In May, the finance ministers of Korea, China and Japan agreed to study the feasibility of using their own currencies to settle transactions among the three countries. The agreement, reached on the sidelines of the Asian Development Bank’s annual conference in Hanoi, drew attention as using local currencies in trade settlements would provide huge benefits to the three neighboring countries.
But the trio has since taken no action whatsoever to follow up their accord. The lack of subsequent action leads us to suspect that they were not serious about reforming the existing dollar-based settlement mechanism in the first place. If that is the case, there is a strong need to urge policymakers of the three countries to implement own-currency settlements for transactions with one another.
The three neighbors are facing a greater need now than months ago to introduce local-currency trade settlements. In recent weeks, the sovereign debt crisis in the eurozone has been going from bad to worse. It is now threatening to push the global economy into a fresh banking crisis.
Last week, warnings on the eurozone crisis mounted as the credit crunch in the region began to show signs of spreading to other parts of the world. World leaders called on eurozone governments to confront the debt overhang to prevent contagion to the wider global economy. The three Northeast Asian countries can cushion the impact of the global financial turmoil by establishing a joint settlement mechanism.
Furthermore, such an arrangement would allow the three economic powerhouses to deepen trade ties among themselves. The three countries all depend heavily on exports for economic growth. But global trade growth is expected to slow sharply as the twin fiscal crises in the eurozone and the United States are adversely impacting the real economy. This heightens the need for the trio to boost three-way trade, which can be facilitated by a local-currency settlement system.
Currently, trade and investment transactions among the three countries are mostly denominated and settled in U.S. dollars. For instance, a Korean exporter to China quotes its prices and invoice in the U.S. dollar rather than in either the Korean won or the Chinese yuan.
Even when transactions between Korean and Chinese firms are denominated in local currencies, banks in the two countries use dollars in the settlement process. This arrangement is not only cumbersome but costly as it requires banks in the three countries to hold a large amount of dollars in reserve to settle transactions.
Consequently, banks in these countries are constantly exposed to foreign exchange risks. They are vulnerable even when the dollar fluctuates for reasons that have nothing to do with the three Northeast Asian economies, as has been well illustrated by the latest eurozone debt crisis.
The three countries can address these problems by settling intraregional trade in their own currencies. One proposal presented by a Korean scholar calls for the governments in Seoul, Tokyo and Beijing to establish a joint settlement body.
Under the plan, the central banks of the three countries need to conduct currency swaps with one another and deposit the currencies of the other countries in the settlement body. This swap arrangement enables local banks in, for instance, Korea, to settle transactions with banks in China or Japan in the Korean won. As a result, banks can save the currency conversion costs.
This arrangement would also help the central banks of the three countries reduce the levels of their dollar reserves and diversify their foreign exchange reserves with one another’s currencies. Furthermore, such a mechanism would help the three countries stabilize the exchange rates among their currencies, which is conducive to expanding long-term trade and investment.
Ultimately, settlement of trade and other transactions in own currencies would help the three Northeast Asian neighbors launch a free trade area. The trio has been pushing for a three-way free trade deal but has achieved little progress thus far. Cooperation in reforming the settlement mechanism could give momentum to the FTA talks.
Recently, the three countries set up a permanent organization to enhance a three-way partnership on economic and regional security issues. The Trilateral Cooperation Secretariat, headquartered in Seoul, needs to tackle the trade settlement issue as a step toward the envisioned FTA.
