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Is East and South-East Asia Including India an Optimum Currency Area?

By becoming a member of an optimum currency area, a country may be able to maximise its economic efficiency. Given the concern about a recurrence of a financial crisis akin to that of the late 1990s, it is believed that the creation of an OCA for east and south-east Asia would enhance the financial integration of the region. On the basis of some stylised facts and an empirical evaluation, this paper looks into whether India should be included in such an OCA.

Is East and South-East Asia Including India an Optimum Currency Area?

By becoming a member of an optimum currency area, a country may be able to maximise its economic efficiency. Given the concern about a recurrence of a financial crisis akin to that of the late 1990s, it is believed that the creation of an OCA for east and south-east Asia would enhance the financial integration of the region. On the basis of some stylised facts and an empirical evaluation, this paper looks into whether India should be included in such an OCA.


onsequent to enhanced financial integration and globalisation, many economies explore the possibility of a common currency area with their neighbouring strategic trading partners. The formation of the European Union contributed in strengthening the move towards this. Much before this, economists explored the feasibility of an optimum currency area framework, which helped analyse whether countries would benefit by becoming members of a currency union [Mundell 1961]. This framework also contributed towards developing economic criteria for countries to join a currency union so as to derive optimum benefits from joining the club.

The deepening interdependency, coupled with concern about a recurrence of the Asian financial crisis of the late 1990s, prompted the Asian economies to undertake various initiatives for regional monetary and financial cooperation. The major initiatives for regional cooperation in Asia include the Association of South East Asian Nations (ASEAN+3), Chang Mai initiative, Executives’ Meetings of East Asia-Pacific Central Banks, Asian Bond Market Initiative and Asian Bond Fund. The South Asian Association for Regional Cooperation (SAARC) was established in 1985 which included Bangladesh, Bhutan, India, the Maldives, Nepal, Pakistan and Sri Lanka. Apart from these, the ASEAN and its full dialogue partners – Japan, China, Korea and India

– are all involved in creating free trade agreements (FTAs) with ASEAN as well as among themselves. These countries, along with Australia and New Zealand, also launched a new forum called the east Asia summit in Kuala Lumpur in December 2005, which aimed at facilitating the formation of a broader regional community in Asia.

Against this backdrop, it is increasingly felt that the creation of a regional unit of account could be an important initiative towards monetary and financial cooperation that would facilitate intra-regional trade and investment. The creation of a single currency unit could enable invoicing of intra-regional trade and financial transactions in Asia, reducing the region’s dependence on extra-regional currencies such as the dollar, which would contribute towards reducing transaction costs. A common Asian currency would also make it easier for corporates and governments to borrow at lower rates of interest. By sharing the same currency, Asia may develop into a single, wider, deeper and more resilient capital market, which would enhance liquidity, and spur the development of new financial instruments in the region. New funding and investment possibilities may open up, which could bring down the financing costs of firms, and complete the integration of financial markets. Markets in the Asian region may become more efficient and competitive. As a result of increased price transparency, and consequent competition, prices would be likely to scale down.

In view of the above, this paper explores whether the east and south-east Asian region including India is suitable to form an optimum currency area. During the course of the analysis we have defined the hypothetical currency union as the Asian common currency area (ACCA), which comprises the currencies of east and south-east Asian countries including Japan and India.1 We have clubbed India with the east and south-east Asian countries keeping in view its high growth rate, strong macroeconomic fundamentals as well as growing trade and economic integration with these two regions. Japan has been included because of its status as a major economic power in Asia and the important role it could play in the regional monetary cooperation in east and south-east Asia. We have first approached the issue through some stylised facts. The results are then substantiated in terms of an empirical estimation. Special attention has been paid to what would be the likely implications for India on joining an ACCA.

The paper has been arranged as follows. Section I reflects on the theory of an optimum currency area. Major international experiences with a common currency have been analysed in Section II. Section III examines the feasibility of the formation of the ACCA first in terms of some stylised facts, followed by results from empirical estimation. Section IV elaborates on what would be the likely implications for India on joining the ACCA. Section V provides conclusions.

I Theory of Optimum Currency Area

The theory of an optimum currency area (OCA) was pioneered by Robert A Mundell in the 1960s. The core of Mundell’s thesis is that countries or regions constitute an OCA when the real benefits for their economies of fixing irreversibly their exchange rates (adopting a single currency) exceeds the real costs. While Mundell pointed out some of the theoretical considerations regarding the optimality of a single currency zone, some quantifiable parameters have been suggested as measures of the costs and benefits of joining a currency union. Two of the most widely discussed parameters are the extent of trade and the correlation of shocks between countries contemplating monetary integration.

Econometric evidence indicates that among most industrial countries, there is a positive relationship between the intensity of their bilateral trade and the nature of their business cycles. Thus, if monetary integration expands trade relations, it would also result in more correlated business cycles and countries are therefore more likely to satisfy the OCA criteria ex post rather than ex ante [Frankel and Rose 1997]. Another well known criterion for joining a monetary union is economic openness. It is widely perceived that larger the degree of openness of a country, lower is the cost of abandoning the nominal exchange rate as a policy instrument. A variant of this theory suggests that it is not the degree of openness itself but the product of the degree of openness and some crucial measures of the external shocks, which serve as an important criterion for OCA [Gros and Steinherr 1997]. An open economy with an export structure widely different from that of the other potential partners would lose more compared to a closed economy with a similar export structure by joining a monetary union.

Beyond the question of suitable criteria for joining a monetary block, a major issue that has attracted interest in the recent debate relates to the operation of financial policies in the context of a single currency. Of those, the implementation of a uniform monetary policy across the members of a union, in place of national monetary policies has received greater attention. For example, through a number of simulation exercises, Krueger, Laxton and Razin (1997) illustrated that an initial lack of credibility of the European Central Bank (ECB) (particularly regarding anti-inflationary policies) might introduce, in the short run, a deflationary bias for the economic and monetary union (EMU) area. The effects are broadly the same for the countries that have tied their exchange rates to the euro. The deflationary effects, however, appear to be smaller for those countries that preserve their monetary independence.

The theory of OCA does not advocate the abolition of independent budgetary responsibilities. In fact, the original formulations of the model have not been explicit about the specific roles of fiscal policy in the context of monetary unification. In practice the conceptual framework within which the EMU had evolved is one in which fiscal policies are indeed constrained, before and after joining the union but to a large extent, national budgetary operations remain in the realm of individual country sovereignty.

Mundell (1997) extended his analysis of the OCA by suggesting some circumstances under which a country might not decide to join a currency union. These include: (i) if it wants an inflation rate different from the currency area rate; (ii) if it wants to use the exchange rate as an instrument of employment policy to lower or raise the wage; (iii) if it is large in size, and, therefore, does not want to sacrifice seigniorage from the use of its money as an international means of payment; (iv) if it wants to maintain monetary independence; (v) if it feels that a regime of fixed exchange rates could conflict with the required policies of a central bank that had a constitutional mandate to preserve price stability; and (vi) if the partners in the prospective currency union are politically unstable, among other reasons.

Mundell also suggested why a country might choose to join an OCA. These include: (i) to gain the inflation rate of the OCA;

(ii) to reduce transaction costs in trade with major partners; (iii) to eliminate the cost of printing and maintaining a separate national currency; (iv) to establish an automatic mechanism to enforce monetary and fiscal discipline; (v) to have a multinational cushion against shocks; (vi) to participate more fully and on more equal terms in the financial centre and capital market of the union; and

(vii) to provide a catalyst for political alliance or integration among other reasons.

