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Introduction:
With the introduction of the Euro on January 1,1999 , the world is slowly shifting towards a three currency system : Dollar, Yen and the Euro . This will give the concerned countries tremendous competitive advantage over their Asian counterparts. To counter this possible threat there has been talk in the Asian financial circles about the feasibility of introducing an Asian Common Currency based on the Euro.
However, we need to be clear as to why countries form unions on the basis of single currency. Currency unions are generally formed as part of a more comprehensive strategy to integrate the economies that wish to be a part of the union. Synergising the various legal frameworks, framing free trade agreements and migration laws usually follows a common currency.
Entering a currency union, thus, is a foreign policy decision of immense importance and needs careful and detailed analysis of the pros and cons.
At this point there is need to differentiate between two terms that can be confused "Currency Union" and "Dollarisation". While the former implies a formation of a new common Central Bank with a new currency for all the member countries, the latter simply is the adoption of the currency of a nation by another (E.g.: adoption of the US $ by Argentina). It has been noticed that there is a general international move towards currency union or dollarisation.
The article briefly explains the various pros and cons involved in forming an Asian currency union along with the issues that need to be tackled before such an integrated system can come into existence.
What can Asia gain from the Single Currency?
A common currency will lead to a reduction in transaction costs for traders. Since the business within Asia will be conducted in the common currency, it will eliminate the need for currency conversion. Another advantage that such a union can have is the likelihood of a reduction in Nominal Exchange Rate and uncertainty for traders of the member countries. This reduced uncertainty should ideally give a fillip to the intra-union trade. Acting as a union would provide the countries with a bargaining power vis a vis the rest of the world which individual nations can not achieve.
A very important advantage that the single currency could have over the Dollar and the Euro is the fact that Asia has control over the major oil reserves (Saudi Arabia, Iran, Kuwait etc.). This will, in turn, have the following implications - firstly, Asia will be able to pressurize the world into trading in their common currency and secondly significant improvement in the Balance of Payments (BoP) of the member states will be possible leading to reduced dependence on the various sources of external aid . The monetary union will lead to greater market transparency by making prices of products across nations (within the union) easily comparable.
What can be the Flip side to such a system?
The first thing that comes to mind when we talk about the disadvantages of a single currency is the question of control over the monetary policies of the member countries. The success of such a union depends on whether nations are prepared to lose some degree of control over its monetary policy and hence be satisfied with a reduced ability to offset demand shocks and to influence their own inflation rates. Recent international experience suggests that this loss can prove to be of great significance (the fact that Argentina went through severe recession was primarily because of its tie- up with the US dollar).
The Approach to Transition towards Common Currency:
The Transition should broadly be on the lines of the Euro and the single currency should be introduced in a phased manner giving ample opportunities to the member states to adjust and adapt to the changed environment. Another thing that will be needed to be done at the time of the introduction, is that the exchange rate between the common and the individual currencies be irrevocably fixed and the countries be allowed to use both currencies during the transition period
There are various issues that seem to be important and need due attention if the transition from multiple to single currency is to be smooth and successful:
- STRATEGIC: There are compelling reasons as to why formation of an Asian Monetary Union will be a strategic move of great consequences . The union will comprise of two of the fastest growing economies on the planet (India and China). It will also offer the single largest market for a range of commodities from computers to cars. This will enhance the bargaining power of the bloc given the saturating American and European markets.
- ECONOMIC: Introduction of a single currency impacts more than just the currency of payment, it has several economic effects as well. For instance, firms that practice price discrimination i.e. charging different prices in different geographical markets and thereby reaping heavy profits, will lose this luxury after the system comes into force Also , companies that will be able to charge their customers in the currency units of their choice will become more popular than their competitors. The Asian monetary union will be able to impose tariffs on the goods from non-Asian countries which would make their products more expensive and would aid in increasing the sales of Asian countries to the fellow member states.
- TECHNICAL: This basically deals with the need to make various financial information systems of the countries compatible with the common currency. As a result a large percentage of the accounts of the concerned countries with the world will need updating. For a country like India it may prove to be a blessing in disguise because of its cheap and skillful software professional pool and because it will have an opportunity to develop the financial systems at a much lower cost.
- POLITICAL: This is easily the most vital ingredient in the recipe of a successful Asian currency. Given the heterogeneity among the Asian countries such as the form of government, languages, culture, values, religion etc., a financially united Asia will only be a dream if these differences are not harmonized and a collective effort put. Moreover, the relations between the countries are not friendly - to say the least. Indo-Pak and Japanese - Korean relations are cases in point.
Conclision:
When one looks at the possibility of the largest continent of the world using the same currency unit, the idea seems impressive and rewarding. However, the very fact that various nations would gain and lose to different extents poses major obstacles. (Why, for instance, would oil producing nations share their natural advantage with other asian states?)
There could be various gains that Asia can reap if it becomes one solid bloc. The reasoning and explanation, however, is not exhaustive. Whether or not Asia should follow the path of Europe ought to be discussed at appropriate forums and the regional conflicts, policy divergences be sorted out.
*Contributed by -
Vineet Madan
IIM Indore.
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