AS THE EURO ZONE HAS STAGGERED THROUGH MULTIPLE rounds of crisis over the past three years, the nations of Southeast Asia have been looking on with more interest than most. These countries have ambitions of closer economic integration that some liken to the European Union, but regional officials are keen to stress the differences. “It’s important to look at the example of Europe and make sure we don’t make the same mistakes they have made,” says Cesar Purisima, Finance secretary of the Philippines.
The Association of Southeast Asian Nations (Asean), conceived in the late 1960s against a backdrop of regional disputes and an escalating war in Vietnam, has proven remarkably durable. Dismissed by many as an ineffective talking shop, the bloc has grown steadily in size and ambition, forging a free-trade area among ten nations with a combined population of 600 million.
Now member countries are embarking on a bold new project to broaden their integration to include financial and capital account liberalization. Officials believe this initiative will deepen the region’s financial markets and spur a new wave of economic growth, offsetting a slowdown in demand from the U.S., Europe and China. But they are careful to avoid overreach. The new plan does not include even a distant hint of a common currency. Asean is determined to make the most of this “luxury to learn” from the European example, as Sri Mulyani Indrawati, a World Bank managing director who served as Indonesia’s Finance minister from 2005 to 2010, calls it.
Adapting to the demands of a new integration project will involve much more than simply applying the lessons of euro-woe, however. Asean came of age as a meaningful grouping in the 1990s, a time of shallow democratization throughout Southeast Asia that gave governments considerable leeway to act. The bloc pursued a relatively narrow agenda with a deliberately limited institutional footprint, and members adhered to a policy of noninterference in one anothers’ domestic affairs. The question now is whether the ambitious financial integration project can be achieved by governments that face greater political constraints at home from their evolving democracies without altering the light institutional structure that has been the group’s historical strength.
Light footprints pair well with small animals. Asean, by contrast, has a big agenda. It is contemplating the integration of financial systems among a very diverse group of countries, involving the opening up of domestic banking sectors to regional competition, the creation of an Asean class of assets and the liberalization of member states’ capital accounts. These financial measures are part of a broader goal, agreed upon by the group six years ago, to create the Asean Economic Community, with a free flow of goods, services, investment, capital and skilled labor by 2015. This is no small animal.
That Asean has arrived at this point is something of a minor miracle — and testament, perhaps, to the constructive flexibility of the principles on which it was founded. When Indonesia, Malaysia, the Philippines, Singapore and Thailand gathered together to form the association in 1967, few outside observers gave it much chance of success. The early 1960s had seen two similar regional groupings, the Association of Southeast Asia and Malaya-Philippines-Indonesia, or Maphilindo, limp to early demises amid territorial disputes among members and tensions stemming from the region’s difficult position as a key battleground in the Cold War.
The founders wanted Asean to be different. They built the association around the principles of consensus, noncoercion and noninterference in internal affairs precisely to avoid the problems that had bedeviled its predecessors. As these economies, strikingly diverse in their levels of development and ethnic composition, turned to exports to spur growth in the 1980s, supply chains took shape across the region, creating pressure to reduce trade barriers. What followed was a steady reduction in tariffs throughout the region and eventually the creation of a free-trade zone in 1992. Fully 95 percent of goods in Asean now move through the region at zero tariffs, according to Ravi Menon, managing director of the Monetary Authority of Singapore.
In the late 1990s the trauma of the Asian financial crisis forged a new sense of solidarity, with Southeast Asian nations turning to foreign reserve accumulation to protect themselves against future external shocks. The Chiang Mai Initiative, a multilateral currency swap arrangement formed in 2000 and now valued at $120 billion, cemented that sense of regional cooperation.
Throughout Asean, which grew during the 1980s and ’90s with the successive entries of Brunei, Vietnam, Laos, Myanmar and Cambodia, there is a sense that integration of the regional goods market is largely complete and that further steps are now needed. “Economic integration has matured enough to make it viable to proceed now with financial integration,” says Mari Pangestu, Indonesia’s minister of Tourism and former Trade minister. To that end, the Asean Secretariat, in consultation with the Asian Development Bank, in April published a blueprint for the road ahead. It contains specific steps for the liberalization of financial services throughout the region, the development of a deeper capital market, the creation of an integrated payment and settlement system and the liberalization of member states’ capital accounts.
