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ASIAN (H)

Politics trumps economics in new currency war

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Author: Joseph E Gagnon, PIIE

On 5 August 2019, the US Treasury Department designated China as a currency manipulator after the Chinese renminbi depreciated beyond the psychologically significant level of seven yuan per US dollar.

China's Central Bank Governor Yi Gang approaches to greet US Treasury Secretary Steven Mnuchin during the G20 finance ministers and central bank governors meeting in Fukuoka, Japan, 8 June 2019 (Photo: Reuters/Kim Kyung-Hoon).

This action comes three months after the US Treasury’s semi-annual report on Macroeconomic and Foreign Exchange Policies of Major Trading Partners of the United States added Malaysia, Singapore and Vietnam to a monitoring list of nine countries, including China, Japan, and South Korea, that meet some of the criteria used to identify currency manipulators. It also comes weeks after a proposal by the US Commerce Department to extend countervailing duties to cover imports subsidised by a deliberately undervalued exchange rate.

The US government is clearly concerned about the exchange value of the dollar and its role in perpetuating a large US trade deficit — a key policy concern for US President Donald Trump. But these actions have little practical significance by themselves. The currency manipulator designation carries no meaningful sanctions that are not already in place against China. None of the countries on the monitoring list are likely to be designated manipulators in the near future. And countervailing duties, which would normally require a designation of currency manipulation, would apply only to Chinese imports, which are already subject to punitive tariffs.

US Treasury had been following a flawed set of criteria for currency manipulation that had at least some grounding in theory and data. But with the designation of China, it has abandoned even the pretence of a strategy that treats partner countries fairly and objectively. These actions take the world further from an effective framework for dealing with the real threat of currency manipulation.

C Fred Bergsten and I define currency manipulation as excessive official purchases of foreign currency (more than 2 per cent of GDP) to hold down the value of domestic currency and support a large trade (current account) surplus (more than 3 per cent of GDP). We also require net official foreign-currency assets in excess of three months of imports and 100 per cent of short-term external debt.

Currency manipulation peaked during the ‘decade of manipulation’ from 2003 to 2013 with purchases in excess of US$500 billion per year. We show that the trade effects of currency manipulation reduced US employment by more than 1 million jobs for several years after the Great Recession of 2008–09.

Manipulation has declined substantially since 2013, but three countries — Singapore, Norway and Macao — continued to make excessive currency purchases in 2018 totalling US$106 billion in support of large trade surpluses.

As the issuer of the world’s premier reserve currency, the United States bears the brunt of the trade deficits that are caused by currency manipulation, though all countries are affected. US policymakers have long sought to identify and deter episodes of currency manipulation, but their efforts are distorted by an unjustified focus on bilateral trade balances. This has become even more pronounced under the Trump administration.

Bilateral balances are not a useful indicator of which countries’ policies are contributing to the overall US trade deficit. For example, Singapore has a bilateral trade deficit with the United States, but its large and persistent official purchases of US dollars keep the dollar overvalued, contributing to the US trade deficit.

The US Treasury’s primary criteria for currency manipulation are that a country must have a current account surplus in excess of 2 per cent of GDP, net purchases of foreign exchange reserves in excess of 2 per cent of GDP, and a bilateral trade surplus with the United States of more than US$20 billion per year.

Most of the countries on the monitoring list are not purchasing significant amounts of foreign currencies and will not violate the test as long as they continue to abstain.

But US Treasury retains discretion to apply an older standard for currency manipulation established by the Omnibus Trade and Competitiveness Act of 1988 based on intent to gain an ‘unfair competitive advantage in international trade’ with no numerical guidelines. It is under this authority that US Treasury designated China as a manipulator. US Treasury argued that the depreciation of the renminbi on 5 August was a deliberate policy action given China’s history of managing its exchange rate and its substantial holdings of foreign exchange reserves.

The purpose appears to be mainly to lengthen the charge sheet against China in the ongoing trade war. But US Treasury’s case is clearly weakened by the fact that China’s current account is close to balance and it has not bought significant amounts of foreign exchange in recent years.

To an unfortunate extent, US currency policy appears to be guided more by political than economic considerations. The main target appears to be China, driven by China’s large bilateral trade surplus with the United States. The principal currency manipulators in recent years — Singapore, Switzerland, Norway, Taiwan and Thailand — have evaded Treasury’s designation. Indeed, the bilateral surplus criterion of US$20 billion per year appears to have been set to avoid having to name Taiwan as a manipulator in 2016, when it had a bilateral trade surplus of US$15 billion.

