Over the past three decades since the establishment of their dialogue relations, China and ASEAN countries have witnessed more frequent exchanges and deeper cooperation in the field of economy and trade. As the Regional Comprehensive Economic Partnership (RCEP) enters into effect, China and ASEAN countries are on track for intensified economic cooperation in areas like trade, investment, and monetary cooperation. However, this will bring about higher requirements to maintain the stability of exchange rates in the region and establish a mechanism for regional exchange rate coordination.
Deepened cooperation
China and ASEAN are now each other’s largest trading partner. The bilateral trade volume has grown from less than $8 billion in 1991 to $684.6 billion in 2020. Since 2009, China has maintained its seat as ASEAN’s number one trading partner for 12 years in a row. The regional economic cooperation bucked the downward trend from China-US trade friction and the COVID-19 pandemic, and continued to increase and deepen. ASEAN overtook the US and the EU as China’s number one trading partner in 2020.
Specifically, bilateral trade volume of goods saw a 6.7% year-on-year increase. China’s exports to ASEAN were $383.72 billion in 2020, and its imports from ASEAN were $300.88 billion for the same year. Both marked a 6.7% year-on-year increase. According to data revealed by the Mission of the People’s Republic of China to ASEAN, bilateral trade maintained its strong momentum in 2021, when the first nine months of merchandise trade volume reached $630.54 billion, marking a 31.1% year-on-year increase.
In the meantime, bilateral investment continues to increase. Foreign Direct Investment (FDI) from China into ASEAN grew by an average annual growth rate of 32.6% from $120 million in 2003, to $14.38 billion in 2020. In the first nine months of 2021, Chinese enterprises’ investment to ASEAN reached $10.59 billion, while ASEAN’s actual investment to China was $7.6 billion. As of the end of June, 2021, the total bilateral trade investment exceeded $310 billion, making ASEAN the most important FDI destination and source for China.
Furthermore, the two sides have enhanced currency cooperation within the region. As related infrastructure for the RMB continues to improve, China has basically established a monetary cooperation framework, or the Cross-Border Interbank Payment System (CIPS). The RMB has become one of the uppermost currencies for cross-border payment within the region, while CIPS and Chinese-funded banks have covered all ten ASEAN countries .
Meanwhile, direct currency trading has also started between the RMB and the Singapore dollar, Thai baht, Malaysian ringgit, Cambodian riel, and Lao kip. In 2020, RMB’s cross-border payment and receipt between China and ASEAN countries reached about 4.15 trillion RMB, with a year-on-year increase of 72.2%, which accounts for 14.6% of RMB’s global cross-border payment and receipt. To be specific, RMB’s cross-border payment and receipt for merchandise trade was 745.898 billion RMB, with a 20.2% year-on-year increase. RMB’s cross-border payment and receipt for direct investment was 425.099 billion RMB, with a 70.8% year-on-year increase. The wide application of RMB in cross-border payment within the ASEAN region fuels monetary cooperation among all sides.
Fluctuation caused by USD
The US dollar remains a key anchor currency in the China-ASEAN region, and the increasingly closer regional economic cooperation will be subject to the US dollar’s volatility in valuation. Profits and earnings of companies involved in the two-way trade are prone to fluctuating exchange rates of RMB and ASEAN currencies to the US dollar. The partial equilibrium model of risk-averse companies suggests a negative relationship between exchange rate fluctuations and trade when the risk of hedging exchange rates becomes more costly. Exchange rates are the factor that dominates profitability of trading companies in developing countries with relatively underdeveloped financial markets. Currently, all countries in the China-ASEAN region are developing countries—except for Singapore. To maximize the effect of expected earnings, the volatility of exchange rates will reduce the export volume of risk-averse companies.
Meanwhile, exchange rate fluctuation in the region, caused by the value of the third-party currency, will exaggerate the negative impact of currency mismatches and change the relative price of production factors. As a result, cross-border investment from companies in the region will be hindered. Currently, the cross-border capital flow in the China-ASEAN region is settled in a third-party currency, which is subject to the fluctuation of exchange rates of RMB and other ASEAN currencies to the US dollar, and adjustment of the US Federal Reserve’s monetary policies. This will not only result in currency mismatches in investment and financing activities, but also affect the returns on investment and financing conducted by China and ASEAN countries, and inhibit cross-border investment conducted by intra-regional companies.