Small steps have already been taken, especially by the so-called leading group of Malaysia, Singapore and Thailand, the region’s most advanced economies. In September 2012, Bursa Malaysia, Singapore Exchange and the Stock Exchange of Thailand formed the Asean Trading Link, a platform designed to allow investors to trade equities across borders with the same kind of ease that exists in Europe. Officials intend to expand the platform to the Indonesia Stock Exchange, the Philippine Stock Exchange and the Vietnamese exchanges in Hanoi and Ho Chi Minh City.
“We want to create this sense of an integrated Asean asset class,” says Purisima, the Philippines’ Finance secretary. In addition to fostering cross-border investment flows, the new platform will lower transaction costs and reduce settlement risk, he adds. Although the three exchanges on the platform are not expecting to double their volumes overnight, the link has succeeded in changing the investment horizon for the region, contends Philippe Carré, global head of connectivity at SunGard Financial Systems, the Wayne, Pennsylvania–based outfit that is providing the technology for the trading link. “This is a good poster child for what Asean can achieve,” he says.
Officials are complementing the exchange cooperation with regulatory harmonization. In April, Singapore, Malaysia and Thailand streamlined disclosure standards so that companies can issue securities in any of the three countries with a single prospectus. Policymakers hope to implement a mutual recognition regime for mutual funds later this year. “We want to create an ecosystem where fund managers, investors and issuers can transact almost seamlessly across the three markets,” Singapore’s Menon says. Eventually, officials plan to roll these innovations out to Indonesia, the Philippines and Vietnam. Other members will join this group once they have reached a sufficient level of development.
Will this step-by-step approach work? Certainly, there are grounds for skepticism. Asean has moved slowly to create the economic community that leaders envisioned back in 2007, and some observers suggest that the recent flurry of pronouncements about financial integration reflects a desire to give the semblance of activity ahead of the 2015 deadline rather than any genuine policy rationale.
The region’s political and economic diversity provides a stiff headwind to the integrationists. Asean includes an absolute monarchy (Brunei), an authoritarian democracy (Singapore), several states struggling to show that democracy and effective government can go hand in hand (Indonesia, the Philippines and Thailand) and a onetime pariah that has only just emerged from decades of international isolation (Myanmar). Levels of development diverge more sharply still: Singapore is one of the world’s wealthiest countries, with per capita income of just over $50,000, according to the International Monetary Fund, while Myanmar is among the poorest at just $824.
Notwithstanding the bloc’s integration efforts to date, Asean members are more plugged in to the global economy than they are to one another. Most countries still rely on exports to drive growth. Just 25 percent of Asean’s total trade is conducted within the bloc; in the EU, by contrast, 49 percent of trade is intraregional.
“The Asean economies are essentially competitive with one another rather than complementary,” says Charles Wolf Jr., a senior research fellow at the Hoover Institution at Stanford University and senior economic adviser at RAND Corp., a Santa Monica, California–based think tank. “The countries in Asean are producing the same sorts of things at the materials end of the spectrum and the low-technology industrials end of the spectrum. They don’t have the complementary economic characteristics that would make financial integration more successful.”
Asean policymakers disagree, insisting that the time is right to proceed to this next step of the integration project — and that investors and companies are leading the call. Financial integration, they contend, is more than just a pet project of the technocrats.
“You need a combination of top-down and bottom-up approaches for these types of projects to work,” says Menon. “If you don’t have any top-down vision, bottom-up efforts get frustrated. But if you’re doing this in isolation and there is no underlying market demand, it doesn’t work either.”
Mark Mobius, executive chairman of the emerging-markets group at San Mateo, California–based investment firm Franklin Templeton Investments, agrees: “There is a growing demand for intraregional investment opportunities.” Private capital flows to Indonesia, Malaysia, the Philippines and Thailand are forecast to hit $91.8 billion this year, down 12 percent from 2012 but more than twice the level of 2009, according to the Washington-based Institute of International Finance.
Asean has a combined GDP of $2.2 trillion, which, if it were a single country, would rank as the seventh largest in the world. The IMF forecasts that the region will grow at an annual rate of 5.5 percent over the next two years, raising its average per capita income to $10,600, solid middle-income territory, by 2015. Weakening demand from Europe and the U.S. and the prospect of softening growth in China make the case for boosting regional economic activity through closer integration more compelling, officials say.