The main US success in the battle against currency manipulation has been the joint pledge of G20 countries to refrain from targeting their exchange rates for competitive purposes. By and large, G20 countries have honoured their pledge over the past four years. Nevertheless, some smaller countries continue to manipulate, and all countries may be tempted to use currency policy to achieve export-led growth during the next global downturn — especially given perceived limitations on the scope for monetary and fiscal stimulus.

The world needs an enforceable set of economically sound rules to prevent beggar-thy-neighbour exchange rate policies. The International Monetary Fund is the appropriate forum in which to debate such rules, but it lacks useful sanctions to enforce them. By attacking the wrong target amid an ill-designed trade war, the United States is sacrificing its moral standing to guide the world to a better outcome on this important issue.

Joseph E Gagnon is a Senior Fellow at the Peterson Institute for International Economics, Washington DC.



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ASIAN (H)

ASEAN distances itself from the United States

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Author: Editorial Board, ANU

Tensions between the United States and China entered a dangerous new phase this week. For the first time in 25 years, US authorities labelled China a currency manipulator after the RMB fell below the 7 yuan-per-dollar level. This opens the door to the United States’ levelling sanctions against China as well even more extreme trade restrictions, as the global trade and technology war morphs into a currency war.

A security officer stands guard during the 34th ASEAN Summit in Bangkok, Thailand, 19 June 2019 (Photo: Reuters/Soe Zeya Tun).

The actions of the United States were arbitrary, to say the least, and have rocked global financial markets. The recent ‘ASEAN Outlook on the Indo-Pacific’ shows that ASEAN countries are more and more wary of the approach being taken by the United States in the region. They are right to be worried.

Labelling China a currency manipulator made little sense, both economically and institutionally.

Economically, a weakening RMB is to be expected in the current economic circumstances. The Chinese economy has been slowing while the United States continues its longest economic boom in history. Chinese exports to the United States have been under increasing strain while escalating global risks have seen increased demand for safe haven US financial assets. All of these variables point to a weakening RMB against the US dollar. ‘They are not driving the currency down’ notes Marc Chandler, Chief market strategist at Bannockburn Global Forex, ‘but just accepting market forces’. Within a narrow band the Chinese monetary authorities let the currency settle where the market took it.

Institutionally, China’s actions fail to satisfy the US Treasury’s own definition of a currency manipulator. ‘China has not been intervening’ says Mark Sobel, a 40-year US Treasury veteran. ‘By Treasury’s own foreign exchange report criteria, China doesn’t even come close to meeting the terms for manipulation’. The IMF has similarly judged that China’s exchange rate in 2018 was broadly in-line with its fundamentals, and has reached the same conclusions for at least the last 5 years.

Is a currency war brewing?

It is unlikely that the Trump administration would be able to achieve the President’s wish of a lower US dollar. Trump could use the Treasury’s Exchange Stabilization Fund to start selling US dollars. But with only US$100 billion in the fund, and dollar holdings of just US$23 billion, it is unlikely to be large enough to achieve any sustained depreciation of the US dollar. This means that any sustained reduction in the US dollar would require action from the US Federal Reserve which, thus far, has held its ground.

Although US institutions will slow the outbreak of a currency war, President Trump does have the power to impose further trade restrictions and sanctions on China. But as the IMF has shown, these costs fall overwhelmingly on US consumers, suggesting that a US recession may be the most likely path for the President in achieving a fall in the US dollar, particularly as the US yield curve inverted significantly last week — a reliable predictor of US recessions.

Last week’s currency tensions also say something important about China. By allowing the RMB to fall below the 7 yuan-per-dollar level, China is perhaps demonstrating some newfound economic confidence and independence. The 7 yuan-per-dollar level was seen by many as an important psychological threshold. Allowing the RMB to fall below it signals an increased willingness of Chinese authorities to behave more independently relative to what the rest of the world is doing.

Whether this newfound financial independence will amount to any structural changes in the Chinese monetary policy and exchange rate framework is still unclear. What is clear is that US foreign policy towards China has entered a new frontier. Twelve months ago, the concern was about the trade war. The concerns then shifted into technology and firms and have now shifted into currencies and financial markets.

Southeast Asian countries are watching, nervously. After more than a year of deliberation, ASEAN adopted the ‘ASEAN Outlook on the Indo-Pacific’ (‘the Outlook’) on 23 June 2019. The Outlook is essentially a guide to how ASEAN sees the Asia Pacific and its engagement therein.

As Amitav Acharya discusses in this week’s lead essay, the Outlook tells us a lot about how ASEAN, particularly Indonesia (which took the lead in conceiving the plan) thinks about the concept of the ‘Indo-Pacific’ and the approach being taken by the US in Asia.

