital share α = 1/3. - Japan’s capital-output ratio k_J/y_J set to 4.75 in calibration. - Frictionless model illustrative calibration (Penn World Table 2011 data used to compute A_i): - Table A1 example outcome variables (selected rows and preserved numeric entries shown in source): - Brunei: Potential Inflows/Pre-flow GDP = 191.1; Potential Output Growth = 114.0; other entries shown: 182.9, 167.6, 247.4, 331.8, 29.5. - Indonesia: Potential Inflows/Pre-flow GDP = 15.1; Potential Output Growth = 10.3; other entries shown: 22.3, 147.3, 18.4, 254.1, 21.4. - Cambodia: Potential Inflows/Pre-flow GDP = 7.2; Potential Output Growth = 3.3; other entries shown: 22.4, 218.3, 10.6, 484.3, 47.7. - Laos: Potential Inflows/Pre-flow GDP = 8.8; Potential Output Growth = 7.5; other entries shown: 20.8, 117.5, 9.5, 110.8, 8.4. - Malaysia: Potential Inflows/Pre-flow GDP = 44.0; Potential Output Growth = 36.9; other entries shown: 61.3, 119.1, 48.0, 119.5, 9.1. - Philippines: Potential Inflows/Pre-flow GDP = 15.2; Potential Output Growth = 11.7; other entries shown: 31.1, 130.0, 17.4, 176.5, 14.0. - Singapore: Potential Inflows/Pre-flow GDP = 121.9; Potential Output Growth = 103.9; other entries shown: 120.3, 117.3, 132.0, 109.6, 8.3. - Thailand: Potential Inflows/Pre-flow GDP = 22.3; Potential Output Growth = 19.5; other entries shown: 38.5, 114.2, 23.9, 91.7, 6.9. - Vietnam: Potential Inflows/Pre-flow GDP = 10.6; Potential Output Growth = 8.3; other entries shown: 24.4, 128.2, 12.1, 167.2, 13.2. - Comparative perspective: Fernandez de Cordoba and Kehoe (2000) found for Spain that required capital flow to equalize German and Spanish notional interest rates would be of order 86 percent of GDP — illustrating frictionless models can imply very large flows. - Sensitivity analysis: - Table A2, Table A3, and Figure A1 show potential inflows (percent of pre-flow GDP) and potential per-worker output growth are highly sensitive to assumptions on recipient TFP (A_i/A_J) and per-worker output (y_i/y_J). Matrices and grids in the source contain exact integer and negative entries for combinations of A_i/A_J and y_i/y_J. - If per-capita output differences reflect adverse TFP terms, potential inflows can be smaller or negative. - Role of adjustment costs and frictions: - Adjustment costs (installation, sectoral bottlenecks, limited mobility) slow pace and reduce size of inflows relative to frictionless model. - Even with adjustment costs similar to literature, predicted inflows remain larger than those observed in practice. - Illustrative quantitative results with adjustment costs (φ = 0.9) — Table A4 excerpts (metric: Change in capital in relation to GDP (in percent): (k_{t+1} - k_t)/y_t; φ = 0.9): - Brunei: 33.1, 8.5, 5.7, 4.2, 3.1, 2.8, 2.6, 1.2 (years following liberalization, excerpted). - Indonesia: 25.4, 4.1, 4.1, 0.3, 2.0, 2.5, 5.6, 2.0, 7.1, 7.0 (excerpted). - Cambodia: 48.4, 4.3, 8.5, 3.6, 0.6, 4.5, 3.3, 5.0, 2.7, 8.3 (excerpted). - Laos: 11.0, 8.8, 1.6, 2.1, 3.4, 1.1, 2.2, 0.9, 5.8, 8.0 (excerpted). - Malaysia: 11.9, 5.7, 1.6, 1.4, 5.1, 2.1, 1.1, 0.2, 8.6 (excerpted). - Philippines: 17.6, 6.5, 2.7, 0.2, 1.9, 1.7, 9.1, 4.8, 1.2, 4.0 (excerpted). - Singapore: 10.9, 6.1, 6.0, 1.3, 3.3, 1.1, 1.9, 4.7, 9.7 (excerpted). - Thailand: 9.1, 7.7, 1.3, 2.1, 1.0, 9.3, 7.9, 6.7 (excerpted). - Vietnam: 16.7, 2.2, 5.4, 2.0, 7.1, 7.0, 1.4, 1.1, 8.0 (excerpted). - Model with adjustment costs: technical highlights - Consumers: discounted utility U = Σ_{t=0}^∞ β^t u(c_t), CRRA u(c) = (c^{1-γ} - 1)/(1-γ). - Firms: Cobb-Douglas α = 1/3, depreciation δ, installation-adjustment costs Ω(I/k) parameterized as in Fernandez de Cordoba and Kehoe (2000) with φ ∈ (0,1). - Investment demand reduces to I_t / k_t = (q_t)^{1/(1-φ)} with Ω'(I_t / k_t) = 1 / q_t. - φ = 0.9 used for simulations (φ = 1 implies no adjustment costs). - Key model takeaways (preserved exactly): - Frictionless models suggest very large potential inflows (examples: Brunei 191.1 percent of pre-flow GDP; Singapore 121.9 percent). - Sensitivity analysis: potential inflows and per-worker output growth highly sensitive to A_i/A_J and y_i/y_J assumptions. - Adjustment costs (φ = 0.9) substantially slow inflows and convergence; frictions explain why observed inflows are much smaller than frictionless predictions. - Binding constraints limiting inflows in practice include: structural investment obstacles; technological and organizational differences; insufficient financial infrastructure (thin bond markets, limited pension systems, bank-dominated systems); policy weaknesses and perceived legal/property risks; concerns about repayment and macro-fiscal vulnerabilities; rising risk premia; and capital account restrictions. ### Steady state calibration and simulation parameters (preserved values) - In steady state determination section, preserved numeric values as reported: - ݎ∗൅ߜൌ0.07 - ݎ∗ൌ0.02 - ߜ ൌ0.05 - ܶൌ40 (years) - Simulation outcomes (Figure A2 series) show time profiles for shadow price of capital ݍ, trade balance in Percent of GDP, investment ݖ, capital stock ݇, per worker output growth rate (in Percent), and change in capital in Percent of GDP for BRN, IDN, KHM, LAO, MYS, PHL, SGP, THA, VNM. *Source: _wp1534 - Section III discusses benefits of further liberalization and regional integration in ASEAN.* ### Section III discusses benefits of further liberalization and regional integration in ASEAN. ### _wp1534 - Section III discusses benefits of further liberalization and regional integration in ASEAN ### Overview and analytical support - Section III discusses benefits of further liberalization and regional integration in ASEAN. - Analysis in the Appendix examines potential capital flows to ASEAN countries using two benchmark open economy models. - The Appendix highlights barriers that typically inhibit cross-border flows and financial integration. - The Appendix analysis is used as a stepping stone to discuss policy measures at the national, ASEAN, and regional levels to promote further safe financial development and financial integration. - The discussion is linked to ASEAN countries’ commitment to establish the AEC (Section IV). Section V presents brief conclusions. ### Growth, trade integration, and financial integration findings - Since the turn of the century: - ASEAN-wide economic growth has averaged 5¼ percent per annum (weighted average). - Economies of the individual member countries expanded by 5¾ percent per annum, on average. - The success of most ASEAN member states has been associated with a long-standing export-oriented development strategy. - Except for Indonesia, Myanmar, and the Philippines, ASEAN countries have sum of imports and exports of goods and services exceeding 100 percent of GDP. - The slump in international trade in 2008–09 triggered by the global financial crisis (GFC) caused growth to slow in ASEAN, followed by a pronounced rebound when international trade recovered. ### Intra-ASEAN trade: trends and constraints - Intra-ASEAN trade almost quadrupled since 2000, to US$630 billion in 2013. - Excluding Singapore, intra-ASEAN trade represents 23 percent of total ASEAN trade, up from 21 percent in 2000. - ASEAN intraregional trade remains considerably smaller than the European Union (50 percent of total trade). - Recent studies indicate that nontariff measures (NTMs) may be holding back the growth of