II International Experience with Monetary Union

Monetary Union in Euro Area

The objective of the monetary union in the euro area was defined in the Maastricht Treaty and the primary objective of the ECB is to maintain price stability in the euro area. Price stability was then defined by the ECB as an inflation rate of below but close to 2 per cent over the medium-term. While assessing the effectiveness of the monetary policy of the ECB, González-Páramo (2005) notes:2

The monetary policy strategy adopted since the introduction of the euro has proven to be effective in the pursuit of this goal. Looking back on the period since 1999, the answer must be a clear ‘yes’. It is true that occasionally the inflation rate has moved above the 2 per cent ceiling as a result of temporary shocks, for example the recent sharp rise in oil prices. In the presence of such shocks, however, what it is important from the monetary policy perspective is that price stability is maintained over the medium term, in other words, once the shock has disappeared. In this respect, it is interesting to note that long-term inflation expectations as measured by the available surveys of market expectations for inflation over the next 10 years have never exceeded 2 per cent since the introduction of the euro.

Another important offshoot of the economic and monetary union in the euro area has been the acceleration in the process of European financial market integration. The depth and breadth of markets have increased as the elimination of exchange rate risk and elimination of hindrances to cross-border trading have attracted more investors in various markets in the euro area. In addition, elimination of intra-area exchange rate risk premia along with reduced risk premia on account of increased emphasis on stability-oriented economic policies has led to reduced financing costs and also added to the resilience of financial markets. New market segments have also experienced rapid growth. One such example is the high-yield segment of the euro area corporate bond market. The success of the euro is also visible from the fact that it plays an important role in international bond and foreign exchange markets as a currency for settlement and invoicing and as an anchor or reference currency.

The Maastricht Treaty also incorporated a set of fiscal rules that later formed the basis for the stability and growth pact adopted in 1997. These were to ensure sound public finances. It was felt that fiscal rules are essential not only to contain domestic deficit biases but also to protect against cross-country externalities and adverse incentives within the union. However, the experience shows that while some countries have managed to maintain sound budgetary positions over recent years, fiscal positions in a number of other countries have deteriorated visibly. Excessive deficits have emerged, and the procedures set out in the stability and growth pact for their prevention and correction were not always properly followed. Now it has become essential to implement the new rules and procedures in a strict manner to ensure credibility and to promote a timely return to sound budgetary positions.

Monetary Integration in Africa

A feature of regional cooperation in Africa is the existence of overlapping regional integration initiatives. In west Africa, the economic community of the west African states (ECOWAS) since its formation has had the objective of constructing a free trade area and single currency union. The absence of any progress on the latter led a subset of ECOWAS countries to propose a second monetary zone, (in addition to the existing communauté financiére d’Afrique (CFA) franc zone in west Africa) termed as west African economic and monetary community (WAEMU), as a fast track to the creation of a unified west African monetary zone.

The existing form of monetary integration in Africa with two currency unions of CFA franc zone dates back to 1959.3 The CFA franc zone comprises two elements, i e, an internal currency union and a bilateral hard peg to the euro (earlier it was the French franc). The CFA franc zone comprises the WAEMU and the central African economic and monetary community (CEMAC), each with its own central bank issuing its own currency with fixed parity with the euro. Both currencies are commonly called the CFA franc. The experience of the two currency unions of the CFA franc zone in Africa shows that it has been beneficial for zone members of the CFA franc zone as it has prompted internal trade. However, financial integration among zone members continues to remain low. The unions have been successful in delivering low inflation probably due to the external peg. However, this did not prevent a bank crisis and overvaluation of real exchange rate due to undisciplined fiscal policies and occasional monetisation of fiscal deficit.

Although the common monetary area (CMA) is not a currency union as national currencies are issued in each of its member countries, these are tightly pegged to the rand through a currency board type of arrangement and exchanged at par. The experience of the CMA is also somewhat mixed. On the one hand, the South African central bank has the highest degree of central bank independence and has successfully delivered low inflation after the adoption of inflation targeting. On the other hand, it has adversely impacted the macroeconomic balance and competitiveness of small members due to significant swings in the rand vis-à-vis major currencies.

Regarding the prospects of monetary integration in Africa, there are currently overlapping plans, which seem to be driven by desire rather than realism and completion dates have been postponed in several instances. The proposed west African monetary zone is scheduled to take place by December 2009. A single currency for Africa has been a long-standing goal for African unity. The 1991 treaty on the African economic community envisages a creation of an African central bank and single African currency 2028 at the very latest. The conditions as of now are not so favourable for such an OCA and intra-region trade and labour mobility is quite low. External shocks also tend to be asymmetric for different countries.

Monetary Union in the Arab Region

The Arab monetary fund (AMF) was established by the economic council of Arab states in April 1976 and commenced its operations in 1977. According to the agreement, the overriding objectives of the AMF are to lay “the monetary foundations of Arab economic integration” and to accelerate “the process of economic development in all Arab countries”. In practice, however, the AMF’s role as a catalyst for Arab monetary integration has been limited by various factors. First, trade linkages among the Arab countries are limited, reflecting the relative similarity of resource endowments, the lack of a diversified export base in manufactures, high costs of transportation and restrictive trade policies. As a result, intra-regional trade accounts for only a small fraction of total Arab trade. Second, there is a great diversity in trade and exchange restrictions and other economic regimes across the Arab countries, which is compounded by political differences and conflicts. Some countries are market-oriented (e g, Jordan, Morocco and Tunisia), while others are public sector-oriented (e g, Libya and Syria). Some have a liberal trade and exchange regime (e g, the Gulf cooperation council countries), while most others have a more restrictive regime. Some are primarily agricultural producers (e g, Mauritania and Sudan), while others are primarily energy producers. Per capita income also varies widely across the region. Third, exchange rate arrangements vary from currency boards to free floating, with managed floating and a peg (official or de facto) to the US dollar being predominant. Finally, the essential character of the AMF as a lending institution has not been helpful in promoting monetary integration. Under these circumstances, the AMF has been more a vehicle of resource transfers than a catalyst of regional integration through finance and adjustment.

Common Currency in East Caribbean

A smaller success story has occurred among the islands of the east Caribbean. The British Caribbean currency board was established in 1950 and included the British West Indies, Trinidad and Tobago, Barbados, the Leeward Islands (Anguilla, Saba, St Christopher, Nevis and Antigua), the Winward Islands (St Lucia, Dominica, St Vincent, Grenada), British Guiana, and the British Virgin Islands. However, a few island countries have left the currency union.

Proposed Asian Currency Unit

The ADB has proposed to adopt an Asian currency unit (ACU) based on a basket of 13 Asian currencies (Singapore, Malaysia, Indonesia, Thailand, the Philippines, Brunei, Laos, Myanmar, Vietnam and Cambodia) plus Japan, China and South Korea (the ASEAN +3) as a yardstick to measure variations in currency values. It will be a weighted average of the members’ exchange rates. The ACU is supposed to help monitor both the collective movement of Asian currencies against major currencies (such as the US dollar and the euro), as well as the individual movement of each Asian currency against the regional average presented by the ACU. The ACU has also been modelled to enable economic interdependence in Asia, cooperation on exchange rate stability and at a later stage, convergence of monetary policy and the introduction of a single currency.