A mechanism should be established to coordinate the China-ASEAN regional exchange rate, in order to reduce adverse impacts of the fluctuating value of the US dollar, promote bilateral trade, investment, and monetary cooperation, and maintain regional financial stability.
First, maintaining a coordinated and stable exchange rate in the region will help reduce the impact of fluctuations in the US dollar’s exchange rates. In August, 2020, the US Federal Reserve adjusted its monetary policy framework to adopt an average inflation target, and there is great uncertainty regarding its monetary policy. Therefore, maintaining exchange rate stability within the China-ASEAN region through enhanced coordination of exchange rate policies will help counter external shocks arising from uncertainty, and reduce the impact of the US dollar on cross-border trade settlements and capital flows, thereby reducing the risk of currency mismatches and improving the real returns and profits from trade and investment.
Second, the establishment and improvement of a regional exchange rate coordination mechanism is the focal point of intra-regional monetary cooperation. The relative stability of exchange rates within the region implies the existence of spontaneous exchange rate coordination. Stronger exchange rate linkages are a prerequisite for the formation of an optimal currency area. Local currency settlement can only minimize exchange rate risks for companies on all sides if multilateral currency exchange rates in the region remain generally volatile in the same direction and relatively stable in the other.
Third, the establishment of a regional or sub-regional exchange rate system pegged to a common currency basket can, to a certain extent, alleviate dependence on the US dollar and maintain financial stability within the China-ASEAN region. Strengthening regional exchange rate cooperation in East Asia can stabilize the price environment in the region, reduce reliance on foreign exchange reserves, and decrease the likelihood of financial crises. In the event of a crisis, it is also possible to use intra-regional currency swaps, and other forms of cooperation, to offset the adverse effects of large fluctuations in exchange rates of extra-regional currencies and mitigate the impact of the crisis. Therefore, maintaining financial stability requires China and ASEAN countries to continuously improve the regional exchange rate cooperation system and exchange rate supervision mechanism, and accelerate the establishment of a China-ASEAN regional exchange rate coordination mechanism.
Regional currency coordination
At present, the exchange rate coordination between China and ASEAN countries still has a long way to go, and corresponding measures need to be taken to further establish and improve the regional exchange rate coordination mechanism and deepen economic cooperation in various fields.
First, linkages between exchange rates in the China-ASEAN region should be reinforced, so as to inject momentum into the coordination of regional exchange rates. Developing an intra-regional exchange rate coordination mechanism requires long-term efforts. In this process, linkage between the exchange rates of China and ASEAN countries should be strengthened for the stability of exchange rates in the region. In the long run, the regional exchange rate coordination mechanism can be built starting from sub-regions. Currencies with stronger exchange rate linkages should be chosen with the same or similar currency basket in the beginning, and then the efforts could be gradually expanded to the entire region.
Second, we should accelerate the pace of RMB internationalization and enhance the role of the RMB exchange rate as a “stabilizer.” As China’s economy shifts from rapid growth to high-quality development, the RMB has become the new choice of currency anchor in the China-ASEAN region. Further accelerating the internationalization of the RMB, and promoting cooperation on foreign exchange derivatives such as currency swaps between China and ASEAN countries, can deepen economic and trade cooperation based on the Local Currency Settlement Framework, reduce the negative impact of the US dollar in China-ASEAN economic integration, enhance exchange rate linkages between the RMB and ASEAN countries’ currencies, and pave the way for the establishment of an exchange rate coordination mechanism in the region.
Third, we should strive for the orderly opening up of the financial market and reinforce the regulation and policy coordination of the financial market. As ASEAN and Chinese economies integrate and financial markets in the region gradually open up, efforts should be made to strengthen financial market regulation, information disclosure, and market exchanges.
Meanwhile, we should also improve the regulations, laws, and transaction rules of the financial markets, establish a regional financial stability index and a mechanism to monitor risks in the region’s financial market, and reinforce the monitoring and warning mechanism for international capital flow, so as to minimize intra-regional exchange rate fluctuations caused by external shocks and provide safeguards to the establishment of a regional exchange rate coordination mechanism.
Wang Hao is deputy director of the Quantitative Finance Research Center at Jilin University and Li Jialin is from the School of Management and Economics at the Chinese University of Hong Kong, Shenzhen.