regional trade in ASEAN. - Policy implication noted: gradual removal of NTMs, consistent with the Strategic Schedule in the AEC 2015 Blueprint, could reinvigorate the creation of the single ASEAN market for goods and services. - China’s rising importance as a trading partner for ASEAN reflects increasing trade in intermediate goods as ASEAN countries and China integrate into supply chain networks. ### Structural shifts in ASEAN trade - Regional trade within ASEAN has become increasingly oriented to final consumer goods. - A large and vibrant domestic market and a growing middle class provide the region with potential resilience against global demand shocks. - Cubero and others (2014) find that, besides global demand, intraregional demand is an important driver of ASEAN-5 growth (excluding Indonesia, which has a lower trade-to-GDP ratio and sends the bulk of its commodity-heavy exports outside ASEAN). ### Selected economic indicators (highlights from Table 1) - Intra-ASEAN trade value: US$630 billion in 2013. - Intra-ASEAN trade share (excluding Singapore): 23 percent of total ASEAN trade (up from 21 percent in 2000). - Trade openness: several ASEAN countries have imports plus exports of goods and services exceeding 100 percent of GDP (except Indonesia, Myanmar, and the Philippines). - Sources for indicators include: IMF, World Economic Outlook; Direction of Trade Statistics; Coordinated Direct Investment Survey; Coordinated Portfolio Investment Survey; World Bank, World Development Indicators; CEIC Data Co.Ltd; country authorities; Bankscope; and IMF staff calculations. ### AEC objectives and initiatives supporting financial integration - The AEC has four main targets: - (i) fostering a single market and production base with a free flow of goods, services, investment, and skilled labor, and freer flow of capital within ASEAN; - (ii) developing a highly competitive economic region nurturing fair competition, consumer protection, intellectual property rights, and infrastructure development; - (iii) attaining equitable economic development by strengthening SMEs; - (iv) achieving ever greater integration into the global economy. - The AEC Blueprint lays out 176 priority actions including nine actions related to: - free flow of financial services; - strengthening ASEAN capital market development and integration; - allowing greater capital mobility. - An AEC Scorecard mechanism was introduced in 2008 to monitor progress on the Blueprint’s milestones and priority actions. Key initiatives to support ASEAN financial integration - In 2010, ASEAN leaders adopted the Master Plan on ASEAN Connectivity, comprising: - (i) enhancing Physical Connectivity (transportation, ICT, energy infrastructure); - (ii) improving Institutional Connectivity (procedures to facilitate international transactions of goods, services, and cross-border movement of skilled workers); - (iii) strengthening People-to-People Connectivity (socio-cultural initiatives such as education and tourism). - Cross-border challenges from connectivity improvements include cross-border crime, illegal immigration, and environmental degradation. - Cross-border collaboration and market infrastructure initiatives: - Working Committee on Capital Account Liberalization monitors implementation of priority actions for freer flow of capital per the AEC Blueprint. - ASEAN Capital Markets Forum (ACMF) focuses on harmonization of domestic laws and regulations and development of market infrastructure to integrate equities markets. - Working Committee on Payment and Settlement Systems (WC-PSS), endorsed April 2010, focuses on policy, legal frameworks, instruments, institutions, and market infrastructure. - Task Force on the ASEAN Banking Integration Framework (ABIF), endorsed April 2011, aims for ASEAN-wide banking sector liberalization by 2020. - Working Committee on Financial Service Liberalization focuses on further liberalization of the banking and insurance sectors. - ASEAN Capital Markets Infrastructure (ACMI) Blueprint developed in 2013; Working Committee on Capital Market Development aims to enable ASEAN issuers and investors to access cross-border ASEAN equity and bond markets through integrated access, clearing, custody, and settlement arrangements. ### Policy directions implied by the analysis - Address barriers highlighted in the Appendix that inhibit cross-border flows and financial integration to unlock potential capital flows identified by benchmark open economy models. - Pursue gradual removal of NTMs in line with the AEC 2015 Blueprint Strategic Schedule to deepen the single ASEAN market for goods and services. - Strengthen regional cooperation on capital account liberalization, payment and settlement systems, banking integration, and capital market infrastructure to support safe financial development and integration. - Complement connectivity initiatives with policies addressing cross-border crime, illegal immigration, and environmental degradation. *Source: _wp1534 - Section III discusses benefits of further liberalization and regional integration in ASEAN.* ### Box 1. ASEAN and ASEAN Economic Community (AEC): A Brief Chronology (concluded) ### Box 1. ASEAN and ASEAN Economic Community (AEC): A Brief Chronology (concluded) ### Initiatives to strengthen regional economic surveillance and crisis management - The ASEAN Integration Monitoring Office (AIMO) was established in 2010 to enhance the ASEAN Secretariat’s monitoring capacity in tracking progress of regional economic integration. - The Chiang Mai Initiative Multilateralization (CMIM), established in March 2010 among the ASEAN+3 countries, is a multilateral currency swap arrangement that replaced the pre-existing Chiang Mai Initiative (CMI)’s network of bilateral swap lines. - A crisis prevention facility, the CMIM Precautionary Line, has been introduced. - An independent regional macroeconomic surveillance unit—the ASEAN+3 Macroeconomic Research Office (AMRO)—has been operating in Singapore since 2011. - In their New Delhi communiqué of May 2013, ASEAN+3 Ministers of Finance and Central Bank Governors called for an “effective cooperative relationship with the International Monetary Fund (IMF) and other multilateral financial institutions in the areas of surveillance, liquidity support arrangements and capacity development.” - Recent initiatives include information sharing on macroprudential policies and capital flow management measures. - Initiatives to expand integration scope include ASEAN+3 and the Regional Comprehensive Economic Partnership (ASEAN+6; comprising ASEAN countries and Australia, China, India, Japan, Korea, and New Zealand). - The U.S.