There are, however, some emerging challenges in the way of a successful launch of the ACU. The first one relates to the medium-term sustainability of the convergence criteria. International experiences indicate that it is important for any country joining a currency union to meet convergence criteria in terms certain macroeconomic indicators. For example, to join the European Union, it is essential for a country to meet certain criteria in terms of inflation, exchange rate stability, fiscal balance and level of public debt. Although any such convergence criteria for joining the ACU is yet to be developed, the current state of their economies reveal substantial differences among the economic performances of the east Asian countries. Second, there should be a concensus on which currencies should be included in the proposed regional units and what weighting each currency should be given. Third, the question of putting the Hong Kong and Taiwan dollars in the basket is an important issue for countries like China. Fourth, the exclusion of India in the first round of talks generates considerable debate. Fifth, the ADB’s vision for ACUs each made up of a basket of currencies, has fuelled debate about whether the Bank was the right launching pad.

An overall assessment of the international experience with monetary unions reveals that while the creation of the euro area was a success, most of the other monetary unions could not live up to their expectations. The lack of clear focus, divergences in the macroeconomic situations and economic policies among the member countries as well as lack of trade and economic integration within the region are some of the major factors that contributed to the failure of the monetary union in various regions. It is important therefore, to address these issues for the successful launch of an ACU.

III Prospects of Asian Common Currency Area

Within the broader objective of facilitating trade and economic integration, the eventual advantages of an Asian common currency would include elimination of exchange rate uncertainty, economies of scale for firms operating in the region, and the possible weight of such a currency deterring speculative attacks. Another important benefit is that the countries involved would be able to monitor how their individual currencies are faring against each other and how the region’s currencies are faring against major international currencies and currency blocks (e g, the US dollar and the euro). Such monitoring would help in raising alarms early enough and in preventing the sort of currency crises that took place in 1997-98. Moreover, the central banks of the member countries could coordinate management of reserves so that when one currency comes under attack they can use each other’s reserves as a defense. Also, the establishment of an ACCA would help in facilitating financial exchanges among the countries in the region and in providing an alternative to hard international currencies like the US dollar as a form of reserves. It is assumed that developing a single Asian currency will help borrowers to tap Asia’s savings and help develop a vibrant Asian bond market as in the case of Europe. Apart from facilitating the development of an Asian multi-currency bond market, the creation of a single currency would also help provide depth to capital markets, which would help reduce exposure to external shocks.

The feasibility of the formation of an ACCA is first examined in terms of some stylised facts. The points are then substantiated in terms of empirical estimation results.

Some Stylised Facts

First, the sizes of different ACCA countries are highly uneven, ranging from the larger China (13.6 per cent of world GDP),4 to the smaller economies of Laos (0.02 per cent of world GDP) and Cambodia (0.05 per cent of world GDP) (Table 1). The remaining economies stand in an intermediate position. The share of Indian economy is 6 per cent of world GDP, the second largest after China.

Second, there are substantial differences in the rate of growth among the ACCA economies. The growth rate varies between 4 per cent (Korea) and 12.2 per cent (Myanmar) in 2005 (Table 2). The divergence would be higher after taking into account Japan, which grew at 2.7 per cent during 2005. Regarding the longterm trend, the average growth rate varies between 2.8 per cent (Japan) and 9.2 per cent (China) during the period 1975-2004 (Table 3). The growth rate lies between 5 and 7 per cent for most of the ACCA countries during the period. The growth rate for

Table 1: PPP Based Share of World GDP

(Per cent)

Emerging Asia 2001 2002 2003 2004 2005

China, People’s Republic of 11.47 12.07 12.68 13.18 13.59 Hong Kong, China 0.38 0.38 0.37 0.38 0.38 Korea, Republic of 1.80 1.87 1.86 1.85 1.84 Taiwan, China 1.05 1.06 1.05 1.06 1.06 India 5.54 5.65 5.83 5.91 6.05 Indonesia 1.43 1.44 1.44 1.44 1.45 Malaysia 0.46 0.46 0.47 0.48 0.49 Philippines 0.67 0.68 0.69 0.69 0.69 Singapore 0.21 0.21 0.20 0.21 0.21 Thailand 0.86 0.88 0.91 0.92 0.94 Laos 0.02 0.02 0.02 0.02 0.02 Cambodia 0.05 0.05 0.05 0.05 0.05 Myanmar 0.13 0.14 0.14 0.13 0.13 Vietnam 0.35 0.36 0.37 0.38 0.39

Source: The IMF World Economic Outlook and Econstat.

Table 2: GDP Growth Rates

(Per cent per year)

Emerging Asia 2001 2002 2003 2004 2005

China, People’s Republic of 8.30 9.10 10.00 10.00 9.90 Hong Kong, China 0.60 1.80 3.20 8.60 7.30 Korea, Republic of 3.80 7.00 3.10 4.60 4.00 Taiwan, China –2.20 4.20 3.40 6.10 4.10 India 5.80 3.80 8.50 7.50 8.10 Indonesia 3.80 4.30 5.00 4.90 5.60 Malaysia 0.30 4.40 5.40 7.10 5.30 Philippines 1.80 4.40 4.50 6.00 5.10 Singapore –2.30 4.00 2.90 8.70 6.40 Thailand 2.20 5.30 7.00 6.20 4.50 Laos 5.80 5.90 5.80 6.90 7.20 Cambodia 5.50 5.20 7.00 7.70 8.40 Myanmar 11.30 12.00 13.80 13.60 12.20 Vietnam 6.90 7.10 7.30 7.80 8.40

Source: Asian Development Outlook 2006.

Table 3: Long-Term Trends in Growth and Inflation: 1975-2004

Emerging Asia Growth Inflation Mean Standard Mean Standard Deviation Deviation

China, People’s Republic of 9.24 3.44 7.05 8.01 Hong Kong, China 6.16 4.72 4.51 5.54 India 5.44 2.83 7.75 3.35 Indonesia 5.75 4.21 11.62 12.19 Japan 2.75 1.95 0.70 1.27 Korea, Republic of 6.97 3.79 4.97 2.24 Malaysia 6.45 4.08 2.75 1.34 Philippines 3.35 3.59 7.80 4.01 Singapore 6.98 3.76 1.55 1.17 Thailand 6.37 4.39 3.88 2.18

Source: International Financial Statistics, International Monetary Fund.

India was 8.1 per cent in 2005, one of the highest among Asia. The average growth rate for India was 5.4 per cent for the entire period of 1975-2004.

Third, the growth correlation coefficients across the ACCA countries are generally positive for Indonesia, Japan, Korea, Malaysia, the Philippines, Singapore and Thailand indicating coherence of economic growth across these countries (Table 4). On the other hand, most of the growth correlation coefficients for India and China are either very small or negative, implying lack of synchronisation of economic growth with the other ACCA countries. The picture changes, when we employ the analysis by breaking up the study period into two parts: period I (1975-1994) and period II (1995-2004). Various studies have already established that 1994-95 is the dividing line, as one could see substantial differences in most important macro parameters from 1994-95 onwards compared to the earlier period. There is a distinct indication of greater synchronisation of economic growth among the ACCA members in period II compared to period I (Tables 5 and 6). This reflects a number of factors, viz, increased economic liberalisation, trade and investment integration and regional cooperation among the ACCA members in the last decade. Even the Chinese economy shows signs of greater synchronisation of economic growth with the other ACCA members during the last decade. It is important to note that the Indian economy continues to remain uncorrelated with the other ACCA member economies, even in period II.