Acharya argues that Indonesia is uncomfortable with the US approach to the concept of the Indo-Pacific, seeing it as exclusionary and aimed at isolating China. In response, Jakarta has been developing an ASEAN-centred Indo-Pacific strategy that is more consistent with ASEAN’s principles of inclusiveness (towards China too), consensus-building, and with its stress on a normative, political and diplomatic — rather than an excessively military–strategic — approach.

Acharya shows how the differences between the ASEAN and US approaches are captured in the terminology used by the two countries to articulate their Indo-Pacific visions. ‘The United States wants a ‘free’ and ‘open’ Indo-Pacific, echoing the wording used by Japan’s Prime Minister Shinzo Abe, but with a more overt military–strategic orientation’ says Acharya. ‘In comparison, Indonesia seeks an ‘open’ and ‘inclusive’ Indo-Pacific. The United States does not use ‘inclusive’ while Indonesia does not use ‘free’’.

This ASEAN-speak may appear semantic, but its significance is substantial. What the Outlook shows is that ASEAN is playing its classic role as a regional consensus-builder. This is needed now more than ever. As US–China tensions continue to move through trade, technology, currencies and finance, Asia will be left footing the costs. Building consensus and addressing the root causes of tensions by reforming global rules and institutions requires Asian leadership and the engagement of China, not its isolation. Remaining on the sidelines has not worked thus far. It is unlikely to work in the future.

The EAF Editorial Board is located in the Crawford School of Public Policy, College of Asia and the Pacific, The Australian National University.



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ASIAN (H)

Why ASEAN’s Indo-Pacific outlook matters

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Author: Amitav Acharya, American University

After more than a year of deliberation, ASEAN adopted the ‘ASEAN Outlook on the Indo-Pacific’ (the Outlook’) on 23 June 2019. The Outlook then got an airing at the ASEAN Regional Forum meetings in Bangkok. The Outlook document ‘provides a guide for ASEAN’s engagement in the Asia-Pacific and Indian Ocean regions’ and resembles an Indonesian-conceived plan.

Indonesian president Joko Widodo delivers a speech in Jakarta, Indonesia, 8 August 2019 (Photo: Reuters/Willy Kurniawan).

The idea of the Indo-Pacific as a regional concept is not new and has been widely discussed in the policy community as a way to link the Indian and Pacific Oceans, and give greater recognition to the role of India and Indonesia in any regional strategic formulation. But the Indo-Pacific concept took on more life and meaning with the US Trump administration’s adoption of it.

As a leader of ASEAN, Indonesia is uncomfortable with the US approach, seeing it as an exclusionary and aimed at isolating China. Jakarta sees the ‘Quad’ — comprising the United States, Japan, Australia and India — as a potential strategic coalition of ‘outside’ powers without ASEAN’s involvement. In response, Jakarta has been developing an ASEAN-centred Indo-Pacific strategy that is more consistent with ASEAN’s principles of inclusiveness (including towards China), consensus-building, and stress on a normative, political and diplomatic — rather than an excessively military–strategic — approach.

The differences are captured in the terminology used by the two countries to articulate their Indo-Pacific visions. Briefly, the United States wants a ‘free’ and ‘open’ Indo-Pacific, echoing the wording used by Japan’s Prime Minister Shinzo Abe, but with a more overt military–strategic orientation. In comparison, Indonesia seeks an ‘open’ and ‘inclusive’ Indo-Pacific. The United States does not use ‘inclusive’ while Indonesia does not use ‘free’.

The US idea of a ‘free’ Indo-Pacific identifies domestic political openness and good governance as key ingredients — putting it at odds with China — while Jakarta’s stress on ‘inclusivity’ implies that its policy is not meant to isolate China. India seems to be taking a middle path, calling for a ‘free, open and inclusive Indo-Pacific Region’.

The Outlook upholds Jakarta’s vision, whose interest in the Indo-Pacific idea is driven by President Joko Widodo’s goal of turning Indonesia into a ‘maritime fulcrum’. ‘The Outlook is intended to be inclusive in terms of ideas and proposals’. There is no mention of any country or major power, not just China and the United States, but also Japan, India and Russia. It avoids any strategic language or tone and there are no military aspects to the document.

Rather, it is more consistent with ASEAN’s ‘comprehensive security’ approach with an emphasis on ‘implementing existing and exploring other ASEAN priority areas of cooperation, including maritime cooperation, connectivity, the Sustainable Development Goals (SDGs), and economic and other possible areas of cooperation’.

The Outlook strongly recalls the traditional ‘ASEAN Way’ of avoiding legalistic institutionalisation — the Outlook is meant to be a ‘guide’, not a legal document or treaty.