-ASEAN Expanded Economic Engagement (E3) initiative, agreed in late 2012, calls for expanding trade and investment and engaging with regional institutions. - Further progress in advancing regional surveillance and strengthening crisis management institutions, including in their analytical capacity and cooperation with the IMF, is high on ASEAN’s agenda. ### Degree of financial integration and its relationship with trade integration - Typically, a country’s degree of financial integration tends to increase with its degree of trade integration. - Pongsaparn and Unteroberdoerster (2011) note that compared with the rest of the world, most Asian economies’ rapid expansion into global trade has not been matched by a commensurate increase in their degree of financial integration. - For ASEAN economies, the main channel of financial integration is through FDI flows. - Pongsaparn and Unteroberdoerster (2011) estimate a model relating the degree of financial integration (measured by countries’ ratio of capital flows to GDP) to country characteristics including trade integration, relative GDP growth, interest and exchange rate movements, and exchange rate volatility, using a panel of 90 advanced and emerging markets. - Except for the financial centers of Hong Kong SAR and Singapore, the degree of financial integration of many Asian economies is below the level predicted by the model for all economies, and in several cases falls behind the norm for Latin America and Eastern Europe. ### FDI inflows: recent trends, magnitudes, and drivers - FDI inflows are generally regarded as a desirable form of capital inflows because they bring capital, improved technology, and knowledge spillovers that can result in total factor productivity growth (TFP) in recipient countries. - Net FDI flows to emerging and developing countries have consistently been positive during the past three decades (Park and Takagi, 2012). - Recent trends and the outlook for FDI flows to ASEAN are favorable: - FDI flows to ASEAN amounted to a record high of US$125 billion in 2013, up 7 percent from 2012. - At almost 9 percent of world FDI inflows, ASEAN’s share of total global FDI is back to the level during the boom years preceding the Asian financial crisis. - The rising trend in FDI inflows, in U.S. dollar terms and in relative terms, applies equally to: - the group of ASEAN-4 countries (Indonesia, Malaysia, the Philippines, and Thailand), - Singapore (which continues to receive half of all FDI inflows into ASEAN), - the group of 5 other ASEAN countries (which now account for about 11 percent of FDI inflows into ASEAN). - Figure 1 (UNCTAD) shows a generally rising trend in FDI flows to ASEAN countries from China, Japan, and Korea (the “plus-3” countries), as well as from the United States and Malaysia and Singapore. - Factors helping make ASEAN an attractive investment destination: - Wage costs in manufacturing in ASEAN have been declining relative to China owing to divergent demographics and exchange rate movements. - The favorable trend in relative wage costs is expected to continue in the coming years, reflecting the stronger labor force growth in ASEAN. - Geopolitical considerations and ASEAN’s growing middle class could also drive more FDI into ASEAN. - ASEAN’s commitment to form a single market and production base can be expected to reduce trade and investment barriers and provide economies of scale. - The U.S.-ASEAN Expanded Economic Engagement initiative calls for expanding trade and investment and engaging with regional institutions. - A World Bank (2014) study finds that foreign ownership restrictions are still common in ASEAN countries, particularly in the services sector; relaxing these restrictions could give rise to substantial productivity-enhancing FDI inflows and provide an impetus to structural transformation and convergence of the emerging and frontier economies in ASEAN. ### Banking integration and cross-border banking exposure - The level of banking integration in ASEAN is rising but from a low base; global banks have a bigger footprint in ASEAN than regional banks. - BIS locational banking statistics indicate that BIS reporting banks’ cross-border exposure to Asia and ASEAN-5 countries in U.S. dollar terms increased during 2012–13. - Deleveraging from the euro area and Eastern Europe continued, and banks’ cross-border assets in Latin America were flat in 2012–13. - BIS reporting banks’ cross-border liabilities have, for the most part, been little changed over the past two years. - Relative to GDP, the value of BIS reporting banks’ cross-border assets trended upward vis-à-vis Malaysia, Thailand, and Indonesia in 2012–13; it remained mostly flat in Singapore and the Philippines. - Bilateral banking integration is particularly low in ASEAN: - ADB (2013) reports that foreign banks accounted for 18 percent of total commercial bank assets in Malaysia, the Philippines, and Thailand in 2009. - The share of ASEAN-based banks in Malaysia was 8.5 percent in 2009; the share was 0.4 percent in the Philippines and 3.7 percent in Thailand. - Duval and others (2014) calculate that the level of bilateral banking integration in Asia has continued to lag the rest of the world and that it is particularly low among ASEAN-5 countries. - Banks are likely to lead ASEAN financial integration given opportunities from European banks deleveraging and the prospects of the ASEAN Economic Community. - Singapore plays a dominant role in regional financial integration as one of the largest financial centers in the world; Malaysian banks have also expanded abroad significantly. ### Cross-border portfolio investment trends - Cross-border portfolio investment inflows to ASEAN countries have been on a rising trend. - Relative to GDP, cross-border portfolio investment in Asia and other emerging markets has remained well below that of the euro area (Pongsaparn and Unteroberdoerster, 2011). - The bulk of Asia’s portfolio investment has remained interregional (with economies outside the region), especially after adjusting for the role of Hong Kong SAR and Singapore in intermediating inflows from outside the region. - In the euro area, by contrast, portfolio investment is mostly intraregional. - ASEAN economies experienced a strong pickup in portfolio investment during 2010–12, following the temporary retreat caused by the global financial crisis. - Advanced economies’ unprecedented liquidity-easing measures to mitigate the effects of the global financial crisis were a key contributing factor to the acceleration of portfolio flows to ASEAN countries. - ASEAN-5 economies may have received a relatively larger share of these inflows by virtue of ongoing progress in developing local currency bond markets, the Asian Bond Markets Initiative, and the linking of stock markets in Malaysia, Singapore, and Thailand. - Data on inflows in equity and bond funds for ASEAN-5 countries show that overall portfolio flows surged in the first four months of (text truncated in source). *Source: UNCTAD; BIS; ADB (2013); Duval and others (2014); Pongsaparn and Unteroberdoerster (2011); Park and Takagi (2012); World Bank (2014).