Financial interdependence and integration: The case of East Asia

Chapter 1: Financial Liberalization, Exchange Rate Policy and Interdependence. There is by now a great deal of evidence pointing to large scale financial account liberalization and therefore increasing capital mobility around the Pacific Basin. Freer financial systems in the emerging economies of East Asia have resulted in strong economic linkages with the industrialized group of nations. As a result, these economies have become increasingly influenced by foreign developments. This has prompted most of the nations in the region to move to a system with greater exchange rate flexibility in order to insulate themselves from foreign shocks. This chapter investigates whether Korea and the Philippines have become more or less vulnerable to external shocks after the transition from a fixed exchange rate regime to a more flexible one. VAR and Error correction specifications of the two East Asian economies were estimated. External shocks were proxied by real interest rates of Japan and the U.S. and world real oil prices. Results indicate that though foreign shocks play an important role in both economies, it appears that Korea was more successful in insulating the economy from foreign shocks as opposed to Philippines. In both the economies however, Japan appears to be playing a more important role after reforms were on their way. Chapter 2: Is There a Zone of Financial Integration in East Asia? Empirical tests of capital mobility typically look for either the existence or the absence of capital mobility between one country and the rest of the world. An alternative scenario could be that there are limited zones of financial integration within certain regions (See Bayoumi and Klein (1995)). For instance, capital may be more mobile within the countries of East Asia than between East-Asia and the rest of the world. The objective of this chapter is to test for integration in Southeast-Asia using the intertemporal approach to the balance of payments. Bayoumi and Klein (1995) have used this model to test for financial integration among the provinces of Canada. Modifying and extending this framework this chapter investigates whether the East Asian economies of Indonesia, Korea, Malaysia, Philippines, Singapore and Thailand are more integrated within the region or with the world (U.S. and Japan). 2SLS and 3SLS methods of estimation were used. Results show Singapore to be closely linked both with the U.S. and Japan as well as with East Asia. The modified model shows Singapore to be more closely integrated with East Asia, than with either USA or Japan, which might be reflection of its dominant role as a financial leader in the region. Results also show that Indonesia and Korea are more integrated with the U.S. and Japan than with East Asia. Thailand however seems to rely more heavily on East Asian capital markets for consumption smoothing.