Chapter 1 Overview

Ana Corbacho, and Shanaka Peiris
Published Date:
October 2018
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A bumpy normalization of monetary policies in advanced economies, capital flow volatility, global policy missteps: these are just a few of the possible risks shaping the global outlook in the years ahead. They represent important challenges for emerging market and developing economies across the globe.

The Association of Southeast Asian Nations–5 (ASEAN-5: the five founding members, comprising Indonesia, Malaysia, the Philippines, Singapore, and Thailand) stand strong in the face of these challenges. The dramatic transformation of their policy frameworks since the Asian financial crisis delivered macro-financial stability during significant domestic and regional transformation as well as global macroeconomic and financial turmoil. Over the past few decades, the ASEAN-5 have strengthened resilience, built up buffers, and adapted their policies to respond to global spillovers.

However, global risks will continue to test ASEAN-5 economies. Against this backdrop, this book proposes a policy agenda to sustain growth and stability in the coming decades. Part I offers a retrospective of the evolution of monetary policy and financial stability frameworks in the ASEAN-5, with special focus on changes since the Asian financial crisis and the more recent period of unconventional monetary policies in advanced economies. Part II looks into the channels of transmission of global spillovers and the monetary, exchange rate, and ASEAN-5 macroprudential policy responses. Part III concludes with forthcoming challenges and maps out ways to further upgrade policy frameworks, exploit synergies, and enhance resilience.

The successful experience of the ASEAN-5 provides valuable lessons for other emerging market and developing economies. The authors’ rigorous and novel analysis leaves no stone unturned as they gather evidence of what has worked and what could work better to meet the challenges ahead.

The analysis put forth in the book supports three broad conclusions:

1. The ambitious reforms of monetary policy and financial stability frameworks since the Asian financial crisis paid off.

Since the Asian financial crisis, the ASEAN-5 countries have adjusted their policy frameworks to address financial booms and busts more systematically, embarking on an ambitious and broad-ranging program of economic and financial sector reforms.

With respect to monetary policy frameworks, a flexible inflation-targeting framework in Indonesia, the Philippines, and Thailand, alongside slightly different frameworks in Malaysia and Singapore, have served the ASEAN-5 economies well in terms of low inflation and output volatility (Figures 1.1 and 1.2). Chapter 2, by Hoe Ee Khor and others, examines the evolution of monetary policy regimes since the Asian crisis, showing how ASEAN-5 countries accommodated the constraints imposed by the “impossible trinity” of a fixed exchange rate, an open capital market, and independent monetary policy. The clarification of price stability objectives, including the adoption of explicit inflation targets in some countries, and the strengthening of central bank operations and transparency, have been major milestones in the evolution of monetary policy frameworks. The transition to more consistent forward-looking frameworks allowed ASEAN-5 economies to withstand the global financial crisis well, as well as the commodity price cycle and the recent low-inflation environment. Moreover, the ASEAN-5 gradually moved toward flexible exchange rate regimes, which strengthened monetary independence and facilitated adjustment to external shocks. Finally, active and independent liquidity management to align market conditions with the announced policy stance and improved central bank communications were key ingredients to their success.

GDP Growth: ASEAN-5 and Peers

(Standard deviation of year-over-year growth)

Sources: IMF, World Economic Outlook database; and IMF staff calculations.

Note: ASEAN-5 = Indonesia, Malaysia, Philippines, Singapore, Thailand; LAC-5 = Brazil, Chile, Colombia, Mexico, Peru; European EMs = Bulgaria, Hungary, Poland, Romania, Russia, Turkey, Ukraine.

Inflation: ASEAN-5 and Peers

(Year-over-year percent change, average)

Sources: IMF, World Economic Outlook database; and IMF staff calculations.

Note: LAC-5 = Brazil, Chile, Colombia, Mexico, Peru; European EMs = Bulgaria, Hungary, Poland, Romania, Russia, Turkey, Ukraine.

Major reforms of micro- and macroprudential policy frameworks allowed ASEAN-5 financial systems to build significant resilience. Chapter 3, by Pablo Lopez Murphy, takes stock of these major initiatives. ASEAN-5 countries overhauled financial regulation and supervision; bank supervisors embraced Basel core principles, strengthened supervisory policies, required banks to hold more capital, and aligned regulations with best practice. The ASEAN-5 also worked to restructure nonfinancial corporations, including by establishing centralized asset-management companies and relying on out-of-court debt workouts as a speedy, cost-effective, and market-friendly alternative to court-supervised workouts. To cap it off, ASEAN-5 countries developed bond markets in local currencies to reduce foreign exchange mismatches, lower credit and maturity risks in banks, and store away a spare tire should the banking system be impaired.