* ### 2013. After that, expectations of a reduction in the U.S. Federal Reserve System’s monetary ### _wp1534 - 2013. After that, expectations of a reduction in the U.S. Federal Reserve System’s monetary ### Financial integration: recent experience and price measures - Expectations of a reduction in the U.S. Federal Reserve System’s monetary stimulus (“tapering”) ignited capital outflows from the group of ASEAN-5 countries and many other emerging markets in 2013. - An improvement in global risk appetite in the second quarter of 2014 caused capital flows to improve again. - Price measures indicate increasing financial integration in ASEAN, but incomplete: - Cross-border interest rate and bond yield differentials have narrowed in recent years, but remain substantial even after controlling for exchange rate movements. - Comovements in ASEAN interest rates and bond yields have increased; this may reflect increasing integration with the global market and/or improving fundamentals (such as lower inflation rates and differentials and improved sovereign credit ratings). - Increased comovements in equity market returns, even after controlling for global factors, suggest that stock markets are more integrated than money and bond markets. ### Toward further financial integration in ASEAN: context and objectives - Most ASEAN countries are at an early stage of development and have large infrastructure gaps; further liberalization of inter- and intraregional flows (goods, services, capital) could boost growth, jobs, and inclusion. - ASEAN Economic Community (AEC) objective: create a common market with “free movement of goods, services, investment, skilled labor, and freer flow of capital” (ASEAN, 2008, p.5). - The AEC process is multiyear and flexible (“ASEAN Way”), allowing individual member countries to liberalize at their own pace contingent on readiness and strengthened policy frameworks and institutions. - Regular review and coordination: Working Committee on Capital Account Liberalization (WC-CAL) and Working Committee on Capital Market Development meet to review progress (example: 27th meeting held in Myanmar in February 2014). ### A. ASEAN financial sector liberalization: what is at stake? - Potential benefits of financial integration: - Spur development of financial sector and product innovation; boost growth, employment, and financial inclusion. - Facilitate development of larger, deeper, and more liquid markets; lower cost of capital; improve resource allocation and risk diversification; lengthen maturity of financing; improve trading and settlement. - Impose greater discipline on governments, banks, and non-bank corporations; increase resilience to shocks. - Distributional and development considerations: - Less-financially developed economies stand to gain most; in most ASEAN countries the outstanding stock of credit to the private sector remains below 50 percent of GDP. - These less-developed countries also currently have the highest credit growth. - Risks and vulnerabilities: - Poorly supervised financial innovation and development can harm macroeconomic stability (examples: poor risk management, overexposure to cyclical activities, weak governance, directed/connected lending). - State-owned banks remain significant in several ASEAN countries; directed credit operations can impose quasi-fiscal liabilities and impinge on private bank profitability. - Cross-border linkages can exacerbate problems and prove costly to output, international reserves, and public finances in a crisis. - Institutional barriers to a common market: - Fragmentation caused by national regulations and standards (bank supervision, rating agencies, credit bureaus, securities commissions), lack of mutual recognition, and inconsistent disclosure requirements. - AEC Blueprint calls for regulatory harmonization and strengthened policy coordination. - Regional stability architecture: - A supranational oversight framework and a single resolution regime with a common backstop (e.g., deposit insurance) may be necessary in a single market for financial services. ### B. ASEAN financial sector liberalization: reform initiatives and design choices - Recent steps: - In 2013, Securities Regulators of Malaysia, Singapore, and Thailand signed an MOU to establish a framework for cross-border trade of collective investment schemes. - ADB (2013) reform proposals for the next ten years: - Nurture globally competitive ASEAN-headquartered banks; provide market access preference to ASEAN banks to allow growth and potential global foothold via mergers/acquisitions. - Full banking integration (EU-style “single passport”) considered too ambitious for the next ten years; propose partial banking integration with different timelines for member states, supported by regulatory harmonization and policy coordination. - Two-track approach: phase out most remaining restrictions on wholesale banking while delaying liberalization of cross-border retail banking (deposit taking). - Three-dimensional framework: equal access, equal treatment, equal environment; define minimum conditions for Qualified ASEAN Bank (QAB) eligibility (minimum capital adequacy, consolidation and consolidated supervision authority, restrictions on large exposure, minimum accounting and transparency). - Unanswered questions and risks identified: - Preferential access for ASEAN banks could reduce efficiency and competition and create too-big-to-fail problems. - Divergent national timelines and political economy considerations may lead to “2+x” or “ASEAN minus x” phased approaches where front-runners proceed and others join later. - Harmonization needs to extend across licensing, accounting standards, minimum capital, risk management, prompt corrective action (PCA) and resolution methods, restrictions on large exposure, anti-money laundering, and consumer protection. - Institutional clarity required for regional cross-border supervision and resolution; choice between subsidiary and branch models has trade-offs and depends on supervisory quality and systemic importance. - Success depends on active cooperation between public and private sectors; national authorities must design reforms with private sector collaboration. ### C. Lessons from Europe for ASEAN banking integration - Important differences between ASEAN and the EU: diversity in exchange rate regimes, stages of economic and financial development, political systems, and cultural contexts. - Key lessons and cautions: - Strong political commitment and clear articulation of benefits for each member state are necessary. - Need clear identification of contagion, spillover, transition, and operational risks; strong national and regional policy frameworks must manage these risks. - Banking integration requires sound institutional and legislative frameworks specifying: (i) minimum regulatory entry requirements; (ii) permissible banking activities consistent with development objectives; (iii) regional arrangements for cross-border supervision and resolution; (iv) (new) regional institutions to set and enforce standards. - Regulatory harmonization is necessary; wide divergences in national implementation of common directives in the EU led to competitive distortions and regulatory arbitrage. - Regulatory harmonization and coordination alone may be insufficient for financial stability; the absence of robust national and EU-wide crisis management frameworks in 2008 exposed vulnerabilities (lack of burden sharing led to national ring-fencing and market segmentation). - Institutional architecture recommendations: - Consider an ASEAN-wide supervisor for oversight of systemic ASEAN banks, with powers to maintain general oversight and intervene when necessary; governance must avoid “nationality dominance” and maintain a regional perspective. - Strengthen bank resolution frameworks by adopting best international practice and FSB initiatives; eventual need for a single resolution mechanism and a common deposit guarantee scheme (DGS) with common backstops may arise, though political resistance is expected due to burden-sharing concerns. ### D. ASEAN capital account liberalization: rationale, risks, and sequencing - Infrastructure and investment needs: - Despite high overall savings in the