Financial crises have become endemic in the global financial system. Large-scale reregulation by authorities in the United States, European Union, and elsewhere in the wake of the global financial crisis of 2008-2010 may reduce the risks and the costs of crises, but the ingredients that produce "manias, panics, and crashes" remain--including human tendencies to discount risk in good times, the existence of multiple channels of financial interconnectedness, the difficulties of identifying speculative bubbles in real time, and the bluntness of monetary policy as a tool when prices of goods and services diverge from those of asset prices (Note 1). The problem is much more acute for developing and middle-income countries that cannot finance their external debt in their own currencies; for these countries, currency crises remain an ever-present threat (Note 2).
These are lessons that have not been forgotten in East Asia, where the memory of the Asian financial crisis of 1997-1998 is still strong and continues to have a profound effect on policies of the Association of Southeast Asian Nations (ASEAN)+3 countries. Since that crisis, governments have sought to self-insure against future crises by accumulating large and growing foreign currency reserves, strengthening domestic financial regulation, developing domestic financial markets, and, in a number of cases, imposing either ongoing or temporary currency controls. As a region, moreover, the ASEAN+3 countries have put in place a set of regional mechanisms meant to reduce the likelihood of crises and more effectively manage those that do arise. Primary among these is the Chiang Mai Initiative (CMI), now renamed as the Chiang Mai Initiative Multilateralization (CMIM). CMIM is often described as a regional bailout fund, or even an Asian Monetary Fund in the mold of the International Monetary Fund (IMF). The truth is more complex. CMIM is a loosely-structured institution that relies on a political bargain and the economic interests of its leading members to work. It is in many ways an impressive accomplishment that should help to manage currency crises that do arise among the participating economies. But at the end of the day, it will only work as planned if the underlying political understandings between likely borrowers and likely creditors and between the leading countries of Japan and China remain viable. As I argue here, that is now open to question--ironically, at least partly because of institutional enhancements meant to keep CMIM economically relevant to the needs of its members.
The Politics of Delegation in CMIM
CMI is now 14 years old. Having begun as a relatively loose network of non-standardized bilateral swap agreements (BSAs) totaling $40 billion, with no central decision making or monitoring apparatus, it has since been enhanced in a number of ways, including an increase in committed funds to $120 billion, inclusion of five additional ASEAN members, "multilateralization" of decision making and disbursal processes, establishment of a modest monitoring agency, and the decision to create a new precautionary line and to further increase committed funds to $240 billion (Note 3). The institutional development is impressive in many ways. CMIM as it now stands is bigger, more formalized, and more comprehensive in membership and function than nearly anyone would have predicted at CMI's inception in May 2000.
As I have argued elsewhere, CMI and CMIM are based on a set of political understandings and bargains (Note 4). One of these is the generic problem facing any bailout fund or insurance scheme: moral hazard. Those participants who might need to draw on CMIM must have a high level of certainty that funds will be provided as needed in the event of a crisis. However, the certain knowledge of a bailout might encourage them to manage their macroeconomic policy and financial regulation irresponsibly in the expectation that the fallout will be limited. Therefore, likely creditors (Japan and China in the case of CMIM, the IMF and its major shareholders at the global level) must create some sort of assurance either that potential borrowers will exercise prudent economic policies or that prudent policies will be imposed on them in the event of a bailout so that creditors do not lose money. In other words, creditors will want to impose conditions on bailout loans, either ex ante or ex post. Ex post conditionality, in which a country in crisis receives funds contingent on performance criteria, is often associated with traditional IMF standby lending. Ex ante conditionality, in contrast, relies on an ongoing assessment of the quality of a country's economic policies; those governments that experience crises despite responsible policies are eligible for emergency loans with limited performance conditions attached. Until 2012, CMIM relied on delegated ex post conditionality, but now it has opened the door to ex ante conditionality in some circumstances, as discussed below.
The second political understanding that underlies CMIM is that collective action is difficult, particularly between Japan and China, which are regional rivals. In theory, the problem of moral hazard can be addressed with clear rules concerning conditionality. In practice, rules require enforcement. In the case of the ASEAN+3, enforcement ultimately falls to Japan and China, which are the largest economies by far, have the greatest capability of bailing out their neighbors, and together account for 64% of funds pledged to CMIM. The problem is that neither wishes to be the "bad guy" that will impose onerous conditions on neighbors. And although the two countries have parallel interests in managing crisis and minimizing moral hazard, their larger rivalries mean that neither can be certain that the other will cooperate in an actual crisis if that does not appear to be in its short-term interests. To address this problem, CMI relied on the "IMF link," in which the bulk (originally 90%, now down to 80%, and possibly soon to 60%) of pledged funds would not be disbursed until the crisis economy entered into negotiations with the IMF. In other words, the ASEAN+3 countries delegated enforcement to the IMF, so that creditors would not be responsible for imposing politically unpopular conditions on their partners.
I should note that my interpretation of the internal politics of CMI/CMIM is not universally accepted. Indeed, participants in the CMI process have also pursued alternatives to relying on IMF conditionality to reduce the moral hazard problem (Note 5). This is not entirely surprising, as delegation of enforcement through the IMF link also means delegating judgment about regional economic conditions to the IMF, whose diagnosis of the causes of a crisis might well differ from those of Japan and China. For this reason, CMI has included a rudimentary surveillance mechanism (Economic Review and Policy Dialogue, or ERPD) since its inception, and various roadmaps have gestured to the likelihood of reducing dependence on the IMF as internal surveillance improves. However, while dialogue is useful, it does not provide opportunities to the leading lenders (Japan and China) to avoid blame for unpopular decisions on lending and conditionality, so under current circumstances it is not a satisfactory substitute for the IMF link. I address this point again in the next section, as there have been significant developments in the CMIM surveillance mechanism since 2009.