Fourth, the inflation rate ranged from 10.5 per cent (Indonesia) to 0.4 per cent (Singapore) in the year 2005 (Table 7). Regarding

Table 7: Inflation

(Per cent per year)

Emerging Asia 2001 2002 2003 2004 2005
China, People’s Republic of 0.7 –0.8 1.2 3.9 1.8
Hong Kong, China –1.6 –3.0 –2.5 –0.4 1.1
Korea, Republic of 4.1 2.7 3.6 3.6 2.7
Taiwan, China 0.0 –0.2 –0.3 1.6 2.3
India 3.7 3.4 5.5 6.5 4.5
Indonesia 11.5 11.9 9.8 6.5 10.5
Malaysia 1.4 1.8 1.2 1.4 3.0
Philippines 6.1 2.9 3.5 6.0 7.6
Singapore 1.0 –0.4 0.5 1.7 0.4
Thailand 1.6 0.6 1.8 2.8 4.5
Laos 7.8 10.7 15.5 10.5 7.2
Cambodia 0.3 3.3 1.2 3.9 5.8
Myanmar 21.2 57.0 36.6 ... ...
Vietnam –0.4 3.8 3.1 7.8 8.3

Source: Asian Development Outlook 2006.

Table 4: Correlations of Growth among Asian Countries – 1975-2004

China Hong Kong India Indonesia J a p a n Korea Malaysia Philippines Singapore Thailand
China 1.00
Hong Kong –0.16 1.00
India 0.19 –0.35 1.00
Indonesia 0.04 0.51 –0.01 1.00
J a p a n –0.19 0.41 –0.13 0.50 1.00
Korea 0.02 0.49 –0.09 0.61 0.45 1.00
Malaysia –0.09 0.57 –0.16 0.73 0.36 0.54 1.00
Philippines –0.52 0.34 0.07 0.23 0.17 0.16 0.41 1.00
Singapore 0.03 0.53 –0.04 0.56 0.34 0.39 0.82 0.42 1.00
Thailand –0.01 0.45 0.10 0.81 0.60 0.73 0.72 0.29 0.56 1.00

Table 5: Correlations of Growth among Asian Countries : 1975-1994

China Hong Kong India Indonesia J a p a n Korea Malaysia Philippines Singapore Thailand
China 1.00
Hong Kong –0.26 1.00
India 0.19 –0.36 1.00
Indonesia –0.16 0.15 0.11 1.00
J a p a n –0.36 0.05 –0.09 0.03 1.00
Korea –0.04 0.21 –0.04 –0.08 0.24 1.00
Malaysia –0.26 0.37 –0.26 0.45 –0.02 0.05 1.00
Philippines –0.60 0.34 0.06 0.18 0.19 0.07 0.36 1.00
Singapore –0.04 0.26 0.03 0.45 –0.11 –0.05 0.79 0.44 1.00
Thailand –0.20 0.08 0.25 0.38 0.42 0.42 0.57 0.42 0.49 1.00

Table 6: Correlations of Growth among Asian Countries – 1995-2004

China Hong Kong China 1.00 Hong Kong 0.37 1.00 India 0.46 –0.09 Indonesia 0.67 0.72 J a p a n 0.68 0.77 Korea 0.30 0.71 Malaysia 0.60 0.84 Philippines 0.58 0.91 Singapore 0.43 0.83 Thailand 0.62 0.65 India 1.00 0.11 0.23 0.00 0.17 –0.03 0.04 0.34 Indonesia 1.00 0.71 0.83 0.89 0.83 0.57 0.89 J a p a n 1.00 0.47 0.80 0.84 0.76 0.56 Korea 1.00 0.87 0.75 0.65 0.84 Malaysia Philippines Singapore 1.00 0.93 1.00 0.85 0.88 1.00 0.82 0.71 0.48 Thailand 1.00
Economic and Political Weekly March 17, 2007 957

the long term trend, the mean consumer price index (CPI) inflation rate varies between 0.7 per cent (Japan) and 11.6 per cent (Indonesia) during 1975-2004 (Table 3). Inflation rates appear to be much more volatile compared to growth rates. The standard deviation of the CPI inflation rate is as high as 12.2 per cent for Indonesia, followed by 8.0 per cent for China. The inflation correlations across countries seem to be generally positive and much higher than the growth correlations reflecting signs of comovement of prices across the ACCA countries (Table 8). This would imply different real exchange rates for each of those countries that are necessary to have appropriate wage flexibility as in the US.

Fifth, the rate of gross domestic investment varies between 43.5 per cent (China) and 15.7 per cent (Philippines) (Table 9). The gross domestic investment rate is around 30 per cent for India.

Sixth, the fiscal balance of the central government represented a surplus of 8 per cent of GDP for Singapore and a deficit of

7.6 per cent for India (Table 10). Given the huge disparities in fiscal balances, a “fiscal stabilisation pact” among the ACCA members would be a welcome step.

Seventh, one factor which has a direct influence on a country’s decision to join a currency union is the degree of openness of the economy. There are marked differences in the degree of openness among the east and south-east Asian economies with the city state of Hong Kong and Singapore standing out as the most open economies in the region (Table 11). India stands out to be the least open economy with the proportion of goods and services as a per cent of GDP at 30.9 per cent. Rate of growth of merchandise exports and imports also vary significantly across the ACCA group. While Chinese exports grew at the rate of 28.4 per cent, exports for the Philippines grew only at the rate of 3.7 per cent in 2005 (Table 12). Similarly, while the imports of Indonesia grew at the rate of 26.2 per cent, the imports of the Philippines grew at 7.4 per cent during the same period (Table 13). Imports to India grew at a faster rate of 30 per cent in 2005. Moreover, there was large variance in external surpluses of the Asian countries (Table 14).

Eighth, regarding the capital account of balance of payments, there is huge variability among the ACCA countries in terms of capital flows and exchange rate movements. Foreign direct investment (FDI) flows to China were as high as $ 60.3 billion in 2005, whereas FDI flows to Korea were a meager 26 million during the same period (Table 15). The FDI flow to India was $ 7.8 billion in 2005-06. The stock of external debt of Hong Kong was a huge $ 445.4 billion, whereas that of Laos stood at $ 2.2 billion at the end of 2005 (Table 16). Similarly, while

Table 9: Gross Domestic Investment

(Per cent of GDP)

Emerging Asia 2001 2002 2003 2004 2005

China, People’s Republic of 34.2 35.2 38.0 39.3 43.5 Hong Kong, China 25.3 22.8 21.9 21.8 20.5 Korea, Republic of 29.3 29.1 30.0 30.2 30.1 Taiwan, China 18.4 17.4 17.4 21.5 20.2 India 23.0 25.3 27.2 30.1 ... Indonesia 23.5 20.4 17.3 21.3 21.3 Malaysia 23.9 24.0 21.6 22.6 19.8 Philippines 19.0 17.7 16.7 17.1 15.7 Singapore 26.5 23.7 15.6 19.4 18.6 Thailand 24.1 23.8 24.9 27.1 31.6 Laos ... ... ... ... ... Cambodia 18.7 20.1 25.1 25.8 26.4 Myanmar 11.6 10.1 11.0 ... ... Vietnam 31.2 33.2 35.4 35.5 35.4

Source: Asian Development Outlook 2006.

Table 10: Fiscal Balance of Central Government

(Per cent of GDP)

Emerging Asia 2001 2002 2003 2004 2005

China, People’s Republic of –2.3 –2.6 –2.2 –1.3 –1.6 Hong Kong, China –4.9 –4.8 –3.3 –0.3 0.3 Korea, Republic of –1.7 0.4 –2.5 –2.5 0.8 Taiwan, China –6.4 –4.3 –2.8 –2.9 –1.0 India –9.9 –9.6 –8.4 –8.3 –7.6 Indonesia –2.4 –2.1 –1.7 –1.1 –0.5 Malaysia –5.5 –5.6 –5.3 –4.3 –3.8 Philippines –4.0 –5.3 –4.7 –3.9 –2.7 Singapore –0.3 –1.6 6.5 5.6 8.0 Thailand –2.1 –2.2 0.6 0.3 0.1 Laos –7.5 –5.3 –7.9 –5.8 –6.0 Cambodia –6.6 –6.4 –6.9 –4.3 –3.1 Myanmar –5.8 –3.6 –4.6 –6.0 ... Vietnam –2.9 –3.6 –4.3 –2.0 –2.3

Source: Asian Development Outlook 2006.

