The urgency of having solid financial safety nets

*This article has been published in The Jakarta Post on 30 November 2013

Macroeconomic data released in the last one month revealed problems in the country’s economy. Slowing down economic growth, soaring prices, and rupiah depreciation of more than 15% in one whole month are some of the most striking data. Even though maturity and currency mismatches, which are the main causes of Indonesia’s financial crisis in 1998, are not found in the current situation, one never knows whether a crisis as severe as the one in 1998 will reoccur. Therefore, it is now an important question for the economy: whom are we running to when a crisis threatens?

Among several options, many Asian countries, including Indonesia, use their foreign reserves for their needs of foreign currency both to stabilize their local currencies and finance their external liabilities. Accumulating foreign reserves as their protection strategy against possible crisis is one of the lessons learnt from the 1998 crisis. Nevertheless, foreign reserve is an imperfect financial safety net in the sense that the idle amount of money in the reserve could otherwise be used for high return-generating investment. Moreover, reserves cannot be relied upon as Indonesia, which has accumulated reserves up to its highest historical level at US$ 117 billion in 2011, is now negotiating bilateral swap agreements (BSA) with three major economies to meet its domestic need of more than US$ 30 billion. Singapore and South Korea also conducted BSAs with the US in 2008 for an amount as large as US$ 25 billion each despite the fact that both countries had huge foreign reserves. Thus, countries choose to make BSA with large countries as foreign reserves seem not as liquid as one may think.

However, BSA has a major shortcoming: high level of uncertainty. Ad hoc in nature, nations have to negotiate with large nations even in an emergency situation as currently Indonesia is doing with two major economies with no guarantee of achieving an agreement. In 2008 Indonesia made effort to carry out BSA with US but it did not succeed that it turned to another large country.    

Regionally, ASEAN+3 countries formed Chiang Mai Initiative Multilateralization (CMIM) as the region’s financial safety net. Going through the painful crisis in 1998 together, these countries initiated CMI in 2000 which later on became CMIM. However, despite of the fact that CMIM has been put into effect since 2010, this initiative has not shown any effective result. CMIM is a reserve pool of its members, with a total amount of US$ 240 billion; 80% of which are from China, Japan, and Korea, and 20% of which are from the ASEAN countries. It has its own monitoring and surveillance unit called AMRO (ASEAN+3 Macroeconomic Research Office). Unfortunately, this pool has not been made used by any of its members. Instead, some members made individual attempts to conduct BSAs with major economies. Hence, there arises concern whether CMIM will also be similar to many other ASEAN initiatives which are agreed by all members but never be put into action?

The region has to address this concern and make sure the effectiveness of the CMIM, for at least three reasons. First, the region faces mutual risks that they need to tackle together in a coordinated policy action. The region’s economic integration has given them not only huge shared benefits but also shared risks. The risks bring about common responsibility of covering them in the regional financial safety net (RFSN). Second, building RFSN is in particular at the interest of innocent bystanders like Indonesia. Many countries in this region belong to middle-income countries which usually have sound macroeconomic management but are not immune to contagious crisis sourced from advanced countries. Hence, having safety nets is vital for them. Third, as illiquidity is usually the first common symptom before a financial crisis starts, fund from RFSN is urgently needed by the economy once the symptom emerges, in order to recover market’s confidence, halt economic agents’ panic actions, and hinder the market falling into insolvency.   

Nevertheless, our RFSN seems neither be able to disburse fund immediately nor have an amount large enough to cover the risks faced by the member economies. The standard procedure requires a high-level meeting of representatives from all of the thirteen members to decide CMIM fund’s disbursement. Moreover, the maximum swap amount of each economy is perhaps not enough to handle the possible upcoming crisis. For example, Indonesia has an access limit of US$ 22.7 billion; merely 30% of which (equivalent to US$ 6.8 billion) can be used without having to involve in IMF-adjustment programs. This amount is substantially lower than US$ 30 billion, the amount presently targeted by the government to have BSAs with several countries.  This may imply that Indonesia makes no attempt to access CMIM due to its small possible swap amount compared to the volume needed by the domestic market. Also, considering that Indonesia received US$ 40 billion during the financial crisis 1998, US$ 6.8 billion looks relatively insignificant. In addition, the linkage of the fund with IMF makes smaller the possible swap amount that Indonesia and many other nations are willing to take. IMF stigma is still attached for some Asian countries. The 1998 experience clearly showed that IMF prescription did not control the calamity in the expected time frame. Furthermore, the IMF was deemed to disgrace the crisis-affected nations. Thus, IMF-linked fund is definitely not an option for member governments to tackle their short-term liquidity problem.

Therefore, it is highly suggested to increase the IMF-delinked countries’ access limit. Moreover, AMRO, as an institution intensively managing CMIM, should learn from IMF as a very experienced institution in coping with various types of crises in the world. However, AMRO has to be able to independently decide who should be given the CMIM facility at any point of time, the amount and its term of swap. Decision from AMRO will expedite the process of fund disbursement.

In brief, crisis prevention is better than crisis recovery. Good regional governance is a must in this case. Good governance for crisis prevention is not merely for regional financial safety net, but also global financial safety nets i.e. global network of safety nets encompassing multiple layers of crisis-prevention system at all levels: national, bilateral, regional, and global. However, in a present era of Asia’s fast economic growth and integration as well as the presence of relatively fresh and bright AMRO, this is the right moment to strengthen CMIM. The region should show to the world that it is capable of handling crisis’ symptoms and therefore may be a magnet to foreign investors.