region, investment needs are huge, including infrastructure. ADB (2012) calculates region needs US$0.6 trillion over the next ten years; ASEAN policymakers have recently raised the figure to about US$1 trillion. - Capital flows from within and outside the region could supplement domestic savings and reduce round-tripping of regional savings through advanced-economy financial centers. - Potential benefits: - Removal of capital outflow restrictions could increase intra-regional capital flows due to “home bias.” - Increased ASEAN integration and openness could channel investment goods from capital-abundant sources (including the “plus three”: China, Japan, and Korea, and from within ASEAN such as Singapore and Malaysia). - Financial integration can accelerate real convergence by facilitating capital deepening; countries at early development stages should receive larger inflows with gains for growth and poverty reduction. - Risks and necessary complementarities: - Neoclassical view omits dangers of improperly sequenced liberalization: original sin (foreign-currency short-term borrowing for long-lived projects), “sudden stops” of foreign capital. - Appropriate policy responses include self-insurance (international reserves accumulation) and taxation measures to internalize externalities, and address incomplete labor insurance markets. - IMF institutional view (IMF, 2012, 2013c): acknowledges benefits of capital flow liberalization (resource allocation efficiency, technological improvement, higher investment, consumption smoothing) while emphasizing risks (higher volatility, vulnerability to capital account crises), especially for countries lagging in financial/institutional development. - Benefits of liberalization are greatest when financial/institutional development is adequate and macroeconomic situation is sound; no presumption that full liberalization is appropriate for all countries at all times. - Policy stance for ASEAN: - ASEAN capital account integration agenda is gradualist, emphasizing correct sequencing and regulatory safeguards to protect against capital flow volatility. - Capital account openness varies widely across ASEAN; de jure indices (sourced from AREAER) can be used to compare openness and assess scope to increase it. *Source: IMF staff paper excerpt (contents provided in the supplied PDF content).* ### Box 2. De jure indices of capital account openness in ASEAN countries ### Box 2. De jure indices of capital account openness in ASEAN countries ### De jure indices and measurement - Indices referenced: - Chinn-Ito index: measures four categories of restrictions on external transactions: (i) the presence of multiple exchange rates; (ii) restrictions on current account transactions; (iii) restrictions on capital account transactions; and (iv) requirements regarding the repatriation of export proceeds. - Quinn-Toyoda and Schindler indices: focus on capital account restrictions (see Vargas (2014) in source). - The three de jure indices are presented on a common zero-to-one range, where a larger number represents a higher level of capital control openness. - The chart ranks countries by their score on the Quinn-Toyoda index and shows substantial correlation across the three indices. ### Patterns of de jure openness across ASEAN members - Singapore: - Has maintained a high degree of financial openness since the early 1980s. - Restrictions introduced around the time of the Asian financial crisis (AFC) were quickly unwound. - ASEAN-4 (Indonesia, Malaysia, the Philippines, and Thailand): - Maintain only few restrictions on the buying and selling of domestic securities by nonresidents. - Reflected in relatively high de facto financial openness (for example, level of actual cross-border portfolio flows). - Some restrictions apply to capital account transactions by residents. - In the aftermath of the AFC and the GFC, introduced or intensified some restrictions on current account transactions, including regarding repatriation of export proceeds and verification procedures for service payments. - Cambodia: - According to the Chinn-Ito index, phased liberalization from 2001 onward made Cambodia the second most financially open economy in ASEAN in 2011. - Capital flows are mostly FDI and official grants; portfolio inflows remain limited (low de facto financial openness) given developing domestic financial markets. - CLMV (Cambodia, Lao P.D.R., Myanmar, Vietnam) generally: - Historically displayed relatively low financial openness. - Did not tighten capital account restrictions with the onset of the GFC, perhaps reflecting limited exposure to volatile portfolio flows. - Myanmar’s recent liberalization and unification of the exchange rate is not yet reflected in the Chinn-Ito index shown in the chart. ### Comparative classification and implications - Comparison with other emerging market economies suggests ASEAN-4 countries are not as open in de jure classifications. - The three indices (Quinn-Toyoda, Chinn-Ito, Schindler) put ASEAN-4 among emerging market economies with less open capital accounts. ### Net capital flows and current account balances (2000–12 averages and selected periods) - Key observation: over the period 2000–12, only four ASEAN countries were net capital importers: Lao P.D.R., Cambodia, and, to a lesser extent, Vietnam and Myanmar. - Net capital exporters during 2000–12: - Indonesia, the Philippines, and Thailand: average current account surpluses of about 2 percent of GDP per annum during 2000–12. - Malaysia: net capital exports averaged 12 percent of GDP per annum during this period. - Table 4. Current account balances (presented in source as percent of GDP for periods 1990−97 (Avg.), 2000−12 (Avg.), and 2013): - Indonesia: -2.5 1.8 -3.3 - Malaysia: -5.6 11.9 3.9 - Philippines: -3.7 1.8 3.5 - Singapore: 12.3 18.9 18.3 - Thailand: -6.4 2.9 -0.6 - Brunei: 43.4 44.1 31.5 - Cambodia: -2.8 -3.8 -8.5 - Lao P.D.R.: -6.6 -16.2 -27.7 - Myanmar: ... -0.4 -5.4 - Vietnam: -6.8 -2.3 5.6 - (Source noted in original: IMF, WEO.) ### Drivers of past net capital exports and policy space - ASEAN countries’ net exports of capital in the 2000s reflected accumulation of official reserves for self-insurance and precautionary purposes after the AFC. - With reserves now broadly adequate in most ASEAN countries, there is scope for a change in the direction of intra- and interregional net capital flows. - Park and Takagi (2012) note that relatively tighter controls on outflows have discouraged capital inflows from within ASEAN while encouraging inflows from advanced countries outside the region. ### Policy guidance and recommended sequencing for liberalization - ASEAN AEC Blueprint guidelines for capital account liberalization: - Ensure an orderly capital account liberalization consistent with member countries’ national agenda and readiness of the economy. - Allow adequate safeguards against potential macroeconomic instability and systemic risk arising from liberalization, including the right to adopt necessary measures to ensure macroeconomic stability. - Ensure that the benefits of liberalization will be shared by all ASEAN countries. - Recommended approach: - Gradualist approach emphasizing careful sequencing and establishing preconditions before moving to the next liberalization step (Ishii and others, 2002). - Maintain certain restrictions that