Liberalizing the financial environment will open up a bigger market for regional banks to compete in, lower the cost of capital for companies and enhance financial deepening — all of which should “accelerate economic activity,” according to the Philippines’ Purisima. “If you have greater prosperity, you also have greater stability,” adds Amando Tetangco Jr., governor of Bangko Sentral ng Pilipinas, the Philippines’ central bank. In the process, Asean hopes to become a consumption-driven dynamo in its own right rather than having to rely on exports to China and the U.S. to foster growth.
Investors, for the most part, share this vision. Individually, the Asean member states “are too small to offer investors a large and liquid market compared to the U.S., Europe or China,” asserts Mobius. “By coming together they will be able to do that and provide higher liquidity for investors who invest in stocks or bonds. Any investor looking at the region will realize this potential market will be much bigger if all the countries are integrated.”
Policymakers point to four additional reasons that closer financial integration makes sense now. First, many Asean nations are surplus economies that enjoy high savings rates. There is a strong desire on the part of governments to ensure that that money gets recycled back into investment and infrastructure projects throughout the region rather than sent offshore. Second, the emerging middle class in Southeast Asia is eager to put its growing wealth to work in ways that surpass mere bank deposits. Deeper financial markets across the region should meet this demand.
Third, rising wage inflation in China means that companies are shifting more manufacturing to the low-labor-cost economies of Asean’s less developed periphery, including Cambodia, Laos and Myanmar, creating a need for more-nimble financing arrangements across the region. Also, companies are looking to diversify their production bases. The 2011 floods in Thailand demonstrated the potential for supply-chain disruption when manufacturers concentrate activity in one area, while tensions between Japan and China have led some Japanese companies to reconsider their dependence on Chinese manufacturing, Purisima notes. “We have become more attractive at the right time,” he says.
Last, there is a growing realization that as Western banks continue the long march of compliance with Basel III, increased capital requirements will reduce their ability to provide long-term financing in the region. Asean will “need more capital markets solutions to bridge that long-term gap in financing” as Western banks retreat from the region, Singapore’s Menon contends. “You need much more integrated financial markets.”
Policymakers have done a good job of setting out the case for deeper financial integration. Whether they can implement the project beyond the series of small initiatives introduced to date is another question entirely. Europe may have provided a salutary lesson on the dangers of integrationist zealotry and hard deadlines, but Asean officials are keen to ensure that the financial project doesn’t move “at the speed of the slowest,” says Indonesia’s Pangestu. Now the group follows an “Asean minus X” formula, whereby countries introduce reforms when they’re ready. It’s a way of letting more-advanced members deepen integration without waiting for the others. Nations “have to have the flexibility to do things at their own pace,” says Zeti Akhtar Aziz, governor of Bank Negara Malaysia, the Malaysian central bank. “We won’t impose any time frame on anyone.”
Asean officials view this “variable geometry” as critical for financial integration. Purisima speaks of “the magic of the Asean way,” which has allowed “very diverse countries to stay together and move toward a more integrated Asean by not forcing the issue on those who have not been ready.”
This pragmatic approach also means that Asean is not dependent on the leadership of particular member states to advance its regional project, says Andrew Sheng, a former chairman of the Hong Kong Securities and Futures Commission who is now president of the Fung Global Institute, a Hong Kong–based think tank. “The European system is very much dependent on a Franco-German understanding, which is a crucial linchpin for the whole project,” he explains. “Within Asean it is much more collegiate.”
But if no one is forcing anyone to do anything, how does anything get done? The time frame for financial integration has been left deliberately vague: Though the Asean Economic Community is slated for completion in 2015, few suggest that full economic integration, however defined, will be a reality by then. Elements of the financial integration project, including the liberalization of national capital accounts and the opening up of domestic banking sectors, are expected to take shape by 2020. At the heart of the project is the idea of a two-speed or even three-speed Asean, with the original five members — Singapore, Malaysia, Thailand, Indonesia and the Philippines — forming the vanguard and implementing reforms first. The other member states will follow in due course once they have put in place the institutional and regulatory structures that will allow them to benefit from liberalization.
Does this multispeed regime risk institutionalizing the dichotomy of center and periphery that has blighted euro zone relations? Pangestu dismisses the idea. “No, because that’s the way we’ve always done it,” she says. For the Philippines’ Tetangco, the two-speed nature of development is simply “a way of making the process more realistic.”
“The Asean system is a little fuzzy,” says Sheng. “But the fuzziness can be an advantage. It’s known as constructive ambiguity.”