All these efforts helped ASEAN-5 countries navigate the global financial crisis well and preserve financial stability. Following the global crisis, ASEAN-5 financial systems were in much better shape than those of many advanced economies because ASEAN policymakers routinely responded to emerging systemic risks. Nowadays, ASEAN-5 financial systems differ in size, access, efficiency, and financial supervision structure, partly reflecting varying stages of economic development. But they also have important similarities, including the increasing importance of shadow banks and financial markets, the large presence of financial conglomerates, and the high participation of the government. A bird’s-eye view suggests that macro-financial risks are contained and generally lower in ASEAN-5 countries than in the global financial system (Figure 1.3), a testament to the benefits of decades of strong reform efforts.

ASEAN-5 Financial Stability Map 2017 versus Global, 20171

Source: IMF staff estimates.

1 Lower values indicate lower risks.

2. Global spillovers will continue to test policy frameworks in ASEAN-5 countries.

In the wake of the global financial crisis, ASEAN-5 policymakers were compelled to adapt their frameworks to strengthen policy autonomy and mitigate risks from global spillovers. Chapter 4, by Shanaka J. Peiris and others, considers the channels through which global financial factors have impacted domestic financial markets and monetary conditions in the ASEAN-5. Principal component analysis of domestic financial conditions identifies two key macro-financial channels of transmission of global financial shocks: one is related to the Chicago Board Options Volatility Index (VIX) and affects largely capital flows and asset prices; the other is linked to US interest rates and affects mainly monetary and credit conditions. The chapter also assesses empirically the transmission of reserve currency monetary policy to domestic short- and long-term market interest rates, as well as to retail bank rates, given their importance in domestic monetary policy transmission (Figure 1.4). Macro-financial spillovers to the real economy are also investigated through Bayesian vector autoregression models. Results suggest that global financial cycles emanate from changes in US monetary policy and that global risk aversion drives domestic financial and macroeconomic conditions in the ASEAN-5.

Global Bond Yields

Change since January 2010 (basis points)

Sources: Bloomberg L.P.; and Haver Analytics.

Note: AEs = advanced economies; EMs = emerging markets; LCY = local currency.

Looking ahead, several global scenarios could shape the outlook and spillover to emerging markets against the backdrop of elevated uncertainty. Illustrative model-based simulations show that faster-than-anticipated monetary policy normalization in the United States or an abrupt growth slowdown in China would hit the ASEAN-5 economies hard through weaker external demand and higher financing costs, warranting a policy response.

Chapter 5, by Hoe Ee Khor and others, explores how monetary and exchange rate policies responded to spillovers during and after the global financial crisis. The chapter presents results from country-specific Taylor rule reaction functions, which show that central banks responded predominantly to domestic inflation developments, although external considerations also played a role. Policy rates are found to be susceptible to global monetary shocks, controlling for the interdependence of economic cycles, while the degree of monetary policy autonomy varies across the ASEAN-5, with monetary transmission influenced by global financial and commodity price shocks.

The move to more flexible exchange rate regimes in the region was instrumental in facilitating adjustment to external shocks and discouraging a buildup of short-term foreign exchange debt. This was a big departure from the pre–Asian financial crisis period, and allowed the exchange rate to act as an effective shock absorber during the global financial crisis. Alongside this policy shift, international reserves in these economies also rose significantly, strengthening external positions and allowing the use of reserve buffers to avoid disorderly market conditions. Calibrated model simulations also suggest that foreign exchange market intervention, in some circumstances, could help reduce business cycle fluctuations in response to capital flow shocks. A key aspect of the policy responses to the global financial crisis and other capital outflow episodes was the timely use of different policy levers, taking into account macro-financial linkages.

The ASEAN-5 economies have been well ahead of other regions in realizing the value of macroprudential policies for financial stability. Chapter 6, by Sohrab Rafiq, documents the increasing use of macroprudential policies in the ASEAN-5 and analyzes the effectiveness of such policies in maintaining financial stability. The past 30 years witnessed a shift in the types of macroprudential tools used by ASEAN-5 countries, with greater focus on the real estate sector and credit-specific domestic prudential tools (Figure 1.5). This responded to the need to address financial stability risks marked by rising household debt and asset price cycles.

Use of Macroprudential Policies

(Number of policy changes, 1990–latest)

Sources: Bank for International Settlements database; and IMF staff calculations.

Note: CEEs = central and eastern European economies; EMs = emerging markets; LAC = Latin America and Caribbean.