provide safeguards against speculation and prevent buildup of financial sector risk while thresholds for upgrading macroeconomic and financial policy frameworks have not been met. - Empirical research suggests financial depth and institutional quality are the two most important preconditions for a positive effect of foreign capital inflows on economic growth. - Specific restrictions often retained as safeguards: - Restrictions on the offshore use of almost all ASEAN countries’ currencies. - Restrictions on external lending in domestic currency. - Limits on the ability of investors to hedge foreign currency risk. - ADB (2013) proposes retaining restrictions on cross-border trading of forwards and derivatives as well as on offshore currency use. ### Financial integration, banking links, and risk mitigation - As AEC financial integration goals are realized, ASEAN banking links are likely to expand further. - Integration implications: - Duval and others (2014): greater banking and portfolio integration between two economies reduces output comovement in general, but during crisis (such as the GFC) banking integration appears to increase synchronization of cycles. - Kalemli-Ozcan and others (2013): global banks pulling funds away from all countries during crisis can amplify output comovement for financially integrated economies reliant on foreign capital flows. - Regional banking integration may reduce impact of financial shocks originating in advanced economies by increasing the role of regional banks. - Supervisory and regulatory considerations: - Rapid bank expansion can outpace bank risk management and supervisory monitoring; uneven supervisory quality in host markets can mask vulnerabilities. - ASEAN has not indicated plans for a single supervisory mechanism; harmonization of regulations (including securities markets) is the current trend. - Options to mitigate risks while harmonization proceeds: - Greater host control over foreign branches (example: Singapore). - Reciprocity arrangements and mutual recognition based on a degree of harmonization (e.g., definition of capital) for supervisory cooperation. - Singapore’s MAS measures: - Set high standards for approving foreign entrants with the same prudential qualifications as locally incorporated banks. - Limited the number of foreign branches permitted to accept retail deposits. - Adopted a program requiring qualified full banks (QFBs) with large retail presence to locally incorporate retail operations. - Established good working relationships with home supervisors and engages parent bank management to ensure they take responsibility for risks identified in branches’ operations. ### Macroprudential, capital flow, and macroeconomic policy responses - Policy toolkit: - Macroprudential tools: tighten conditions for housing loans, require banks to hold more capital, etc., when risks originate in the banking system. - Temporary capital flow management measures: may be useful when risks are associated with capital flow surges. - Importance of financial market development: mature financial systems can handle capital flows without being overwhelmed (BNM Governor Zeti Akthar Aziz quote in source). - Historical experience: - Malaysia and Indonesia in 2013: narrowing/turning deficits in current accounts led investors to blame overly loose macroeconomic policies and sell assets; decisive macroeconomic policy packages later in 2013 (and early 2014 in Indonesia) helped reverse capital flow reversals. - Trade-offs and broader policy implications: - Capital account liberalization can lead to a loss of policy independence, prompting a need to strengthen fiscal policy and structural reforms. - Harmonization of regulatory and supervisory frameworks can accelerate financial integration, but inadequate coordination across regional initiatives could produce conflicting regulation and greater regulatory fragmentation. - Monetary and financial integration without fiscal or political integration, as illustrated by Europe, is fraught with danger for heterogeneous economies; unlike the euro area, ASEAN does not share a common currency, allowing exchange rate movements to help absorb shocks. ### Regional safety nets, surveillance, and IMF collaboration - Regional safety net developments: - May 2012 ASEAN+3 meeting adopted proposals to double the CMIM’s size to US$240 billion and to introduce a crisis prevention facility; the amended CMIM came into being in July 2014 following required ratifications. - IMF cooperation: - Ongoing collaboration in surveillance, liquidity support arrangements, and capacity development. - May 2014 ASEAN+3 meeting endorsed “Guidelines for the further cooperation with the International Monetary Fund.” - IMF contributes research, analysis, seminars, and institution-building support (for example, joint seminar in January 2014 with AMRO) and shares macrofinancial expertise with AMRO. ### Conclusions and forward-looking considerations - Further ASEAN intraregional integration (trade, FDI, portfolio investment, cross-border banking) could be an important source of growth, employment, more inclusive development, and resilience to shocks. - Financial integration in ASEAN lags behind the rest of the world; important scope remains for further financial sector and capital account liberalization. - Need for a measured, gradual, and evolutionary approach to financial integration; supranational oversight frameworks and strengthened regional macrofinancial surveillance (e.g., AMRO) and financial safety nets (e.g., CMIM) may be necessary. - Ongoing monitoring of financial systems is critical for early detection of vulnerabilities as countries with low credit-to-GDP ratios catch up; strong credit growth can give rise to financial sector vulnerabilities. - The ASEAN/AEC framework allows more advanced economies to move faster with financial integration; once adequate safeguards are in place, removal of protectionist barriers to regional banking integration would be in their interest. *Source: Box 2. De jure indices of capital account openness in ASEAN countries, from the provided IMF content unit.* ### Appendix 1. Potential Capital Flows to ASEAN: The Sky is the Limit? ### Appendix 1. Potential Capital Flows to ASEAN: The Sky is the Limit? ### Overview - Increased ASEAN integration and openness could unleash large capital flows into relatively capital-scarce ASEAN countries as capital accounts are liberalized further. - Capital could flow from capital-abundant countries including the “plus three” (China, Japan and Korea) and from elsewhere within ASEAN (e.g. Malaysia and Singapore). - The Appendix presents two benchmark open-economy models that underscore the potential for large capital inflows to ASEAN, especially to frontier economies (e.g. Cambodia, Lao P.D.R., Myanmar, and Vietnam), and discusses barriers that inhibit cross-border flows. ### A. Capital Flows to ASEAN in a Neoclassical Growth Model Without Adjustment Costs - Framework and assumptions: - Single-sector Cobb-Douglas production function: Y_i = A_i K_i^α L_i^{1-α}, with intensive form y_i = A_i k_i^α. - Marginal product of capital: r_i = α A_i k_i^{α-1} or in intensive form r_i = α y_i / k_i. - Capital share α is set to 1/3. - Japan (J) represents the advanced creditor country; i denotes an ASEAN country. - Frictionless setting: notional rates