The roundtable brought together 24 experts on financial systems and financial policy from Japan and Europe to discuss the role of regional financial stability mechanisms with special focus the European Stability Mechanism and the Chiang Mai Initiative. The following is a summary of the keynote speech by Professors Pascha and Roevekamp, the statements made by the two commentators, Professor Yoshino and Dr. Meyerhoefer, and the discussion among all participants.
Presentation on Institutionalizing Regional Financial Stability
by Frank Roevekamp and Werner Pascha
Financial crises can have distinctive regional characteristics as seen during the Asian financial crisis of 1997/98 and the crisis of the euro area starting from 2010. Regional financial arrangements (RFAs) could therefore be considered as a helpful complement to global mechanisms, particularly to the IMF.
The presentation on the issue started with an overview of the evolving role of the IMF. Especially after the Asian crisis a move towards stronger regional mechanisms could be observed. The Chiang Mai Initiative was launched in 2000. In the wake of the euro zone crisis the European Stability Mechanism (ESM) was established in 2012.
RFAs can have positive effects, if a crisis is of regional scope and if it supports the ownership of countermeasures and reform efforts. RFAs may however also cause redundancies and lead to coordination problems, if crisis-countries start bargaining with the RFA and the IMF and if the interests of the regional and global mechanism are not well aligned. The potential for moral hazard behaviour and measures to avoid it may be one appropriate viewpoint to design RFAs and to set their relationship to the IMF.
A comparison between the ESM and the CMIM (Chiang Mai Initiative Multilateralization) revealed important difference of these RFAs in areas like governance, organization, instruments and processes. A few points stand out: The fund size of the ESM (€700bn) is much bigger than that of the CMIM ($240bn). The CMIM is working furthermore without any paid-in capital. The ESM provides aid under strict conditionality conditions; the according process is “outsourced” to the EU-Commission, the ECB and the IMF. The application of conditionality for CMIM stability support remains unclear on the other hand for the part not linked to the IMF. Finally the ESM has been tested in practice and is providing aid to euro zone countries whereas the CMIM has not been activated yet, even in times of crisis.
For the CMIM to become a functioning RFA a clarification of its conditionality framework is required. It furthermore needs to gain operating credibility. To work with a certain amount of paid-in capital is one proposal to serve this purpose. Also the ESM however is still facing policy challenges rooted in moral hazard issues as evidenced by the current issues with Greece.
There are a number of important issues that need to be solved when evaluating and redesigning regional financial arrangements. How successfully can the character of a shock be identified, exemplified by the case of Laos? Even if such an identification issue can be solved, how will this be possible under the constraints of an actual crisis unfolding? In this context, there are considerable issues of statistical data collection and dissemination that need to be addressed. Another issue is how to deal with crisis situations, i.e. the question of appropriate instruments. From the domestic context, deposit insurance schemes could serve as an important comparative case. A critical issue when considering instruments is the willingness to face structural problems and the political problems involved. What is potential for ex-post punishments? A related topical issue is the acceptability of fiscal transfers and to what extent solidarity among members is accepted even under stressful conditions. The topical question of newly emerging multilateral development bank schemes as supported by China must also be considered.
In addition to the technical and financial element of financial assistance programs and currency unions, the political facet of any bilateral or multilateral arrangement is key. Only if the political commitment towards a closer integration – including fiscal issues (affecting the roles of national parliaments) and ultimately possible political harmonization – is there at the highest political level, a reliable assistance mechanism that is strong enough to weather times of crisis will emerge. The clear outline of rules and the political will to accept them also in times of financial distress, will convince respective donor countries to contribute to a common currency scheme in a financially significant way. Rules may come at the cost of inflexibility, but no rules will divide national fiscal stances within one currency union and ultimately, as history has shown, let the union disintegrate.
Facilitation between donors and creditors within a currency scheme leaves a significant role to the IMF. The institution may work as the necessary fresh pair of eyes that brings in the external perspective. In addition, the IMF is comparatively insulated against political manoeuvring that will take place within any currency scheme’s multi-layer, multi-player environment.
