June 13,2008

Use China's Forex Reserve to Contain Vietnam's Financial Crisis

By Zhou Jiangong
In the 1997 Southeast Asian Financial Crisis, China, with its closed capital account, avoided the region-wide economic earthquake triggered by the Thai baht depreciation. At that time, China promised the RMB would not depreciate to take advantage of its neighbors?distress, and it would use its foreign exchange reserve to help Hong Kong maintain its exchange regime pegged to dollar. Its role in Southeast Asia’s regaining of its stability and emerging as a healthy market was crucial and much praised globally.
Now, more than 10 years later, another Southeast Asian country, Vietnam, is on the edge of serious financial trouble.
China’s capital account is still closed, but its foreign exchange reserve, which stands at $1.7 trillion, is ten times of what it was in 1998, and higher than the total foreign exchange reserve of  G7.
With such a reserve, and a basically steady and healthy macroeconomy, China should now be able to make greater contributions to the stability of currencies, markets and economies in the neighboring area. It should help to keep Vietnam from dropping into a deep financial hole and prevent the crisis from spreading to other emerging economies. 
Two scholars at the Institute of World Economics & Politics of the Chinese Academy of Social Sciences have raised an interesting suggestion: under the framework of currency cooperation in East Asia, China ought to help Vietnam to maintain exchange rate stability. Now the Chiang Mai Initiative, an agreement between the ASEAN and China, Japan, and South Korea to manage regional short-term liquidity problems, can help Vietnam survive the sudden liquidity risk. China should also consider bilateral aid. This is an interesting and imaginative suggestion, especially the bilateral aid.
Aiding Vietnam, i.e. stabilizing neighboring economies, is vital to China’s self-interest. China is not alone anymore. The Southeast Asian Crisis ten years ago slowed China’s economic growth, reducing exports and proliferating risks in the banking and financial systems. China is more open to the world now, and its financial market is unable to avoid outside influences. Indirect and infectious influences have already been felt. This round’s market slump, the heating inflation and current currency turmoil are all at least in part effects of China’s growing relationship with the outside world. Risks continue to proliferate. China’s banking industry has not yet been tested by a real economic cycle or the negative influence of other economies.
If a financial crisis starting in Vietnam were to spread to other countries, over half of China’s export destinations, such as Hong Kong, Taiwan, ASEAN, and Korea, whose bilateral trade with China is worth over $100 billion a year, would be affected. Consider that Japan and India would also be affected, if indirectly, by the crisis, and over 50% of China’s total trade would take a big hit.
China and ASEAN are now negotiating the establishment of a free trade area. Ten years ago China and its neighbors were competing tooth and nail for US and European markets. Now, with bilateral trade between China and ASEAN countries growing rapidly, a mutual dependence is deepening.
Due to economic slow downs in both the US and China and China’s inflation-curbing tight monetary policy, a new Southeast Asian Financial Crisis could lead to a serious financial turmoil and the risk for economic hard-landing in China.
Here’s a lesson for China about how to go about aiding Vietnam. In the first half of the 1990s, Mexico borrowed and borrowed during an economic boom. Then its economy slowed, its currency depreciated, and its loans in US dollars were of a sudden much more expensive to repay. Government finances took a dive. Loans totaling $25 billion needed to be repaid in less than a year, and its $60 billion foreign exchange reserve was dwindling rapidly. The Clinton administration in the US, acting decisively in cooperation with international institutions such as the IMF and without waiting for approval from Congress, offered Mexico $50 billion of short-term loans, so Mexico was able to survive the short-term liquidity crisis and repay the loans. Mexico’s economy has not had to look back since.
Now Vietnam, like Mexico at that time, is suffering a temporary liquidity crisis. The market estimates Vietnam needs about $30 billion to $50 billion to ride out the crisis. For China, which is eagerly seeking ways of mopping up its excess liquidity and putting its foreign exchange reserve to work, the situation presents an enormous and not to be missed opportunity.  Beijing should immediately hold bilateral talks with Vietnam and convey its willingness to help that country through its crisis with sizable short-term loans. The Vietnamese situation will certainly stabilize quickly, as its basic economy is strong and its people vibrant and hard working.
At a stroke, China will have accomplished a number of worthy goals. It will have helped a neighbor in need, cementing relations and creating good will between two countries that have not often got on well with each other.  It will also have made good use of its foreign reserves, and probably at a profit. The US earned $500 million from its loans to Mexico.
Most importantly, China will have shown the world that its foreign exchange reserve can be a crucial force for stability in global financial markets. It would also serve as an announcement that China is a ready and responsible player on the stage of the world’s economy.  


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