As the geopolitical situation worsens, the Asia-Pacific region should improve currency swap deals, further develop bond markets and push for IMF quota adjustment, while China and the RMB do their bit

Against the backdrop of high interest rates maintained by the US Federal Reserve and escalating geopolitical tensions, there has been a collective devaluation of Asian currencies in the first half of 2024. Asia's major currencies, including the Japanese yen, the Republic of Korea's won, the Indian rupee, the Indonesian rupiah and the Vietnamese dong, have all suffered sharp depreciation. In early July 2024, the exchange rate of the Japanese yen against the US dollar was close to 162 yen per dollar, hitting its lowest level since 1986. The issue of financial security in Asia has once again aroused the attention of Asian countries.

In the past 20 years, the degree of economic and trade integration within Asia has been deepening. According to statistics, about 60 percent of merchandise trade and foreign direct investment of Asian economies takes place within Asia. But financial integration in Asia is lagging behind. The US dollar remains the primary currency for pricing, settlement, financing and reserve in Asia. For example, Asia's exports and imports to the US account for 9 percent and 5 percent of Asia's total exports and imports, respectively, but 89 percent of Asia's exports and 77 percent of its imports are denominated in US dollars. This makes the region very sensitive to changes in the US Federal Reserve's monetary policy and the US dollar's exchange rate.

The high level of national debt in certain Asian countries has also increased financial risks in the region. Asian countries have seen an increase in debt in the wake of the COVID-19 pandemic. In response to the US Federal Reserve's high interest rates, Asian countries will have to raise rates as well, further raising the risk of debt defaults and consequently a financial crisis.

The geopolitical situation in the Asia-Pacific region also affects Asia's financial security. In recent years, the US has formed cliques in Asia, aiming to influence intra-regional economic and trade cooperation and the stability of industry and supply chains through the launch of such schemes as the "Indo-Pacific" Economic Framework for Prosperity and the "Chip 4 alliance". This will inevitably have a great impact on intra-regional economic integration and further affect financial stability in Asia.

In the face of the above-mentioned risks, it is imperative for Asian countries to strengthen financial cooperation within the region, strengthen the building of the Asian financial safety net, and enhance Asian countries' capabilities to cope with financial risks.

To start with, Asian countries should improve the Chiang Mai Initiative with the goal of maintaining regional financial stability.

The CMI was the first regional currency swap arrangement launched by the Association of Southeast Asian Nations and China, Japan and the ROK — collectively known as ASEAN+3 — in 2000 and upgraded to the Chiang Mai Initiative Multilateralization in 2010.

At present, CMIM still has some flaws in capital scale, loan conditions, operating efficiency and so on, which limits the role of the mechanism. The CMIM needs to expand the foreign exchange reserve pool and enrich the types and maturity of loan instruments. The quota payment method of member states needs to be changed from the committed contributions to both committed contributions and paid-in capital. In order to fill the gap between the supply and demand of regional liquidity funds, enhance the level of regional financial integration and improve the multi-layer global financial safety net, it is necessary to upgrade CMIM to a regional monetary fund. Second, Asian countries should further develop Asian bond markets to promote local savings for local investment and reduce reliance on non-regional financial markets and bank financing.

The Asian Bond Markets Initiative was adopted in 2003 by ASEAN+3. Over the past more than two decades, the bond markets of major Asian economies have grown steadily. By the end of 2022, the stock of bond markets in representative Asian economies (including China, Japan, South Korea and six ASEAN countries) had reached $33.4 trillion. But the breadth and depth of Asian bond market development needs to be further improved.

From the perspective of the composition of bond varieties, the proportion of corporate bonds is relatively small. At the end of 2022, the proportion of corporate bonds in representative Asian economies was only 27.4 percent. With the development of corporate bonds lagging behind, the bond market can hardly play a role in avoiding exchange rate and term risks.

In terms of the scale of the bond markets, the scale of bond markets in Asia's representative economies accounted for 102 percent of GDP at the end of 2022, but there is still a big gap compared with European countries and the US. By the end of 2022, the share was 204 percent and 135 percent in the US and the EU, respectively.

In order to promote the development of the Asian bond market, Asian countries should expand the scale of the bond market, optimize the structure of the bond market, particularly by expanding the proportion of corporate bonds, strengthen risk prevention and control, and improve the building of relevant systems, including enriching risk-hedging strategies and establishing a rating system in line with Asia's market conditions.

Furthermore, Asian countries should push for the IMF quota adjustment as soon as possible to better reflect the status of Asian countries in the global economy. They need to strengthen cooperation and connectivity in financial infrastructure, including further opening up the payment environment among countries and facilitating cross-border local currency transactions. They should also continue to make good use of bilateral currency swaps and improve their domestic financial safety nets.

The steady development of the Chinese economy will provide impetus and guarantee for the economic growth and financial stability in Asia.

First, China should promote the development of local currency markets in Asia through more use of RMB in the region.

With the advancement of the internationalization of the renminbi, the renminbi is being used more often in Asia, especially in ASEAN member states. The Renminbi Cross-border Interbank Payment System has covered all ASEAN member states, and most ASEAN countries have included the renminbi in their foreign exchange reserves.

Second, the renminbi bond market is an important driving force for the development of Asian financial markets.

The renminbi bond market accounts for roughly 80 percent of the Asian bond market. New issuance in China's bond market is also the largest source of new issuance in the Asian bond market, accounting for a third of new issuance.

Third, China has an important role to play in the building of financial cooperation mechanisms in Asia.

China is one of the largest contributors to the CMIM, accounting for 32 percent of its total foreign exchange reserves. China has also signed bilateral currency swap agreements with a number of Asian countries.

The author is an associate researcher with the Institute of World Economics and Politics at the Chinese Academy of Social Sciences. The author contributed this article to China Watch, a think tank powered by China Daily.

The views do not necessarily reflect those of China Daily.

Contact the editor at editor@chinawatch.cn.