Yet some adjustment to the Asean way will be necessary if financial integration is to take hold. Most policymakers agree that the Jakarta-based Asean Secretariat, which has a staff of 260 and an annual budget of $16 million, will need to expand. Beyond that, financial integration may force a rethinking of the Asean principle of nonintervention in member states’ domestic affairs.
One of the signature projects of financial integration will be to offer “qualified Asean banks” — local banks that meet certain capital adequacy, risk management and accounting criteria — preferential access to other Asean markets. The idea is that by expanding beyond their home markets, these banks will take the lead in building a regional financial services network. But as this happens, questions will inevitably arise, says IMF deputy managing director Naoyuki Shinohara: How do you supervise those banks across the region? Who is in charge of the supervision? What approach do you take to resolution in the event that one of those banks fails?
“As these countries liberalize they will face risks from each other and outside as well,” Shinohara says. “That means they are destined to lose at least a degree of autonomy on various issues.”
Officials are keen to play down that prospect. The Philippines’ Purisima, for instance, maintains that if an issue in one country affects the common interests of Asean, this will lead to “an orderly discussion — but not to the point where you use a big stick. The emphasis will still be on a consensual approach.” The World Bank’s Indrawati asserts that the “sense of responsible ownership” that has emerged among Asean members will be enough to ensure compliance with regional standards. “The other countries won’t isolate you, but you will feel that you are isolated,” she says. “This is very difficult from the Western point of view to understand.”
It’s arguable that this approach, based on ad hoc understandings and informal procedures, has been effective. Franklin Templeton’s Mobius, for instance, says the recent opening up of Myanmar “is to a great extent a result of work done by Asean,” which engaged with the hermetic nation and gave it regional membership in 1997, when the ruling military regime was an international pariah.
Asean’s financial integration faces a new degree of political risk. In the 1980s and early ’90s, when the major planks of regional trade liberalization were being laid down, authoritarian regimes held power in most member countries. These days electoral constraints weigh much more heavily on many governments. Consider Malaysia, where Prime Minister Najib Razak’s grip on power has weakened since his ruling Barisan Nasional coalition saw its parliamentary majority reduced in last month’s election. The travails of leaders such as President Susilo Bambang Yudhoyono of Indonesia, who has had to deal with a string of corruption scandals throughout his two terms, and Prime Minister Yingluck Shinawatra of Thailand, who has had a tough time reconciling the “red shirt” and “yellow shirt” factions that have polarized her country over the past three years, show that democratic politics, with all its messiness and volatility, is firmly entrenched in Asean. Pushing through the reforms needed to drive financial integration is no longer a matter of executive decree, as it was in the days of Malaysia’s Mahathir Mohamad and Singapore’s Lee Kuan Yew; leaders need to placate interest groups and build consensus. Opening up domestic banking sectors, for example, will require a major charm offensive to ensure the support of local banks that might fear a loss of market share. “This kind of integration always affects vested interests,” says the IMF’s Shinohara. “It hurts some part of the economy, some companies. Certainly, a degree of political will is important to push through integration.”
Purisima, who as Finance secretary will be tasked with much of the heavy political lifting to open up the Philippines’ domestic banking sector, insists that the will is there “on the part of leaders to expend political capital to deal with vested interests.” He cites the liberalization of the Philippines’ airline industry, which began in the 1990s but has been pursued more aggressively by President Benigno Aquino III, leading to a surge in air travel by Filipinos last year. Malaysia’s failed experiment in the 1990s with state-sponsored national automobile manufacturer Proton shows the dangers of protectionism, says Purisima. “There’s enough knowledge among leaders now about the real benefits of opening up,” the Finance secretary says. “There’s always the noisy minority that will lose out from liberalization if they don’t shape up. But it’s important to consider the silent majority that will be winners.”
Asean leaders are acutely aware of the enormity of the task ahead and of how difficult it will be to harmonize reforms and regulations to ensure that financial integration takes hold. “Asean financial integration has not gone as fast as goods market integration, and that’s quite disappointing,” says Singapore’s Menon. But, he adds, that’s because it’s more difficult: Trade integration is largely a question of removing tariffs, whereas with financial integration “you’re not talking about a single tariff but many, many rules that need harmonizing.”
The Europeans could have predicted as much. Their integration project resembles ancient Rome’s Appian Way: expansive and ambitious at its inception but worn and bumpy today. If Southeast Asian nations can plot a path to financial integration while avoiding the potholes that bedevil Europe, they will truly validate the Asean way.