Table 11: Export and Import of Goods and Servicesas a Per Cent of GDP

(Per cent)

Emerging Asia 2001

China, People’s Republic of 43.1 47.7 Hong Kong, China 278.0 296.4 Korea, Republic of 73.3 69.1 Taiwan, China ... ... India 27.7 30.9 Indonesia 68.2 57.8 Malaysia 214.4 211.0 Philippines 100.3 99.9 Singapore ... ... Thailand 125.2 121.7 Laos 69.4 67.2 Cambodia 118.5 123.7 Myanmar ... ... Vietnam 111.6 116.5

Source: World Development Indicators, World Bank.

Table 8: Inflation Correlation among Asian Countries: 1987-2004

Cambodia China Hong Kong India Indonesia Japan Korea Lao PDR Malaysia Philippines Singapore Thailand Vietnam
Cambodia China Hong Kong, China India Indonesia Japan Korea Lao PDR Malaysia Philippines Singapore Thailand Vietnam 1.00 –0.07 0.35 0.74 0.77 0.43 0.66 0.43 0.82 0.69 –0.35 0.67 0.76 1.00 0.66 0.28 –0.30 0.22 0.30 –0.27 0.22 0.25 0.49 0.34 0.31 1.00 0.71 –0.14 0.79 0.64 –0.23 0.58 0.34 0.68 0.63 0.43 1.00 0.13 –0.16 0.04 0.02 0.45 0.17 0.43 0.36 0.51 1.00 0.17 0.25 0.61 0.32 0.02 –0.12 0.27 0.44 1.00 0.82 –0.01 0.49 0.21 0.40 0.53 0.39 1.00 –0.17 0.65 0.14 0.67 0.81 0.42 1.00 0.20 0.06 –0.41 0.03 0.25 1.00 0.24 0.76 0.73 0.53 1.00 0.33 0.16 0.46 1.00 0.80 –0.17 1.00 0.50 1.00
958 Economic and Political Weekly March 17, 2007

China held a foreign exchange reserve stock of $ 818.9 billion, the reserve holding of Laos was only $ 0.2 billion at the end of 2005 (Table 17). The foreign exchange reserve of India was $ 137.2 billion at the end of 2005.

Ninth, the exchange rates of the ACCA reflected large crosscurrency volatility (Table 18). While China, Hong Kong, Malaysia and Singapore have maintained a fixed exchange rate, currencies of other countries have fluctuated against the US dollar. While the Korean won appreciated against the US dollar by 11.7 per cent, the Indonesian rupiah depreciated against the US dollar by 8.3 per cent in 2005.

To sum up, the significant cross-country variations in the size of the economy, stages of development, growth performance, inflation performance, degree of openness and other external sector indicators among the ACCA group members indicate that at present, the ACCA would represent a basket of heterogeneous group of countries. The group has to go a long way towards the synchronisation of their economies for a successful integration into an OCA.

Estimation and Empirical Results

Synchronisation of economic growth among the member countries is an important criterion for the success of a currency union. We have already used correlation matrices of output growth and inflation rate to analyse the pattern of movements in the output and prices across the Asian countries. One limitation of looking at correlations of output growth and inflation across countries is that no distinction is made between underlying disturbances themselves and the response to those disturbances. Here we have made an attempt to estimate the symmetry of underlying shocks among the east Asian economies, as a preliminary guide to identifying potential members for a monetary union. Following the method adopted by Bayoumi and Ostry (1995), GDP growth rate was regressed upon its own lagged values. The residual from this regression was taken to represent the underlying output disturbances. Reflecting the inclusion of a lag in the estimation procedure, the correlations were generally calculated over the period 1976-2004. Given the size of the crosscountry data set, no attempt was made to identify the source of these disturbances, which could reflect various factors including domestic economic policies, external shocks, political instability, civil unrest and droughts.

The size of the underlying disturbances was calculated using the standard deviation of the residuals. The standard deviation varied from 1.5 per cent per annum for Japan to 4.6 per cent for Hong Kong. The standard deviations hovered between 3-4 per cent for majority of the ACCA countries, including China, Indonesia, Korea, Malaysia, the Philippines, Singapore and Thailand. The standard deviation for India was 2.7 per cent.

Next, we looked at the correlations of these disturbances. In assessing the symmetry and asymmetry of correlations of structural shocks, it is assumed that if the correlation is positive, the shocks are categorised as symmetric and if the correlation is negative, or if it is not statistically different from zero, the shocks are categorised as asymmetric. In our exercise, for the entire period of 1975-2004, out of 45 correlations, 28 are significantly different from zero (Table 20). Significant correlation coefficients are indicated in bold. Of those, only two of the correlations are negative. Five correlations are significantly different from

(Per cent per year)

Table 12: Growth Rate of Merchandise Exports

Emerging Asia 2001 2002 2003 2004 2005
China, People’s Republic of 6.8 22.4 34.6 35.4 28.4
Hong Kong, China Korea, Republic of –5.8 –14.0 4.9 7.9 12.1 20.7 15.9 30.6 11.2 12.1
Taiwan, China –17.3 6.4 10.5 20.7 8.8
India –1.6 20.3 23.3 23.9 15.8
Indonesia –12.3 3.1 8.4 12.6 20.1
Malaysia –10.6 7.2 11.0 20.9 12.0
Philippines Singapore –16.2 –10.5 9.9 5.2 2.7 15.0 9.8 24.3 3.7 15.7
Thailand –7.1 4.8 18.2 21.6 15.0
Laos –3.3 –5.9 7.2 12.7 48.6
Cambodia 12.1 11.7 15.5 22.1 9.3
Myanmar 43.0 –3.9 12.6 8.2 ...
Vietnam 6.5 7.4 20.4 30.3 20.5
Source: Asian Development Outlook 2006.
Table 13: Growth Rate of Merchandise Imports
(Per cent per year)
Emerging Asia 2001 2002 2003 2004 2005
China, People’s Republic of 8.1 21.3 39.8 35.8 17.6
Hong Kong, China –5.5 3.1 12.2 17.0 10.2
Korea, Republic of Taiwan, China –13.4 –23.7 7.7 3.4 18.0 12.2 25.6 32.5 16.1 8.5
India –2.8 14.5 24.1 48.5 30.0
Indonesia –14.1 2.8 10.9 28.0 26.2
Malaysia –10.3 8.3 4.8 25.5 9.3
Philippines –13.3 6.3 3.1 8.0 7.4
Singapore Thailand –13.7 –3.0 3.3 4.6 8.4 17.4 27.2 25.7 15.7 26.0
Laos –4.7 –12.4 1.9 56.4 23.8
Cambodia 8.0 10.7 10.4 24.7 17.1
Myanmar 13.4 –16.1 1.3 –10.6 ...
Vietnam 6.0 19.5 37.4 26.0 16.0
Source: Asian Development Outlook 2006.
Table 14: Current Account Balance
(Per cent of GDP)
Emerging Asia 2001 2002 2003 2004 2005
China, People’s Republic of 1.3 2.4 2.8 3.6 7.0
Hong Kong, China Korea, Republic of 5.9 1.7 7.6 1.0 10.4 2.0 9.5 4.1 11.1 2.1
Taiwan, China 6.3 8.7 9.8 5.7 4.7
India 0.7 1.3 2.3 –0.8 –2.5
Indonesia 4.2 3.8 3.4 1.2 1.1
Malaysia 8.3 8.4 12.8 12.6 15.7
Philippines Singapore –2.5 16.8 –0.5 13.4 0.4 24.1 1.9 24.5 2.4 28.5
Thailand 5.4 5.5 5.6 4.3 –2.1
Source: Asian Development Outlook 2006.
Table 15: Foreign Direct Investment (FDI) Inflows
($ million)
Emerging Asia 2001 2002 2003 2004 2005
China, People’s Republic of Hong Kong, China 46878 12431 52743 –7781 53505 8139 60630 –11689 60325 3323
Korea, Republic of 1108 –224 100 4588 2 6
Taiwan, China –1371 –3441 –5229 –5247 –4403
India 6130 5035 4322 5652 7751
Indonesia –2977 145 –597 1023 2258
Malaysia Philippines 287 335 1299 1477 1104 188 2563 109 713 970
Singapore –8590 5051 7233 6307 14562
Thailand 3540 841 1466 1289 3289
Laos 2 4 5 20 17 27
Cambodia 142 139 7 4 121 216
Myanmar Vietnam 192 273 191 397 128 1222 ... 1730 ... 1914