Enhancements to CMI since the Global Financial Crisis
In response to the global financial crisis, the ASEAN+3 governments accelerated the timetable of CMIM and significantly increased the amount of funds available to crisis countries, including the non-IMF-linked portion of available funds as noted above (Note 6). The justification for increasing the scale and certainty of disbursal of funds was obvious, as one country after another--albeit none of the ASEAN+3 countries--found themselves borrowing from the IMF and other partners in unprecedented amounts.
"Multilateralization" is a more complicated story. It is, to be sure, an ambiguous term, and neither official announcements nor news reports have been particularly helpful in clarifying what it means on a practical level (Note 7). The actual impact has been fourfold. First, CMIM is formally a reserve pooling arrangement, although there is no central management of committed reserves. Second, the former BSAs, which were contracts that were not standardized in terms of conditions, currency, or reciprocity, have been replaced by a single contract that stipulates the responsibilities of each member in the event that a CMIM economy falls into crisis and requests assistance. Third, each participant commits a set amount of reserves on which CMIM can draw and is entitled to draw specific amounts if it experiences a crisis (Note 8). Fourth, decisions to disburse funds in a crisis are to be decided by a weighted voting procedure based on committed reserves. In sum, multilateralization formalizes responsibilities of CMI member countries, standardizes the relationship between lending and borrowing, and adds a new layer of voting to the decision making process. However, it does not eliminate the IMF link (which is still a precondition for releasing the bulk of funds).
At the same time that the ASEAN+3 finance ministers agreed to multilateralization, they also agreed to establish an autonomous monitoring agency, the ASEAN+3 Macroeconomic Research Office (AMRO). In principle, AMRO is meant to contribute to an effective surveillance regime; eventually, some have argued, it will be able to enforce ex ante conditionality, reducing or perhaps even eliminating the justification for the IMF link. At the moment, AMRO is too understaffed to take on such an ambitious role, although it could of course be expanded. In my analysis, however, a greater challenge is that it is hard to imagine that AMRO can be made effectively autonomous from the CMIM governments that oversee it. If AMRO is not autonomous, then member countries cannot credibly claim that they are delegating assessment and decision making. For this reason, I do not expect that the IMF link will be superseded by AMRO any time soon.
Despite all of the fanfare that attended CMIM and the establishment of AMRO, the most important change in the capabilities and responsibilities of CMIM has been less widely discussed. It is the anticipated establishment of the CMIM Precautionary Line (CMIM-PL), which will operate in parallel with the existing funding mechanism (renamed the Stability Facility, or CMIM-SF). While CMIM-SF will continue to require that crisis countries enter into negotiations with the IMF for balance of payments assistance, with whatever conditions that entails, CMIM-PL is meant to be provided on the basis of ex ante conditionality (i.e., monitoring) and without stringent ex post conditions, although official statements are ambiguous as to whether responsibility for ex ante conditionality will be made by the ASEAN+3 countries themselves or the IMF. CMIM-PL fills a hole in the CMI system that was made apparent in the fall of 2008, when South Korea and Singapore sought emergency swap lines from the U.S. Federal Reserve. At the time, South Korea was facing dollar liquidity problems resulting from the seizing up of global markets rather than from economic mismanagement. Using CMI would have required IMF involvement, which would have been economically disruptive and politically unpalatable, and so the Korean government consciously avoided working through CMI.
There is little doubt that CMIM-PL addresses a real need for more developed, globally integrated, economically well-managed CMIM countries like South Korea that could suffer capital flight and lack of market confidence if forced to negotiate an IMF agreement. In this sense, it is a clear enhancement to CMIM's economic functionality and may serve the region well. However, it reopens the political bargain at the heart of CMI and CMIM by forcing the ASEAN+3 governments to decide which crisis economies are eligible for the light conditions of CMIM-PL loans, and which will be required to involve IMF ex post conditionality. Given the limited capabilities and autonomy of AMRO, unless ex ante conditionality is fully delegated to the IMF (perhaps by making release of funds contingent on qualification for the IMF's Flexible Credit Line), the decision will necessarily be decided by the governments whose votes are required for approval--i.e., Japan and China, the major contributors. At some point, therefore, they may not be able to avoid the question of where to draw the line between responsible and irresponsible governments, and will thus be the targets of resentment by citizens and governments of economies that are told that they must negotiate a bailout package with IMF-imposed ex post conditionality because they do not qualify for the Precautionary Line.
Conclusion
One of the successes of the original CMI and of the initial version of CMIM was that they addressed the major economic interests of both borrowers and creditors while allowing creditors to avoid political blame through the mechanism of the IMF link. While critics of the IMF's actions in the Asian financial crisis and advocates of regionalism found that mechanism objectionable, it was actually an elegant solution to the basic political contests between borrower and creditor and mistrust between Japan and China.
CMIM-PL threatens the political basis of CMIM, even as it addresses a major problem of economic functionality. It reintroduces the problem of how to evaluate the merit of economies in the midst of severe crisis, which is a high-stakes game to say the least. It is not clear that this contradiction can be overcome through institutional means unless it is again turned over to the IMF--AMRO is not capable of filling the role of enforcer (and likely will never be), while mistrust between Japan and China means that cooperation of the leading CMIM powers is not assured in the event of a crisis. Depending on what the next crisis looks like, this may not be an issue at all, but it raises the likelihood of conflicts arising within the ASEAN+3, raising questions about CMIM's long-run political sustainability. As the ASEAN+3 member states develop procedures for how to use the precautionary line, it is essential that they consider the political implications and sustainability of whatever procedures they put in place.