of return to capital equalize across countries after liberalization in a single period. - Key derived relationships (as presented): - Relative return to capital: r_i / r_J = (A_i / A_J)^{1/3} (y_J / y_i)^{2/3}. (A2) - Potential capital flow (relative to pre-flow GDP) expressed in terms of Japan’s capital-output ratio k_J/y_J, per-worker output ratio y_i/y_J, and pre- and post-liberalization per-worker capital ratios k_i/k_J and k_i^*/k_J. (A3–A8) - Potential per-worker output growth rate (post- versus pre-liberalization): y_i^*/y_i = (y_i/y_J)^{-1/3} (A_i/A_J)^{1/3} ((A_i/A_J)^{1/3} (y_i/y_J)^{-1/3})^{1-1} — summarized in Equation (A9) as a function of y_i/y_J and A_i/A_J. ### Calibration and Illustrative Results (Table A1) - Calibration data sources and choices: - Penn World Table (Feenstra, Inklaar, and Timmer, 2013) used to calibrate A_i for nine ASEAN countries (Myanmar data not available) and Japan. - Output-side real GDP in 2011 (PPP, millions of 2005 U.S. dollars) for Y_i. - Capital stock in 2011 (PPP, millions of 2005 U.S. dollars) for K_i. - Number of persons engaged in economic activity in 2011 (millions) for L_i. - Cobb-Douglas with α = 1/3 used to compute A_i by A_i = Y_i / (K_i^α L_i^{1-α}). - Japanese capital-output ratio k_J/y_J set to 4.75. - Table A1 (excerpted outcome variables shown in source): - Columns reported include: y_i / y_J, k_i / k_J, A_i / A_J, r_i / r_J, y_i^*/y_J, Potential Inflows/Pre-flow GDP, Potential Output Growth. - Example rows (values preserved as in source table segment): - Brunei: Potential Inflows/Pre-flow GDP = 191.1; Potential Output Growth = 114.0; other entries shown in table segment: 182.9, 167.6, 247.4, 331.8, 29.5. - Indonesia: Potential Inflows/Pre-flow GDP = 15.1; Potential Output Growth = 10.3; other entries shown: 22.3, 147.3, 18.4, 254.1, 21.4. - Cambodia: Potential Inflows/Pre-flow GDP = 7.2; Potential Output Growth = 3.3; other entries shown: 22.4, 218.3, 10.6, 484.3, 47.7. - Laos: Potential Inflows/Pre-flow GDP = 8.8; Potential Output Growth = 7.5; other entries shown: 20.8, 117.5, 9.5, 110.8, 8.4. - Malaysia: Potential Inflows/Pre-flow GDP = 44.0; Potential Output Growth = 36.9; other entries shown: 61.3, 119.1, 48.0, 119.5, 9.1. - Philippines: Potential Inflows/Pre-flow GDP = 15.2; Potential Output Growth = 11.7; other entries shown: 31.1, 130.0, 17.4, 176.5, 14.0. - Singapore: Potential Inflows/Pre-flow GDP = 121.9; Potential Output Growth = 103.9; other entries shown: 120.3, 117.3, 132.0, 109.6, 8.3. - Thailand: Potential Inflows/Pre-flow GDP = 22.3; Potential Output Growth = 19.5; other entries shown: 38.5, 114.2, 23.9, 91.7, 6.9. - Vietnam: Potential Inflows/Pre-flow GDP = 10.6; Potential Output Growth = 8.3; other entries shown: 24.4, 128.2, 12.1, 167.2, 13.2. - Comparative perspective: - Fernandez de Cordoba and Kehoe (2000) found for Spain that the capital flow required to equalize German and Spanish notional interest rates would be of the order of 86 percent of GDP — illustrating that frictionless models can imply very large flows. ### Sensitivity Analysis (Table A2, Table A3, Figure A1) - Sensitivity to TFP and per-worker output: - Table A2 and Figure A1 show how potential capital inflows (in percent of recipient pre-inflow GDP) vary with different assumptions about recipient country TFP (A_i/A_J) and output per worker (y_i / y_J). - Lower-right portions of matrices indicate that if per-capita output differences are attributable to adverse TFP terms, capital inflows can be smaller or negative. - Potential per-worker output growth: - Table A3 and Figure A1 present potential per-worker output growth for combinations of recipient country TFP and output per worker implied by Equation (A9). - Graphical grids (values as presented in source): - Grids include numeric matrices and plotted series for A_i/A_J values ranging from 1.8 down to 0.1 and y_i / y_J values from 0.10 up to 1.90. Entries in these grids include many exact integers and negative values as shown in the source figures. ### B. The Effect of Adjustment Costs and Frictions on Capital Flows to ASEAN Countries - Role of adjustment costs and frictions: - Adjustment costs (installation costs, sectoral bottlenecks, limited intersectoral mobility) and other frictions slow the pace and reduce the size of capital inflows relative to the frictionless model. - Even with frictional adjustment costs similar to those reported in the literature, predicted capital inflows remain much larger than those actually observed in practice. - Frictions and constraints listed (verbatim themes from source): - Structural factors: - Structural obstacles to investment limit current account deficits and capital flows. - Infrastructure upgrading is still needed in Indonesia, the Philippines, and Thailand. - Technological factors: - Differences in productivity of capital across countries may reflect organization of production and externalities (e.g., “learning by doing”). - Insufficient financial infrastructure: - Limited capacity to channel capital flows efficiently; thin local currency bond markets; limited private pension funds; rudimentary local currency settlement arrangements. - ASEAN financial systems are bank dominated; regional banking integration plans have considerable way to go. - New bank capital rules could limit bank growth; bank financing alone may be insufficient for infrastructure financing. - Pension systems provide relatively limited coverage; private pension schemes (third pillars) are being developed in some countries. - Credit market constraints due to limited suitable domestic collateral assets. - Policy weaknesses (actual or perceived): - Uncertain or turbulent macroeconomic prospects limit capital inflows and can lead to capital flight. - Perceived risk of confiscatory taxation, exchange controls, unclear property rights, uneven application of laws and contracts; related to dollarization in some frontier economies. - Concerns about repayment: - Large sustained current account deficits plus domestic macro-fiscal vulnerabilities can raise market concerns; historical example: in the eight years before the Asian financial crisis some ASEAN countries averaged about 6 percent of GDP per annum current account deficits (Lao P.D.R., Malaysia, Thailand and Vietnam). - Rising risk premia: - Difficulty for market participants to distinguish fundamentals from exuberance leads to higher required risk premia, which limit flows. - Capital account restrictions: - Discussed in the main text of the paper (Section III.D). - Illustrative quantitative results with adjustment costs (Table A4): - The model produces gradual convergence of capital-labor ratios and per-capita incomes; results for adjustment costs similar to those in literature are shown in Table A4. - Table A4 reports change in capital in relation to GDP (in percent) across years following liberalization for selected ASEAN countries under parameterization with φ = 0.9 (where φ = 1 implies no adjustment costs and instantaneous inflows). - Example time-path excerpt (years following liberalization, φ = 0.9) preserved from source table segment: - Brunei: Year-following liberalization entries: 33.1, 8.5, 5.7, 4.2, 3.1, 2.8, 2.6, 1.2 (presented in table layout). - Indonesia: 25.4, 4.1, 4.1, 0.3, 2.0, 2.5, 5.6, 2.0, 7.1, 7.0 (excerpted). - Cambodia: 48.4, 4.3, 8.5, 3.6, 0.6, 4.5, 3.3, 5.0, 