Note: For India, the figures are for financial years and the source is the Reserve Bank of India, Bulletin.

Source: Asian Development Outlook 2006.

zero at the 10 per cent level. Four correlations are significantly different from zero at the 5 per cent level. Nineteen correlations are significantly different from zero at the 1 per cent level. It is also clear from the table that the growth disturbances for Hong Kong, Indonesia, Japan, Korea, Malaysia, Singapore and Thailand show significant positive correlations, which implies synchronisation of real disturbances among these countries. For the Philippines, correlations of growth disturbances are significantly different from zero with countries like Hong Kong, Korea, Malaysia, Singapore and Thailand. But none of the correlations are significant for India and China. In fact, four of the correlations are negative for China as against two for India, implying the presence of asymmetric disturbances with other ACCA members.

In the next step, the entire period of study is divided into two parts: period I (1975-94) and period II (1995-2004). This break has been introduced to study the effect of rapid liberalisation measures undertaken in various countries on synchronisation of external shocks. After the break, correlation results deteriorated for period I (Table 21). The correlation matrix for period I now includes only 19 significant coefficients, of which three are negative in value. During period I, the real disturbances seem to be correlated only for countries like Hong Kong, Malaysia, Singapore and Thailand. China remains the most uncorrelated economy, followed by India, Japan, Korea, Indonesia and the Philippines. The situation undergoes a sea change in period II, where out of 45 correlations, 36 turn out to be significant (Table 22). It is evident from the correlation matrix that there is strong evidence of synchronisation of real disturbances among all the major ACCA members, vis, China, Hong Kong, Japan, Korea, Indonesia,

(US $ billion)

Table 16: External Debt Outstanding

Emerging Asia 2001 2002 2003 2004 2005
China, People’s Republic of 170.1 168.5 193.6 228.6 ...
Hong Kong, China 340.0 350.7 371.6 429.3 445.4
Korea, Republic of 128.7 141.5 157.6 172.3 190.0
Taiwan, China 34.3 45.0 63.1 80.9 ...
India 98.8 104.9 111.7 120.3 119.2
Indonesia 133.1 131.3 135.4 137.0 132.7
Malaysia 45.6 48.9 49.1 52.8 51.7
Philippines 51.9 53.6 57.4 54.8 54.2
Singapore 160.1 163.4 189.1 225.8 246.0
Thailand 67.5 59.5 51.8 51.3 50.9

Note: For India, the source is the Reserve Bank of India and the ministry of finance, government of India.

Source: Asian Development Outlook 2006.

(US $ billion)

Table 17: Gross International Reserves

Emerging Asia 2001 2002 2003 2004 2005
China, People’s Republic of 212.2 286.4 403.3 609.9 818.9
Hong Kong, China 111.2 111.9 118.4 123.6 124.3
Korea, Republic of 102.8 121.3 155.3 199.0 210.3
Taiwan, China 122.2 161.7 206.6 241.7 253.3
India 51.0 71.9 103.1 131.2 137.2
Indonesia 28.0 32.0 36.3 36.3 34.7
Malaysia 30.8 34.6 44.7 66.7 70.5
Philippines 15.7 16.4 17.1 16.2 18.5
Singapore 75.8 82.3 96.3 112.8 116.6
Thailand 33.0 38.9 42.1 49.8 52.1
Laos 0.1 0.2 0.2 0.2 0.2
Cambodia 0.5 0.7 0.7 0.8 0.9
Myanmar 0.2 0.3 0.5 ... ...
Vietnam 3.5 3.8 5.6 6.0 7.7

Note: For India, the source is the Reserve Bank of India. Source: Asian Development Outlook 2006.

Malaysia, Singapore, the Philippines and Thailand except India. Interestingly in period II, while Chinese output disturbances have become totally synchronised with the other ACCA members, the Indian economy continues to remain uncorrelated.

The same exercise has been carried out for inflation. The standard deviation for inflation disturbances varied widely from

0.8 per cent for Japan to 12.5 per cent for Indonesia. The correlation coefficients of inflation disturbances are shown in Table 23, with the significant correlations marked in bold. In the case of inflation, out of 36 correlations, 14 are significantly different from zero, of which only one is negative. Of the significant coefficients, eight are significant at 1 per cent level, five are significant at 5 per cent level and one is significant at the 10 per cent level. It shows that there is no definite pattern in the correlation coefficients of inflation disturbances. The inflation disturbances of China are totally uncorrelated with other ACCA members, as noted in the case of growth correlations. It is interesting to note, however, that unlike in the case of growth disturbances, the inflation disturbances of India are correlated with Indonesia, Korea, Malaysia and Thailand. Since for inflation, the period of study is 1987-2004, no break in the period has been introduced here.

It is clear from the above analysis that there are indications of coherent output fluctuation among the majority of the ACCA members (Hong Kong, Indonesia, Japan, Korea, Malaysia, the Philippines and Singapore). The degree of synchronisation of real disturbances have undergone rapid growth in the last decade, which is marked by liberalisation of economic policies, greater integration of trade and investment, and regional cooperation in

Table 18: Exchange Rate to US Dollar

(Annual average)

Emerging Asia 2001 2002 2003 2004 2005

China, People’s Republic of 8.3 8.3 8.3 8.3 8.2 Hong Kong, China 7.8 7.8 7.8 7.8 7.8 Korea, Republic of 1291.0 1250.7 1191.9 1143.7 1024.1 Taiwan, China 33.8 34.6 34.4 33.4 32.2 India 47.7 48.4 45.9 44.9 45.2 Indonesia 10260.9 9311.2 8577.1 8938.9 9750.0 Malaysia 3.8 3.8 3.8 3.8 3.8 Philippines 51.0 51.6 54.2 56.0 55.1 Singapore 1.8 1.8 1.7 1.7 1.7 Thailand 44.5 43.0 41.5 40.3 40.2 Laos 8954.6 10056.3 10652.0 10380.0 10500.0 Cambodia 3924.0 3917.0 3979.0 4019.0 4097.0 Myanmar 6.7 6.6 6.1 5.7 ... Vietnam 14725.2 15279.5 15656.0 15781.0 15939.0

Source: Asian Development Outlook 2006.

