Weaponization of Global Finance: Implications for Asia and China’s Regional Role

On February 28, the US-led coalition of mostly Western countries cut Russia out of the SWIFT (Society for Worldwide Interbank Financial Telecommunications) international financial payment messaging system and froze the central bank’s access to much of its US$643 billion reserves. This was the first weaponization of the dollar-anchored global financial system on such scale against a major country’s central bank.

However justified by Russian leader Vladimir Putin’s aggression against Ukraine, this is likely to accelerate efforts, particularly by non-Western countries, to develop alternative payments systems. As the Times of India headline put it: “Question every country will ask – can US freeze my forex reserves too?”.

Asian countries are paying close attention, particularly China. Perceived Western triumphalism with respect to primarily Western sanctions brings back memories in the region of the Asian financial crisis of 1997. A deeper appreciation of that catastrophe and its aftermath, can help in understanding what Asia’s financial future may hold in the aftermath of the disruptions of the pandemic and the Ukraine war.

Revisiting the Asian financial crisis of 1997

In the region, the 1997-98 crisis and conditions imposed on bailout loans by the International Monetary Fund (IMF) devastated not only the financial systems of Indonesia, Korea and Thailand but also their economies and social conditions, upending domestic politics. Malaysia was also severely hit by the crisis, but chose to opt out of an IMF-led program. Despite doing so, in general, the pace of its recovery was similar to that of the other economies.

The Asian financial crisis was a new type of policy challenge – a capital account crisis. It differed fundamentally from traditional current account crises that characterized Latin American economies earlier in the 1990s (the result of inappropriate macroeconomic policies such as unsustainable budget deficits, leading to balance of payments problems). In Asia, rapid private capital inflows, mostly dollars, led to a high ratio of short-term foreign debt to foreign reserves. When short-term credit lines were not renewed, with sudden capital outflows currencies sharply depreciated, and reserves were exhausted in futile attempts at their defense.

It was the earlier experience with current account crises in Latin America, that provided much of the basis for policy responses, including by the IMF. Its programs were intended to restore the confidence of the financial markets, and generate the capital inflows needed to increase foreign reserves.

Perhaps partly because of that, conditions imposed by the IMF for essential loans were seen as “one size fits all”, as well as exceedingly harsh and intrusive, and with insufficient regard for wider economic, social and political consequences. Conditions were largely imposed by the IMF, with the US Treasury seen as pulling strings behind the scenes. There was limited appreciation of the complexity of the policy reform process.

The humiliation was captured in an iconic January 1998 photograph of Michel Camdessus, the IMF managing director, with arms folded watching as the Indonesian president Suharto, head bowed, hunched over a table to sign an emergency loan agreement. (Four months later, the strongman would resign after support for him collapsed.) This episode inspired quiet resolve among East Asian economies to lessen future reliance on external (Western-led) institutions. 

Crisis aftermath

East Asian economies rapidly built up significant foreign, mostly dollar, reserves, to a large extent as protection against a repeat of the Asian financial crisis and the sudden shortage of international liquidity. It also reflected distrust of the IMF, whose programs were seen to have contributed to deep economic contractions and related social suffering and political instability. 

In 2000, they eventually entered into a regional financial cooperative mechanism, now called the Chiang Mai Initiative Multilateralization (CMIM). The CMIM is an arrangement for mutual support among finance ministries and central banks of the ASEAN-Plus Three (the 10 Southeast Asian economies and China, Japan and Korea) and the Hong Kong Monetary Authority. The role of the mechanism is to provide short-term lending (“swaps”) in case of a balance-of-payments crisis. The CMIM has US$240 billion in financing, with China and Japan as the largest contributors. It is backed by an independent surveillance unit, the ASEAN+3 Macroeconomic Research Office (AMRO) that monitors and analyzes regional economies and supports decision-making. The CMIM maintains a link to the IMF for both technical and financial support – and for political reasons. 

CMIM financing has not been used to date. The economic impact of the Covid-19 pandemic underlined its potential importance to support financial stability in the region. It also generated renewed commitment to bolster its role and appeal. The weaponization of Russia’s reserves is likely to reinforce further the CMIM’s perceived value – and expand the regional role of China’s currency, the renminbi (RMB). Recent events point in this direction.

An important goal for China is to internationalize the RMB. On a global scale, this is not likely to happen anytime soon. China will not open its capital account for a fully convertible RMB, allowing free outflow from its domestic financial system. Beijing, however, can expand the RMB’s role in bilateral trade over time, as in the case of Saudi Arabia, with a now perhaps more receptive Southeast Asia.

China is ASEAN’s largest trading partner and its fourth largest investor. It is the largest partner to the region’s leading economies – Indonesia, Malaysia, Singapore, Thailand and Vietnam. This provides significant scope for expanding RMB-denominated bilateral trade. 

In addition to the CMIM, China currently has bilateral currency swap arrangements, if little used so far, with 41 countries, for over RMB3.5 trillion (US$554 billion). In Asia, participants include South Korea, Singapore, Indonesia, Malaysia and Thailand. The implementation this year of the Regional Comprehensive Economic Partnership (RCEP) involving the ASEAN+3, Australia and New Zealand is likely to expand intra-regional trade and investment and create additional opportunities for regionalization of the RMB. 

Furthermore, if confidence in the dollar should begin to fray, this will put the value of Asia’s extensive, mostly dollar, reserves at risk. Even such a staunch US ally as Japan may then begin to reconsider the composition of its US$1.3 trillion reserves. 

Asian economies are not likely to move out of the US dollar. They may, however, increase their hedging against it by developing alternative payment and reserve systems, as reflected in the recent IMF study entitled “The Stealth Erosion of the Dollar Dominance”. This would lead to growing fragmentation of the global financial system and expand, even if in a limited way, the regional role of the RMB and China’s influence.