The currency basket need not necessarily be identical. Weights assigned may vary depending on the trade patterns of countries. However, it will be necessary to have close coordination on macroeconomic matters so that exchange rate alignment stays in sync with realities.
Realising that the medium-term coordinated basket peg proposition will take a while to be debated and adopted, it will be be prudent for East Asian central banks to begin the process by immediately initiating networking.
This is urgent in the face of current erratic dollar movements.
As the global exchange rate system is in a state of flux, it is important for East Asia to work towards some kind of convergence of exchange rate policies in the immediate term.
There has to be a clear understanding among foreign exchange authorities on the kind of interventions that may have to be made in the near term.
A well-coordinated and concerted action by East Asian countries will be more effective rather than these countries going at it alone. A consultative council of East Asian central banks would provide an avenue for meaningful interaction.
Regional trading arrangements, aided by geography, have moved East Asia closer to a regional trading bloc. But regional cooperation in trade and investment would be incomplete without cooperation on exchange rates. For a start, priority should be given to building the necessary regional institutions and formulating formal mechanisms similar to those of European integration.
Exchange rate integration, given East Asia’s diversity, is likely to be a long and challenging process. Despite having greater political will and less cultural, economic, and political diversity than East Asia, it still took Europe 50 years to come together as a monetary entity.
It will not be easy to construct a collective exchange rate system that would be acceptable by all participating countries. A transitory regime, such as a coordinated basket peg system, could be the first step.
The merit of a basket peg is that it has the attributes of a currency peg without being shackled to any single anchor currency.
This means the exchange rate of a currency will be tied to a basket of key currencies (e.g. euro, dollar and yen) so that variations in the exchange rate will be smaller due to the offsetting impacts of currencies in the basket.
A common basket for all regional currencies would mean the exchange rates of regional currencies would not deviate much from one another if the weights assigned to the component currencies in the basket are identical for all. That seems a tall order, as the weights would depend greatly on the trade patterns of individual countries.
An identical foreign exchange rate regime for all East Asian countries is neither feasible nor desirable for now, because the grouping is highly heterogeneous with different economic and market structures with varying degrees of sophistication, and balance-of-payments adjustments may not be forthcoming to the extent that exchange rate movements are constrained.
A more down-to-earth approach would be to balance pragmatism and idealism. We should look for exchange rate arrangements that would allow commonality with some latitude for variation.
Given the preference for hybrid regimes in East Asia, a coordinated basket peg system could serve as an acceptable premise for exchange-rate management, providing flexibility and stability in exchange rates.
A common denominator would be the composition of the currency baskets. One suggestion is that the euro, dollar and yen constitute the basket for all East Asian countries (except Japan, whose currency is the yen). To avoid being put into straitjackets, weights given to the anchor currencies may vary from country to country or from time to time.
As the movements in euro, dollar and yen would tend to be partially offsetting, the regional currencies would be fairly stable vis-a-vis currencies in the basket, and since the regional currencies would also be tied to similar baskets, intra-regional exchange rates would be even more stable.
This system cannot ensure that all regional currencies move strictly parallel, but it can ensure they all move in the same direction, somewhat in tandem, appreciating or depreciating together.
Such a system could work smoothly, especially if there are no serious bilateral trade imbalances within the grouping.
All this would call for continuous consultation among East Asian countries, especially regarding macroeconomic policies. East Asian central banks will have to work very closely with one another, and this process will have to be institutionalised. But there is no need for a supranational East Asian central bank in the absence of a single currency.
Emeritus Professor Datuk Dr Mohamed Ariff is executive director of the Malaysian Institute of Economic Research. This article was originally published in the New Straits Times , January 24 2009.