Table 19: Trade Integration within Asia, 2004

(Per cent)

Emerging Asia Export to Asia as Imports from Asia as Per Cent to Total Exports Per Cent to Total Imports

China, People’s Republic of 33.4 37.6 Hong Kong, China 56.6 69.3 Korea, Republic of 42.3 28.9 Taiwan, China ... ... India 28.0 21.3 Indonesia 41.8 43.7 Malaysia 48.1 48.7 Philippines 40.7 43.4 Singapore 55.7 47.1 Thailand 41.3 36.4 Cambodia 9.3 90.3 Myanmar 67.2 89.5 Vietnam 28.6 71.9

Source: Direction of Trade Statistics, IMF.

east and south-east Asia. There is, however, absolutely no indication of co-movement of output fluctuations of India with the rest of the ACCA members. The inflation fluctuations for India however, are more synchronised with the other ACCA members. The Chinese economy got synchronised with the other ACCA members in the last decade.

IV Implications for India

It is well recognised that adopting a single currency is the ultimate step in economic cooperation. The previous section explains the impediments in deriving maximum benefits if member countries decide to move towards a single currency. But adopting a common unit of account to facilitate increased trade flows could be a step in the right direction and this may pave the way for moving towards a single currency based on OCA criteria. But from India’s macroeconomic status, as of today, some important issues in adopting a single currency to facilitate greater trade flows with the rest of the region are discussed below.


The east and south-east Asian region has emerged as one of the largest trading partners of India in recent years. India is working on FTAs/CECAs with ASEAN, South Korea, Japan, China, Singapore, Thailand, Malaysia among others. With the importance of the region as a destination for India’s exports likely to grow further in the coming years, entering into a currency union would further facilitate India’s trade with these countries. Over time, ACCA may become an important aspect of overall emerging regional monetary and financial cooperation in Asia.

Table 20: Correlation of Underlying Disturbances (Growth) across ACCA Countries, 1975-2004

China Hong Kong India Indonesia J a p a n Korea Malaysia Philippines Singapore Thailand
China Hong Kong India Indonesia J a p a n Korea Malaysia Philippines Singapore Thailand 1.00 –0.18 0.15 0.04 0.00 0.00 –0.11 –0.42 0.03 –0.02 1.00 –0.32 0.52 0.34 0.50 0.61 0.43 0.60 0.44 1.00 0.07 0.13 0.01 –0.07 0.07 0.01 0.24 1.00 0.35 0.67 0.75 0.29 0.57 0.69 1.00 0.51 0.43 0.15 0.34 0.48 1.00 0.59 0.33 0.46 0.75 1.00 0.41 0.82 0.63 1.00 0.43 0.38 1.00 0.50 1.00
Note: Significant correlations are marked in bold.
Table 21: Correlation of Underlying Disturbances (Growth) across ACCA Countries, 1975-1994
China Hong Kong India Indonesia J a p a n Korea Malaysia Philippines Singapore Thailand
China Hong Kong India Indonesia J a p a n Korea Malaysia Philippines Singapore Thailand 1.00 –0.27 0.13 –0.08 –0.10 –0.11 –0.33 –0.49 –0.04 –0.16 1.00 –0.32 0.13 0.04 0.18 0.43 0.36 0.43 0.30 1.00 0.14 0.15 0.19 –0.16 0.03 0.06 0.60 1.00 –0.21 –0.10 0.34 –0.08 0.38 0.06 1.00 0.34 0.00 –0.09 –0.11 0.37 1.00 0.11 0.18 0.06 0.43 1.00 0.21 0.72 0.39 1.00 0.30 0.37 1.00 0.44 1.00
Note: Significant correlations are marked in bold.
Table 22: Correlation of Underlying Disturbances (Growth) across ACCA Countries, 1995-2004
China Hong Kong India Indonesia J a p a n Korea Malaysia Philippines Singapore Thailand
China Hong Kong India Indonesia Japan Korea Malaysia Philippines Singapore Thailand 1.00 0.60 0.14 0.72 0.56 0.54 0.61 0.64 0.23 0.71 1.00 –0.12 0.75 0.85 0.73 0.84 0.90 0.79 0.53 1.00 0.06 0.28 –0.13 0.10 –0.03 0.00 0.29 1.00 0.69 0.92 0.90 0.81 0.52 0.84 1.00 0.60 0.87 0.90 0.81 0.50 1.00 0.87 0.74 0.58 0.82 1.00 0.94 0.82 0.71 1.00 0.85 0.53 1.00 0.31 1.00
Note: Significant correlations are marked in bold.
Table 23: Correlation of Underlying Disturbances (Inflation) across ACCA Countries
China Hong Kong India Indonesia J a p a n Korea Malaysia Singapore Thailand
China Hong Kong India Indonesia J a p a n Korea Malaysia Singapore Thailand 1.00 0.36 –0.01 –0.22 –0.10 0.08 0.15 0.28 0.03 1.00 0.20 –0.39 0.53 0.54 0.07 0.53 0.53 1.00 0.44 0.03 0.82 0.87 –0.06 0.73 1.00 –0.34 0.24 0.58 –0.67 0.30 1.00 0.40 –0.06 0.62 0.37 1.00 0.67 0.27 0.79 1.00 –0.25 0.63 1.00 0.14 1.00
Note: Significant correlations are marked in bold.
Economic and Political Weekly March 17, 2007 961

Joining a currency unit has its disadvantages. The expected benefits of a currency union that goes beyond being a mere monitoring index of regional exchange rate movements, and indeed of a single regional currency, as against the resulting loss in domestic macroeconomic policy independence must be weighed very carefully by individual countries. The decision to adopt a common currency is often opposed by many on both bases – that it represents a further weakening of national sovereignty and it would be economically disadvantageous in limiting an individual government’s powers of economic management. While joining a currency unit may eliminate exchange rate fluctuations and facilitate greater trade and financial flows, the biggest drawback is that member countries will have to live with the same monetary policy and the same short term interest rates, whether or not they are appropriate for the specific economic conditions of a particular country. At this point, the following facts relating to India are noteworthy:

First, regarding the size of the economy, India is no doubt a large economy with its GDP accounting for around 6 per cent of the world GDP. Also, the economic conditions in India differ substantially from the other ACCA economies. India has one of the highest rates of growth among the east Asian economies. Apart from this, India has a robust export performance, comfortable level of foreign exchange reserves and sustainable stock of external debt, which has made it resilient to external shocks. Given its large size, robust economic performance and resilience to external shocks, pursuance of independent economic policies would be advantageous for India, rather than being guided by the monetary and economic policies of smaller group members.

Second, of the advantages of a common currency area, academic economists tend to focus most on the nominal anchor for monetary policy. The argument is that a central bank that wants to fight inflation can commit more credibly by fixing the exchange rate, or even giving up its currency altogether. Workers, firm managers and others who set wages and prices then perceive that inflation will be low in the future because the currency peg will prevent the central bank from expanding even if it wanted to. When workers and firm managers have low expectations of inflation, they set their wages and prices accordingly. The result is that the country is able to attain a lower level of inflation. This is why countries like Italy, Spain and Portugal, which had high inflation rates in the 1970s, were eager to tie their currencies to those of Germany and the rest of the European monetary system countries. But for a country like India, which does not have a history of very high inflation rates, and effective monetary policy mechanisms to maintain price stability, joining a currency union would not bring any benefit on the inflation front.

