ANDREW CROCKETT: Thank you, Tharman, for that very interesting and illuminating lecture. We have time for some questions. Before turning to questions from the floor, perhaps while people are writing down their questions to pass up or thinking about them, may I take the privilege to ask the first question?

ANDREW CROCKETT: Thank you, Tharman, for that very interesting and illuminating lecture. We have time for some questions. Before turning to questions from the floor, perhaps while people are writing down their questions to pass up or thinking about them, may I take the privilege to ask the first question?

You made a persuasive case, Tharman, that countries should have flexibility to pursue the exchange rate and interest rate policies that best suit their circumstances. How significant do you think the danger is that, in doing so, you may create tensions with other trading partner countries, perhaps within the region, or maybe even especially if the region is coordinated, that you may create a pattern of payments imbalances that provokes reactions from abroad? I am thinking, of course, of the situation now where many Asian countries semicoordinate their exchange rate policies but generate very substantial surpluses, which lead, at least at the political level, to a certain amount of noise from the rest of the world.

THARMAN SHANMUGARATNAM: I think that's a very important question. It is one of the weaknesses of the present situation that there is no immediate check on countries that want to run exchange policies that are effectively “beggar thy neighbor” policies aimed at short-term competitive gain.

But the situation is not one where these policies can be sustained for long, because each economy that runs, say, an under-valued exchange rate, faces its own problems within a matter of time—typically, the problems of excess liquidity, leading to distortions in their own economy. I believe too that policymakers are increasingly aware, through multilateral surveillance, through the advice we get from the ADB, the IMF, and others—they are increasingly aware of these problems.

There is a much stronger consensus in Asia now on good policy, good monetary and exchange rate policy, than there used to be before the Crisis. So, I would argue that Asian countries will realize that it is in their self-interest not to pursue currency policies aimed at the short term but to pursue currency policies that are aimed at a secular path that reflects the underlying fundamentals of their economies.

The current imbalances are not satisfactory for Asia—not just for the United States and others.

ANDREW CROCKETT: Thank you very much. Let's turn to the floor.

Question: My question is related to the accumulation of huge foreign exchange reserves in Asia. How do you view this huge accumulation of foreign exchange reserves, with a huge portion in U.S. dollars, in relation to the exchange rate policies and respective economic interests of the countries concerned?

THARMAN SHANMUGARATNAM: Well, that's a very large question that in fact has been discussed at several fora during these IMF and World Bank Meetings. Let me say very briefly that it is not just a question of exchange rate policy but fundamentally a question of savings and investment imbalances. And if we look at the sources of savings-investment imbalances in Asia—in China, in Southeast Asia—they suggest that a very complex set of structural issues are in play, such as Chinese consumption, with savings rates high and consumption low, being shaped by social security systems that are not fully developed. Why are Southeast Asian investment rates not as high as we would like? Again, the issues are structural—uncertain labor laws, the need for further reforms in the business environment and in financial supervision—these are some of the concerns that policymakers are working at.

I would say we should look past the external imbalances, look at the causes in savings and investment flows, and address solutions to those causes.

ANDREW CROCKETT: Thank you. I have a question from the floor here, a written question, which goes as follows: “You argue for an endogenous monetary integration process. What prospects do you give for a formalized top-down economic and monetary integration process for Asia and other parts of the world? Do you rule out success for such a process?”

THARMAN SHANMUGARATNAM: Well, that is my whole talk, but as I concluded, we should always stay pragmatic in Asia. Never rule out a solution. The case is now not compelling, and I think the de facto evolution of Asian monetary regimes has been one that will allow us to get quite far in achieving our real objectives. We should always remember that our objective is not monetary integration. Our objective is trade and financial market integration.

NAFTA is a very interesting parallel for us to look at—Canada, the United States, and Mexico—all with floating exchange rates. They don't fix their exchange rates. There is a very high degree of trade integration, a high degree of financial integration, a high degree of cross-border FDI. Economic growth there has gone up by most measures. It has not required currency fixity.

I think that Asia will require more management of its exchange rates—we cannot let them be completely free floating—but the experience of NAFTA is, I think, more instructive than the experience of the EU for Asia.

Question: Singapore has the highest-value circulating banknote in the worldthe 10,000 dollar note, which shows a woman scientist at her computer. Some 40 years ago, a film was made, I think with Gregory Peck, on his amusing efforts to spend or get change from a million pound note. Regarding Asian monetary integration or de facto cooperation, is there any plan to film a distinguished actress going around to banks and exchange offices in Tokyo, Shanghai, Mumbai, and Jakarta to demonstrate how rich Asians already are, without the need to introduce a common Asian million dollar note?

THARMAN SHANMUGARATNAM: Well, we will add this to the list of proposals for Asian monetary integration.

Question: At what pace and by what method do you think India should move toward greater convertibility of its own currency?

THARMAN SHANMUGARATNAM: Well, that is a very dangerous question to ask a minister in another government, and I would not want to comment on India's priorities. There is, however, increasing sense among financial market players in India, and indeed the Prime Minister himself, that there is an opportunity for India to make Mumbai a true financial center. And that this will only occur if they go through a process of gradual removal of capital controls and restrictions. I doubt it will happen quickly, judging from the debate that is taking place right now, but if you take a 20-year view, whether it is about India or China, I think all countries, large and small, will see it in their own interests to try to achieve a freer flow of capital.

We are not purists, we are not ideologues, and we should never be. Let's do what is in our interests, and if it means moving toward freer capital mobility, let's do it intelligently, in steps.