The use and effectiveness of macroprudential policies is a frontier area in macroeconomic policymaking globally and one in which we are still very much in learning mode. Event studies and panel data estimations for the ASEAN-5 show that macroprudential tools have been effective in containing systemic vulnerabilities and procyclical dynamics between asset prices and credit over the past two decades. In particular, the use of loan-to-value ratios and real-estate-related taxes have effectively mitigated property price appreciation and housing sector credit growth. Macroprudential policies have also complemented monetary policy and enhanced the monetary policy transmission mechanism via the bank lending channel. Moreover, the increased use of macroprudential tools has mirrored shifts in the management of bank capital across the region, coincided with lower risk taking and less reliance on noncore funding by banks, and led to more prudent bank balance sheet management. The ASEAN-5’s successful experience with macroprudential policies thus holds lessons for other advanced and emerging market economies.

The more active use of macroprudential policies is a sign that ASEAN-5 policymakers have long recognized that financial imbalances can build up even during periods of economic tranquility and benign inflation pressure. Evidence for the ASEAN-5 implies that financial stability will not necessarily emerge as a natural by-product of a so-called appropriate monetary policy stance. The findings in the chapter suggest that central banks therefore have strong incentives to pursue macroprudential policies to safeguard financial stability. Still, policymakers should be mindful that macroprudential policy entails costs and trade-offs. Moreover, for macroprudential policy to be effective, its objectives need to be defined clearly and supported by a strong accountability framework. In this respect, ASEAN-5 countries continue to develop appropriate institutional underpinnings.

3. Challenges ahead call for upgrading policy and institutional frameworks, exploiting policy synergies, and reaping the benefits of regional integration.

A decade after the global financial crisis, the global macroeconomic and financial landscape is still influenced by some of its legacies. ASEAN-5 countries faced a protracted period during which most advanced economies’ expansionary monetary policies were not well aligned with domestic economic conditions in emerging market economies. The global outlook is for gradual normalization of monetary policy in advanced economies amid relatively low inflation pressure. However, an inflation surprise could suddenly tighten global financial conditions and spark capital flow volatility, with serious implications for emerging market and developing economies across the globe.

As discussed in Chapter 7, by Juan Angel Garcia Morales and others, monetary policy in ASEAN-5 countries must continue to adapt to the new normal of uncertain and volatile global conditions. The chapter first analyzes the evolution of inflation dynamics in the region over the past two decades. The primary focus on price stability has enhanced the effectiveness of ASEAN-5 monetary policy frameworks. Since the Asian financial crisis, inflation expectations have gradually become the most important driver of inflation dynamics, confirming the forward-looking orientation of monetary policy frameworks in the region (Figure 1.6). The analysis in the chapter also suggests the impact of economic slack on inflation has declined in recent years. This flattening of the Phillips curve may have important implications for monetary policy in ASEAN-5 economies. For example, in countries particularly affected by low-oil-price shocks and facing below-target inflation, the recovery in inflation could be weaker than in the past. Moreover, the decline in natural rates of interest in some of these economies, mirroring developments in other countries around the globe, may constrain the scope for monetary policy to counter the next economic slowdown.

Contributions to Inflation in the ASEAN-5


Source: IMF staff estimates.

Differences in inflation performance vis-à-vis central bank targets and financial sector vulnerabilities call for different responses to the global challenges in the new normal. Potential further refinements in monetary policy frameworks may well be asymmetric across ASEAN-5 countries. Yet all ASEAN-5 economies are in a position to continue to adapt their monetary policy frameworks through enhanced communication and better monitoring of inflation expectations. In this respect, the authors present novel estimates of inflation expectations based on trend inflation that complement existing survey-based measures. Transparency about the response to a rapidly changing and uncertain outlook, as well as the adjustments in monetary policy frameworks to cope with it, will likely be essential features of effective central bank communication in the period ahead.

The ASEAN-5 weathered the global financial crisis well, but crisis legacies continue to linger, and some financial vulnerabilities have been on the rise. Chapter 8, by Pablo Lopez Murphy and others, provides an analysis of systemic risks and discusses a policy agenda for strengthening financial stability frameworks. The authors first scrutinize the fast pace of credit growth since the global financial crisis. Yet they conclude that there is no evidence of generalized credit booms in the ASEAN-5 following the global crisis, unlike during pre–Asian crisis periods. However, the rapid increase in corporate leverage and household debt in some countries calls for careful monitoring. Moreover, the high degree of interconnectivity within the financial sector and between the financial and the real sectors, while unavoidable in a financial deepening process, could be an emerging vulnerability. Finally, new technologies could bring benefits but also risks to ASEAN-5 financial systems.