2.7, 8.3 (excerpted). - Laos: 11.0, 8.8, 1.6, 2.1, 3.4, 1.1, 2.2, 0.9, 5.8, 8.0 (excerpted). - Malaysia: 11.9, 5.7, 1.6, 1.4, 5.1, 2.1, 1.1, 0.2, 8.6 (excerpted). - Philippines: 17.6, 6.5, 2.7, 0.2, 1.9, 1.7, 9.1, 4.8, 1.2, 4.0 (excerpted). - Singapore: 10.9, 6.1, 6.0, 1.3, 3.3, 1.1, 1.9, 4.7, 9.7 (excerpted). - Thailand: 9.1, 7.7, 1.3, 2.1, 1.0, 9.3, 7.9, 6.7 (excerpted). - Vietnam: 16.7, 2.2, 5.4, 2.0, 7.1, 7.0, 1.4, 1.1, 8.0 (excerpted). - Note: in the source, Table A4 headers indicate the metric is "(Change in capital in relation to GDP (in percent): (k_{t+1} - k_t)/y_t)" and φ = 0.9 is the adjustment-cost parameter used (φ = 1 implies no adjustment costs). ### C. Capital Flows to ASEAN in a Model with Adjustment Costs (Model Details) - Consumers: - Representative infinitely-lived households maximize discounted utility: U = Σ_{t=0}^∞ β^t u(c_t), with β ∈ (0,1). - Period utility u(c) is CRRA: u(c) = (c^{1-γ} - 1)/(1-γ). - Households supply one unit of labor inelastically and hold assets composed of installed capital and foreign bonds. - Market price of installed capital at date t is q_t. International bonds bear world interest rate r_t^* (exogenous). - Budget constraint and Euler condition yield standard intertemporal relations; with the calibration choice β (r^*_{t+1}) such that β (1 + r^*_{t+1}) = 1 implies constant consumption path c^*. - Firms: - Perfectly competitive firms with Cobb-Douglas technology and α = 1/3; TFP A assumed constant over time. - Capital depreciates at rate δ per period. - Installation of new capital goods subject to adjustment costs: capital accumulation equation k_{t+1} = Ω( I_t / k_t ) k_t + (1-δ) k_t, where Ω satisfies sign and curvature properties. - Adjustment cost parameterization (Fernandez de Cordoba and Kehoe (2000) specification): Ω(I/k) = (1/φ) (δ + (I/k))^{1-φ} ( (I/k) )^{φ/(1-φ)} with φ ∈ (0,1). Source sets φ = 0.9 for simulations. - First-order condition for investment: Ω'(I_t / k_t) = 1 / q_t. (A20) - Investment demand schedule reduces to I_t / k_t = (q_t)^{1/(1-φ)}. (A21) - Investment Euler equation links shadow price q_t to expected future marginal product of capital, depreciation, and adjustment-cost-related terms (A22). - Equilibrium and steady state: - Feasibility constraint (per worker): c_t + I_t + (1 + r_t^*) b_t = A k_t^α + (1 + r_t^*) b_{t-1}. (A23) - Trade balance defined by b_t - (1 + r_t^*) b_{t-1} = A k_t^α - c_t - I_t. - A perfect-foresight equilibrium is sequences {q_t, k_t, I_t, c_t, b_t} that satisfy optimization and market clearing. - Steady state conditions: k_{t+1} = k_t = k̄, I_{t+1} = I_t = Ī, and Ω(Ī/k̄) = (δ + Ī/k̄)^{1-φ}/φ = (δ)^{1-φ}/φ when Ī/k̄ = δ; Ω'(Ī/k̄) = 1. ### Key Takeaways and Implications (from the Appendix analysis) - Frictionless neoclassical models suggest very large potential capital inflows to capital-scarce ASEAN countries following complete liberalization, driven by large marginal product of capital differentials relative to advanced creditors (e.g., Japan). - Calibrations using 2011 Penn World Table data and Japan’s capital-output ratio (4.75) yield substantial potential inflows for many ASEAN countries (examples: Brunei 191.1 percent of pre-flow GDP; Singapore 121.9 percent). - Sensitivity analysis shows potential inflows and potential per-worker output growth are highly sensitive to assumptions about recipient TFP (A_i/A_J) and initial per-worker output (y_i/y_J); adverse TFP can reduce or reverse predicted inflows. - Incorporating realistic adjustment costs (φ = 0.9) substantially slows the pace of inflows and convergence; adjustment costs and other frictions explain why observed inflows are much smaller than frictionless predictions. - Binding constraints that limit capital inflows in practice include: structural investment obstacles and infrastructure gaps; technological and organizational differences; insufficient financial infrastructure (thin bond markets, limited pension systems, bank-dominated systems); policy weaknesses and perceived risks to property/contract enforcement; concerns about repayment and macro-fiscal vulnerabilities; rising risk premia; and existing capital account restrictions. - The models highlight the potential benefits of financial liberalization and integration for ASEAN growth and development, while underscoring the importance of addressing hard and soft infrastructure, financial market development, and policy credibility to realize those potential gains. *Source: Appendix 1. Potential Capital Flows to ASEAN: The Sky is the Limit?* ### 1. The steady state capital- and output-labor ratios are pinned down by the world interest rate ### 1. The steady state capital- and output-labor ratios are pinned down by the world interest rate ### Steady state determination - The steady state is pinned down by the world interest rate and the marginal productivity condition as stated in the source: ݎ∗ ݇ܣߙൌߜ൅ and ݕ௦௦ ݇ܣൌ௦௦ ఈ. (Text presents the marginal productivity condition in original notation.) - The steady state capital ݇௦௦ is given by ݇௦௦ൌቀ ఈ஺௥∗ାఋቁభభషഀ (expression preserved as in source). - The model assumes Japan is in a steady state at period ൌ0ݐ. ### Parameter choices and calibration - Using the estimation of capital per worker and the TFP term, the authors obtain ݎ∗൅ߜൌ0.07. - The simulation sets ݎ∗ൌ0.02 and ߜ ൌ0.05. - The economy is solved to reach a steady state in a sufficiently large number of periods ܶ; in the simulation, ܶൌ40 (years). ### Simulation setup - The authors solve for an equilibrium path in which the economy approaches the steady state over ܶൌ40 (years). - Figures (Figure A2) display time profiles for: - Shadow Price of Capital ݍ - Trade balance in Percent of GDP - Investment ݖ - Capital Stock ݇ - Per Worker Output Growth Rate (in Percent) - Change in Capital in Percent of GDP - Country series included in the simulations (as labeled in Figure A2) are: BRN, IDN, KHM, LAO, MYS, PHL, SGP, THA, VNM. ### Simulation results and dynamics - Before ASEAN capital-account liberalization: - The shadow value of installed capital ݍ௧ is high initially, reflecting economy-wide relative scarcity of capital. - Capital accumulation is correspondingly high. - Capital inflows are gradual (in contrast to the frictionless model). - Over time, the shadow price of capital falls and the economy approaches the steady state in which investment merely replaces units of capital depreciated. - Investment and consumer demand both drive early capital inflows. - After increased openness to capital flows: - Openness leads to consumption and investment booms as domestic households and firms smooth consumption and augment plant and equipment. - Firms respond to adjustment costs by reducing investment relative to the frictionless model, yet capital inflows are quite high. - Households, correctly anticipating higher future incomes, finance the shortfall between permanent and disposable incomes through foreign borrowing, intermediated by domestic banks. - In the absence of liquidity constraints, consumers maintain a constant optimal rate of consumption as in Equation (A14). ### Key quantitative values (preserved exactly) - ݎ∗൅ߜൌ0.07 - ݎ∗ൌ0.02 - ߜ ൌ0.05 - ܶൌ40 (years) *Source: _wp1534 - 1. The steady state capital- and output-labor ratios are pinned down by the world interest rate* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/wp/2015/_wp1534.pdf_