Summary of discussion
The presentation stimulated a lively discussion around the following topics:
- ESM and the Greece debt crisis
Japanese participants voiced concern about the handling of the crisis. Shouldn’t there have been a “haircut” at the outbreak of the crisis? Should the bigger EU countries not give the new Greece government a chance and strike a compromise? Insisting of rules might not be the best answer. The strong countries tend to bent rules. Participants from EURO countries countered that Greece has already received strong support, but needs to show commitment to necessary reform processes even if they are painful in the short run. Other countries like Ireland or Portugal went through a similar process. Other EURO governments are accountable to their parliaments in any deviation from the rules. However, it is likely that a some kind of compromise will be found.
- Moral hazard and RFAs
Are strict rules (“conditionality”) really needed to contain moral hazard? Rules have the cost of being inflexible. When they are renegotiated the small countries are in a poor position. Lack of strict rules or lack of enforcement however will induce lack of commitment to reforms and debt consolidation. The issue is how can flexibility ex ante or ex post be maintained without interference to commitments made on the debtor side to “try its best”. Moral hazard might also be discussed in terms of potential distortions created in financial markets. RFAs should be a mechanism to ensure stability of the financial system in increasingly globalized markets, rather than the "bailout" of particular banks or particular countries.
- The role of the IMF and IMF reform
Involving the IMF as a third party as in the case of ESM can strengthen the commitment of regional partners to implement conditionality. Concerns were raised that the IMF was not a neutral global institution, but under the influence of “a big player”. It was agreed that this needed to be corrected and the stalled IMF reform needed to be further pursued. The EU and Japan could well take initiative here.
- The difference between CMIM and ESM
CMIM very much relies on peer pressure as the main governance scheme. The negotiating line is between potential debtor and creditor nations with Japan and China the creditor side, sometimes joined by Singapore, sharing similar interests. They would not allow “cherry picking” debtor nations. Without a single currency, CMIM relies on currency swaps. It needs no paid-in capital to signal credibility.
The discussion showed, that experts not necessarily agree, and that much more occasions like the roundtable are needed to promote understanding of the critical aspects of RFAs.
List of Participants
- Ariyoshi, Akira – Hitotsubashi University, Asian Public Policy Program
- Cicogna, Angelo – Banca d’Italia, Tokyo Office
- Cogliati, Alberto – Banca d’Italia, Tokyo Office
- Duignan, Rene – EU Delegation in Tokyo
- Hosen, Mitsuo – Nihon University, Faculty of International Relations
- Kashiwagi, Shigeo – Keio University, Faculty of Business and Commerce
- Kawai, Masahiro – University of Tokyo, Graduate School of Public Policy
- Kinoshita, Nobuyuki – Aflac Japan
- Merk, Klaus – Deutsche Bundesbank, Tokyo Office
- Meyerhöfer, Florian – Embassy of the Federal Republic of Germany in Tokyo
- Molteni, Corrado – Embassy of Italy in Tokyo
- Hosoi, Keisuke – Ministry of Finance, Regional Financial Cooperation Division
- Okubo, Yoshio – Japan Securities Dealer Association
- Oshima, Yuya – Bank of Japan, International Department
- Pascha, Werner – Duisburg-Essen University, Institute of East Asian Studies
- Roevekamp, Frank – Ludwigshafen University of Applied Sciences, East Asia Institute
- Samikawa, Ikuko – Japan Center for Economic Research
- Shirakawa, Masaaki – Aoyama Gakuin University
- Shirata, Cindy Yoshiko – Bunkyo University, Faculty of Business Administration
- Takemori, Shumpei – Keio University, Faculty of Economics
- Takeuchi, Atsushi, Japan Center for Economic Research
- Waldenberger, Franz – German Institute for Japanese Studies
- Yamada, Takahito – Bank of Japan, International Department
- Yoshino, Naoyuki – Asian Development Bank Institute