The chapter discusses the challenges and policy agenda ahead for strengthening financial stability frameworks. Because they can smooth credit cycles, macroprudential policies are a key pillar for containing the dangers of rapid credit growth. Policymakers should consider upgrading toolkits with systematic countercyclical macroprudential policies to build buffers during booms. Financial system regulation and supervision and crisis management frameworks are other key pillars for resilience. The Basel III standards should be a benchmark all countries should aspire to meet. Similarly, the Key Attributes for Effective Resolution of Financial Institutions are the relevant metric for resolution frameworks. In turn, while regulatory frameworks for cryptocurrencies are still evolving, they should balance containing risk against promoting innovation.

Managing boom-and-bust cycles in the presence of global spillovers remains a key policy challenge for ASEAN-5 economies. Chapter 9, by Manrique Saenz and others, documents that recessions that follow a bust have entailed both temporary and permanent output losses in the region. Moreover, growth downturns are magnified in the presence of financial vulnerabilities, such as excessive household and corporate debt. Countercyclical monetary policy can play a key role in managing boom-and-bust cycles but, on its own, its effectiveness can be limited. The chapter hence proposes exploiting synergies between monetary, macroprudential, and fiscal policies to manage fluctuations along the real and financial cycles and sustain growth.

Macroprudential policies can play an important role in complementing monetary policy. Model simulations show that countercyclical macroprudential tools targeted at financial imbalances, coupled with monetary policy focused on inflation and growth, can enhance macroeconomic and financial stability and deliver better macroeconomic results than a strategy that uses monetary policy as the only tool. This result is robust to a relative flattening in the Phillips curve. Countercyclical macroprudential tools are also shown to reduce systemic risks with minimal costs to real economic activity in response to a wide array of shocks.

Fiscal policy can also complement monetary policy in smoothing out the cycle while supporting medium- and long-term growth. Policy scenarios show the payoff to infrastructure investment under different monetary policy reaction functions. In particular, for countries facing persistently low inflation, an infrastructure push, coupled with monetary accommodation, can lead to significant increases in real GDP. The additional growth also allows them to protect their fiscal space, even if the investment scale-up is financed with debt. For countries with more limited fiscal space and high inflation, a focus on high-efficiency investment is likely the best option for achieving a higher multiplier.

Deepening regional financial integration could support financial resilience, stability, and development. Chapter 10, by Yiqun Wu and others, delves into the benefits and challenges posed by the ASEAN Economic Community’s move toward financial liberalization and freer capital flows by 2025. The chapter shows that regional financial integration has lagged not only regional trade integration, but also financial integration with countries outside the region (Figure 1.7). Based on evidence from panel data estimations, the chapter proposes that improving regulatory and institutional quality and reducing capital flow restrictions are promising avenues to promote regional financial integration. The chapter also provides empirical support for significant benefits from regional financial integration, ranging from enhanced resilience to global shocks to economic rebalancing and higher growth.

Trade and Portfolio Integration, 2001–151

Source: IMF staff calculations.

1 Trade intensity score is calculated as a country’s share in global trade as a proportion of its GDP share. Portfolio investment intensity score is calculated as a country’s share of the global financial portfolio as a proportion of its GDP share.

When advancing regional financial integration, it is crucial to harness the gains while minimizing the risks. Close attention must be paid to financial stability and safety nets. The opening up of financial markets requires, in the first place, strengthening domestic financial systems and improving macroeconomic fundamentals. At the regional level, cooperation must proceed to enhance information sharing, surveillance, and crisis management and to build an effective cross-country safety net. In recent years the regional safety net has been substantially enhanced. A multilateral currency swap arrangement among the ASEAN Plus Three countries (Chiang Mai Initiative Multilateralization, or CMIM) was established in March 2010, and a crisis prevention facility (the CMIM Precautionary Line) has been introduced. An independent regional macroeconomic surveillance unit—the ASEAN+3 Macroeconomic Research Office—has been in operation since 2011 and was converted to an international organization in 2016. The office seeks to strengthen cooperative relationships with international financial institutions and inked a memorandum of understanding with the IMF in 2017 to enhance cooperation to respond more effectively to the needs of their common membership.

Given these preconditions and requirements, a gradual approach to regional financial integration is likely the right way forward. Appropriately sequenced liberalization and upgraded regulatory and policy frameworks to handle higher cross-border interconnectivity could help contain systemic risks while ASEAN-5 countries reap the benefits of regional financial integration.

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