Common Currency for South Asian Countries

Rishabh Pandey (B13167) Roopan Roy John (B13168)

Santanu Mallick (B13169) Saiyam Sanghvi (B13170) Siddharth Garg (B13174)

What are Currency Unions

Currency Unions are formed in the sixth stage of Economic Integration Economic integration is the unification of economic policies between different states through the partial or full abolition of tariff and non-tariff restrictions on trade taking place among them prior to their integration. This is meant in turn to lead to lower prices for distributors and consumers with the goal of increasing the combined economic productivity of the states. Economic integration progresses in 7 stages : 1. Preferential trading area 2. Free trade area 3. Customs union 4. Common market 5. Economic union 6. Economic and monetary union 7. Complete economic integration Economic Union = Currency Union + Customs Union + Single Market

Stage of Economic Integration around the World

Preferential trading area Free trade area Customs union Common market Customs and monetary union Economic union Economic and monetary union

What are Currency Unions

Currency Unions are where states share a common currency without necessarily having further economic integration Currency Unions are of three types : • Informal Unions : Where there is a unilateral adoption of foreign currency

• Formal Union : Adoption of foreign currency through a bilateral or multilateral

agreement with the issuing authority. Could be in the form of a currency peg

• Formal with Common Policy : A common currency along with a common issuing authority and a common monetary policy is adopted across multiple countries.

Examples of types of Union

Informal Union Formal Union Formal Union with Common Policy

CFA Franc

CFP Franc

Pound Sterling

Singapore Dollar (MAS)

INR USD

Russian Ruble

Israeli Shekel

Euro

A history of currency unions

• The German Zollverein Between German Confederation in 1818

• The Latin Monetary Union France, Belgium, Italy, Switzerland and Greece 1865-1927

• The Scandinavian Monetary Union Sweden, Denmark and Norway 1870-1924

A history of currency unions (Cont.)

• The USA National currency act 1863 and Federal Reserve Bank in 1914

• The Gold Standard A system of fixed exchange rates in which currencies are given a fixed value in terms of gold

• The Bretton Woods system 1944-1971

The Euro

• Maastricht Treaty 1992

• More choice and stable prices for consumers and citizens

• Greater security and more opportunities for businesses and markets

• Improved economic stability and growth

• More integrated financial markets

• A stronger presence for the EU in the global economy

• A tangible sign of a European identity

Advantages of a Common Currency

• Elimination of transaction costs

• Transparency of prices

• Increased Investment

• Independence of Monetary and Fiscal policy

• Increased trade and reduced cost to firms

• Reduced exchange rate uncertainty

• Low inflation, standardization of interest rates

• Labour Mobility and Wage Effect

The Euro zone crisis could be an opportunity for India to re-float the idea of a common currency in South Asia. Conditions may not be conducive for the creation of such a single currency, but acceptance of this as an objective may compel South Asian countries, especially India and Pakistan, to end mistrust, jointly fight terrorism and enhance mutual security for greater cooperation and economic integration.

At the 15th ASEAN Summit in Cha-am Hua Hin in Thailand in October 2009, Japan’s call for adoption of a single Asian currency was backed by China. The plans for a single-currency trading bloc aimed to take in all countries of the East Asia Summit, which brought ASEAN together with Australia, China, India, Japan, New Zealand and South Korea.

In 2003, Prime Minister Atal Bihari Vajpayee had mooted the idea of open borders and a single currency. Vajpayee felt that South Asian countries developing greater economic stakes in each other would create sensitivity to shared concerns and promote common interests.

The concept of an Asian Currency Unit (ACU) was born as a concept almost 10 years ago, prior to the Asian currency meltdown

For the greater good

Independence of monetary policy Economic issues can be tackled by suitable devaluation/revaluation of money. Eg- GREECE

1.Similarity of shocks and inflation Regions with synchronous shock make ideal candidates for a union as there is no need for monetary policy autonomy. 2.Dissimilarity of shocks Countries with asynchronous shocks make ideal candidates, as there are further benefits of risk diversification.

Factor mobility 1.Labour mobility can be an alternative adjustment mechanism to restore equilibrium in regions subject to asymmetric shocks. 2.Labour mobility is unlikely to operate at the high frequency with which demand shocks take place.

Openness 1.In a small, open economy, a large portion of consumption and intermediate goods is imported, and prices are given by international markets. 2.Because the currencies of small, open economies inherently suffer from shocks (due to specialization and currency speculation) domestic prices would fluctuate in accordance. Therefore, giving up monetary policy autonomy is no big loss.

Economic diversification 1.The likelihood of asymmetric shocks and their impact in the economy are small when exports are diversified. 2.Second, export diversity will help to stabilize investment, thereby requiring a smaller adjustment in prices and employment than would otherwise be required after an industry-specific export shock.

Fiscal transfers Fiscal transfers can significantly mitigate the cost of relinquishing monetary policy autonomy, as it can cushion the effects of economic disturbances.

Problems with a Common Currency

Monetary policy and similarity of economies The SAARC is neither integrated, nor do the economies complement one another. The monetary and labour policies of different nations need to be aligned.

A regulatory body would be required to ensure that the respective governments do not run into large deficits. Also the member countries need to meet the certain norms for inflation, current deficit and other parameters.

Internal trade Intra-regional trade (about $6 billion) is less than 5% of the region's trade with the rest of the world. The trade is overwhelmingly (some 70%) dominated by Indian traders.

Mobility of labour and capital Immigration laws between a few countries at present are quite liberal ( eg-Nepal and India), however free movement of people between India and Pakistan seems like a distant dream.

Political will and border disputes Mutual suspicions are rife between India and its neighbours especially Pakistan. Lack of political will for reconciliation between the nations.

Problems with a Common Currency in South Asia

Learning from a Crisis

• Talk of greater financial and monetary cooperation in the South Asian region started after the Asian Financial Crisis of 1997

• The crisis was triggered when the Thailand ran out of enough forex reserves to maintain it’s fixed exchange rate regime and the Thai baht was forced to float

• This in turn triggered a devaluation of currencies and devaluation of stock prices and other assets across South Asia, including Japan.

Asian Currency Unit

• At the 39th Annual Meeting of the Asian Development Bank

(ADB) in Hyderabad in May 2006, ministers from China, Japan

and Korea announced that they would make concerted effort

at coordinating their currencies with the objective of evolving

towards the creation of a regional currency i.e. the Asian

Currency Unit (ACU).

Impact of a Common Currency

• Reduction in transactional costs in intra-regional trade incurred due to exchange rate fluctuations

• Fostering greater economic and political cooperation by increasing mutual interdependence

• More efficient factors market by facilitating greater flow of capital and labour across borders

• Greater monetary policy discipline among member nations leading to an overall low inflation policy

Obstacles towards a Common South Asian Currency

1. Lack of Central Institutions: There is no surveillance mechanism or

institute to make sure that countries follow limits on deficits and

other monetary policies

2. Underdeveloped Bond Market: A well developed bond market

facilitating orderly cross country flows of debt within the region is

an important prerequisite for the ACU

3. Diverse Exchange Rate Regimes : While currencies like Indian Rupee, Singapore Dollar, Thai Baht, and Malaysian Ringitt are managed floats, Chinese Renminbi is pegged to the US Dollar and the Japanese Yen and the Korean Won are freely floating

4. Political Considerations: • Unlike Germany in Europe, there is no central country in Asia which

can take lead. Japan has historical issues with Korea and China. And India and China have been engaged in a territorial dispute for years.

• Also, diverse political systems ranging from mature democracies to non democratic governments to monarchy make the consensus building more difficult

Obstacles towards a Common South Asian Currency