Third, it is important to note that there is no synchronisation of India’s economic growth with other ACCA members. Moreover, there is a clear asymmetry of underlying shocks for India compared to the east and south-east Asian economies. This is evident from the lack of synchronisation of the growth disturbances of India with the other ACCA member countries.

Fourth, regarding trade openness, the openness indicator (measured in terms of export and import of goods and services as per cent of GDP), reveals that India is the least open economy compared to all the countries included in the ACCA (Table 11). While the city states of Hong Kong and Singapore top the list as the most open economies, even countries like Malaysia, Thailand, Korea, the Philippines, China, Cambodia, Vietnam are far ahead of India in terms of openness. The theory of OCA reveals that very small and more open economies are far more likely to benefit from joining a currency union, than large and less open countries. Therefore, apart from its large size, and lack of synchronisation in economic growth, in terms of the openness criterion India does not qualify to join a currency union.

Fifth, India’s performance in terms of trade integration with the rest of Asia is also poorer compared to many of the east and south-east Asian countries. The percentage share of India’s exports and imports from the east and south-east Asian region to India’s total exports and imports (28 per cent and 21.3 per cent, respectively) are much lower than those of all other ACCA members (Table 19). Therefore, in terms of trade linkages also India does not qualify for joining the ACCA as of now.

Sixth, the report of the committee on fuller capital account convertibility (chairman S S Tarapore), recommends a five-year roadmap with three phases on the timing and sequencing of measures. Phase I would be the current year, 2006-07, while phase II would be the following two years, 2007-08 and 2008-09, and the last phase would be 2009-10 and 2010-11. After each phase there should be a stock taking and the phasing of measures could be modulated. In view of the above, India also has to ensure that joining a currency union would provide some additional advantages than adoption of full (i e, capital account) convertibility for the Indian rupee.

Finally, a recent study5 reveals that the boost to trade within the euro area from a single currency is only moderate and likely to vary between 5 and 15 per cent with a best estimate of 9 per cent. Furthermore, the gain does not build up over time but has already occurred. Moreover, the three European Union countries that stayed out – Britain, Sweden and Denmark – have gained almost as much as the founder members, since the single currency has raised their exports to the euro zone by 7 per cent. In addition, the experience of the Euro currency area highlights the macroeconomic disadvantages of its 12 member states. The loss of

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monetary sovereignty first hobbled Germany and more recently Italy. This makes the case of India’s sharing a common currency with the east Asian countries even more weak.

V Conclusions

East and south-east Asia for the past couple of decades has seen significant increases in intra-regional cross-border trade, investment and financial flows, thereby emerging as an independent economic zone. Multinational corporations (MNCs) have created a production network in the region by placing various sub-processes of production in different countries according to their comparative advantage, relative factor proportions and technological capabilities. As a result, intra-regional, intra-industry trade in manufactured products, parts, components, semifinished and finished products has soared. Essentially, trade has been boosted through increases in direct investments. Not only US, European, and Japanese MNCs but also Asian companies are making significant direct investments in the region, further strengthening economic ties in east and south-east Asia. With an increase in the opening up of financial markets, capital flows in the form of bank loans and portfolio investments have also expanded and begun to connect the region’s economies financially. This, together with trade and investment linkages, has strengthened macroeconomic interdependence in the region, creating greater synchronisation of business cycles. This has generated a whole lot of debate regarding whether the east and south-east Asian Countries should enter into a monetary union and form a common currency area.

Our empirical analysis, reveals that the east and south-east Asian economies including Japan and India appear to have rather diverse macroeconomic characteristics on the basis of the criteria of OCA. This study indicates that the region displays significant cross-country variations in the size of the economy, stages of development, growth performance, inflation control, degree of openness and other important external sector indicators. There are also substantial differences in some key qualitative aspects such as the quality of the institutions and preparedness for technological advance. Therefore, it seems that the ACCA group has to go a long way towards the synchronisation of their economies before the successful launch of a single currency, even though one can notice a high degree of economic openness, trade integration and synchronisation of output growth as well as real disturbances during the last decade.

Regarding India’s taking a part in ACCA, it is viewed that India would gain from joining such union in terms of greater trade and financial integration with the rest of Asia. But as per the theory of OCA, the following factors cannot be ignored: first, given its large size, joining a currency union would result in a loss of macroeconomic policy independence for India. Second, India is still less open compared to other east and south-east Asian economies and its trade linkages with the other Asian countries are not yet strong enough to justify its joining a currency union. Third, India is a large economy with substantial differences in macroeconomic indicators compared to the other ACCA countries, which constitutes another disadvantage for India to join the currency union. Fourth, there is absolutely no synchronisation of economic growth and the underlying output disturbances of India with the other ACCA members.

The introduction of a new currency unit, to promote regional trade as the preliminary objective is a welcome step. India may actively consider joining this club, even though a number of issues are yet to be addressed. It is expected that with an increasing share of east and south-east Asia in India’s trade, joining a currency union could facilitate in removing the impediments. The region may focus on stabilising her economic growth and increasing trade ties with each member through FTA/PTAs and other bilateral and multilateral trade and financial agreements, which would facilitate deriving maximum benefits from joining a single currency.

Another important issue which deserves our attention is that a small group of countries, for example SAARC countries, may consider aligning their domestic currency with a strong optimal one in the region and move towards adopting a single currency within the region at a later date. There are a number of positive aspects which would contribute towards strengthening the economic power of this group, once this move is positioned.




[Views expressed in the paper are strictly those of the authors and not of the institution to which they belong.] 1 In the selection of countries, we have followed the regional classification

provided by the Asian Development Bank (ADB). The ACCA basket

comprises currencies of countries in east Asia, south-east Asia, Japan and

India (except Mongolia). A list of the countries included under east and

south-east Asia is provided in the Annex.

Annex: ADB Classification of East and South-East Asian Region

East Asia South-East Asia

China Cambodia Hong Kong Indonesia Korea Lao Mongolia Malaysia Taiwan Myanmar

Philippines Singapore Thailand Vietnam

2 González-Páramo, José Manuel (2005), ‘European Monetary Union: WhereDo We Stand’, keynote speech by José Manuel González-Páramo, memberof the executive board of the European Central Bank at the Euro conferencewelcome dinner: Expanding ASEAN-EU economic links – the role of theeuro Kuala Lumpur, July 13, 2005.

3 Former French colonies constitute the core group in the CFA.

4 GDP based on purchasing power parity share of world total.

5 Richard Baldwin, June 2006.


Bayoumi, T A and J D Ostry (1995): ‘Macroeconomic Shocks and TradeFlows Within Sub-Saharan Africa: Implications for Optimum CurrencyArrangements’, IMF Working Paper, December.

Frankel, A and Andrew K Rose (1997): ‘The Endogeneity of the OptimumCurrency Area Criteria’, Optimum Currency Areas: New Analytical andPolicy Developments, International Monetary Fund.

Gros and Steinherr (1997): ‘Openness and the Cost of Fixing Exchange Ratesin a Mundell-Fleming World’, Optimum Currency Areas: New Analyticaland Policy Developments, International Monetary Fund.

Krueger et al (1997): ‘EMU: Ins, Outs, and the Macroeconomic Effects ofAlternative Monetary Policy Rules’, Optimum Currency Areas: NewAnalytical and Policy Developments, International Monetary Fund.

Mundell, Robert A (1961): ‘A Theory of Optimum Currency Area’, American Economic Review.

– (1997): ‘Updating the Agenda for Monetary Union’, Optimum CurrencyAreas: New Analytical and Policy Developments, International MonetaryFund.

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