Question: Minister Shanmugaratnam, I think your comparison of the evolution of integration in Europe and Asia provided a number of insights, which certainly made a compelling case for your conclusion that perhaps de facto financial coordination is probably the best outcome. But in terms of having a completeness in terms of the analysis, I wonder whether it would be instructive to look at the U.S. economynot NAFTA, but just the U.S. economy. Historically, convergence or lack of it has been a problem for the United States as well, but there have been two stabilizing phenomena. One has been the high level of mobility of labor from the lagging areas to the more dynamic areas and the second has been the political will for large-scale fiscal transfers, again from the dynamic areas to the really lagging areas. So there can be stabilizers that can change the prior conditions. If there is a political will to move to Asian integration and if one comes to the conclusion that one can reduce the trade-off through these two measures; that is, you can reduce the trade-offs and make the objective of moving more quickly to monetary integration more realizable.

THARMAN SHANMUGARATNAM: I think that is a relevant economic comparison, but I don't see how Asia, with independent sovereign states, will ever be able to contemplate that. The European and NAFTA examples are very useful ones for us to study. In Europe, there was a political imperative, which doesn't exist in Asia. And I think we should avoid thinking that we need to do something dramatically different from what is already happening in our markets and through our own actions so far in order to achieve our objectives of higher growth, lower unemployment, and low inflation.

The current situation is already moving in that direction—the current situation of de facto monetary coordination.

Question: Tharman, you seemed to suggest in your speech that a combination of floating and some kind of domestic anchor like inflation targeting was an effective framework for Asian countries, both for macroeconomic stabilization and for development. And I guess my question is: do you see any downside to this? I am thinking particularly of the case of the Reserve Bank of New Zealand, which actually invented the framework and which itself is actually questioning this framework.

THARMAN SHANMUGARATNAM: I would simply say that it is the lowest-risk and lowest-cost alternative that we have. It is not optimal in every sense. In particular, it will not help to spur the development of an Asian financial market—a common, unified bond market, for instance—the way that it happened in Europe. But given the diversity of Asia, given the costs of surrendering monetary policy autonomy of national economies, I see it as the lowest-risk path that we have.

Question: I enjoyed your presentation very much. With regard to the intermediate regime option, my impression is that you raised three options. Singapore takes a sort of a mixture of all three options. Singapore has a monetary policy based on a managed floatan exchange-rate-based monetary policywhile paying some attention to inflation, but not formal, rigid, inflation targeting. The managed float is against a basket of currency, and the basket includes not only major global currencies but regional currencies as well. In a sense, my impression is that what you are proposing for other Asian currencies is something like Singapore's exchange rate arrangement. I'm not sure if I understand your presentation perfectly.

THARMAN SHANMUGARATNAM: Well, that is not the way I would put it. [Laughter.] But it is the way it is happening, quite independently of Singapore's designs. In fact, I think this de facto solution that is happening before us will increasingly converge on what some of the proponents of monetary integration want, because with increasing trade integration in the region, increasing commonalities of interest, increasingly facing the same economic cycles as a result of trade integration, the weights in each of our baskets that we use for a managed float will tend to converge. They will never be identical, but they will converge. And Asian currencies' weights in each other's baskets will also go up. So by virtue of that, I think we will get an increasing degree of stability among Asian currencies. But it will still preserve the flexibility needed when a shock does happen: both the markets and the authorities will have that ability to adjust the currency, and I think that's a very useful adjustment mechanism to preserve.

Question: That was a terrific analysis. One school of thought is in favor of monetary integration without reference to the political and social context. As we saw in Argentina, that can create chaos. But what can we learn from that for the euro? The euro is still a very young phenomenon. How can we ensure that social diversification in Europe cannot derail that?

THARMAN SHANMUGARATNAM: I think there are some things to be learned from Europe, particularly about financial market integration. The procedures they have set in place for cross-border supervision, the procedures they have set in place to harmonize rules and regulations for the capital markets, the greater institutionalization of what in Asia is still a very informal process of consultation and surveillance—these are important lessons that Asia can learn from Europe.

Question: Can I just add one further thing to your comparison between Asia and Europe and ask you to comment on it? Until now, the European Monetary Union has consisted, with one or two exceptions, of well-run, mature economies. But there are now waiting on the eastern wing of Europe somewhere approaching 10 emerging market economies, standing in line for what looks to many observing it to be a very difficult process indeed of coming into membership. On the one hand, they are emerging markets which, as you have said, have extremely low costs into which there is vast FDI, generating very large booms which may need quite different monetary restraint from core Europe. On the other hand, there is increasing financial integration, which is leading to cross-border borrowing, especially by households, which in some countries is alarming.

I went to a seminar in Frankfurt given by the head of the central bank in Hungary who gave a fascinating presentation at which I stood up and said this sounded to me rather like Thailand between 1994 and 1997not to the amusement of many people in the room. I wonder if you think that the point in Asia is that there are more emerging market economies with very great structural changes yet to come than in the monetary union of core Europe, and that this means that monetary union could not be sustained?

THARMAN SHANMUGARATNAM: Yes, I think you have expressed that point better than I did. I would add that we also want to preserve competition between social models. I think that is one of Asia's strengths; that is part of Asia's vibrancy—the fact that there will be competition between social models, and not an attempt to impose a common social model on all Asian players.

ANDREW CROCKETT: Well, thank you very much, Tharman, and thank you to the audience. I think you have given us a very thoughtful analysis of what is a very topical subject and subjected it to a degree of analytical rigor and historical perspective and some practical common sense that enables us to see some of the perhaps glib solutions that are often advocated in a more realistic light. So, let me ask the audience to join me in thanking you for a very spectacular lecture.

Asian Monetary integration: Will It Ever Happen?