Moreover, the Outlook stresses reliance on existing ASEAN norms and mechanisms, such as the Treaty of Amity and Cooperation and the East Asian Summit. It is ‘not aimed at creating new mechanisms or replacing existing ones; rather, it is an Outlook intended to enhance ASEAN’s Community building process and to strengthen and give new momentum for existing ASEAN-led mechanisms to better face challenges and seize opportunities arising from the current and future regional and global environments’. This reflects a determination to preserve ASEAN centrality in the development of Indo-Pacific architecture and counter any linking of the Indo-Pacific to a balance of power approach.

While some Western observers dismiss Outlook’s importance because it does not target China specifically or carry compliance measures, but this criticism misses the point: this is how ASEAN has been doing its business since its founding. ASEAN’s main roles in regional security have been in norm-setting and confidence-building, rather than in exercising hard power or conflict-resolution.

What’s disappointing is not the document, but the gap between how the West sees ASEAN and how ASEAN sees itself. ASEAN is bound to disappoint those who would like to see it act like a great power in a classical concert of powers. This is not what ASEAN is nor what it will ever be.

While the Outlook is written in typical ‘ASEAN speak’, it does not blank out the crucial issues and principles at stake in current maritime disputes in the South China Sea. The document stresses ‘cooperation for peaceful settlement of disputes; promoting maritime safety and security, and freedom of navigation and overflight; … sea piracy, robbery and armed robbery against ships at sea; and the like’.

The Outlook avoids the term ‘free’, which China sees as being directed against it. At the same time, it contains references to ‘freedom of navigation’, which is Washington’s area of emphasis. ASEAN is playing its classic role as a regional consensus-builder, which is all the more essential at a time of rising bilateral tensions between the United States and China.

In the final analysis, the Outlook is an act of diplomatic and political assertion by ASEAN. ASEAN is telling the world that ASEAN has its own way of developing the Indo-Pacific idea — previously pushed by outside powers such as Japan, Australia, India and the United States — and that it won’t let outside powers dominate the ‘discourse’ on the Indo-Pacific. The Outlook also legitimises the role of Indonesia, possibly the only Southeast Asian country with the size, geography and potential power to stand up to China and the United States, or indeed to all major powers. This is what’s critical to the preservation of ASEAN centrality.

Amitav Acharya is Distinguished Professor of International Relations, American University, Washington DC.



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ASIAN (H)

India must look Northeast before looking East

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Author: Subir Bhaumik, Centre for Studies in International Relations and Development India

India’s ‘Look East’ policy mainly focussed on maritime trade when the country sought to turn to East and Southeast Asia for trade and commerce in the 1990s. In particular, after Myanmar joined ASEAN, India began to make an effort to situate its ‘troubled northeast at the heart of what eventually evolved into its so-called “Look East” policy’. India has funded many infrastructure projects in Bangladesh (to connect the Indian mainland to its north-eastern states) and in Myanmar (to facilitate its relationships with the rest of Southeast Asia).

An Indian boy looks out from a window in Khonoma village, on the outskirts of Kohima, the capital of northeastern Indian state of Nagaland, 12 August 2005. (Photo: Reuters/Adnan Abidi). This has led Indian policymakers and analysts to revise their attitudes about the country’s troubled northeast. Some say this new strategic vision could be a game-changer for Asia. It has the potential to bring China, India and Southeast Asia closer in terms of economic integration and turn South Asia into one of the world’s economic hotspots. Regional initiatives such as the Bangladesh–China–India–Myanmar (BCIM) Economic Corridor and Bay of Bengal Initiative for Multi-Sectoral Technical and Economic Cooperation (BIMSTEC) are important steps.

Northeast India’s great potential to connect the Indian mainland to East and Southeast Asia — somewhat similar to the function Yunnan serves for China — has been undermined by the failure of the Indian government to resolve ethnic insurgencies that have discouraged investment.

After two decades of negotiations with separatist Naga rebels, India is yet to find a sustainable solution. The Naga rebels, an armed insurrection group backed by Pakistan and China, were the first to challenge India’s post-colonial nation-building process. Mizo, Manipuri and Assamese rebels followed suit, along with rebels from groups like the Bodos, Dimasas, Karbis and the Khasis.

The proliferation of ethnic insurgencies forced India to deploy formations of army and paramilitary forces and led to the imposition of draconian laws like the Armed Forces Special Powers Act that undermined human rights and increased alienation. India has brought an end to some of these insurrections by negotiating settlements with rebel groups and by introducing ballot box democracy in the region.

The Modi government signed a ‘framework agreement’ with the Naga rebels in 2015. But a final settlement has eluded Delhi. India appears to be willing to grant considerable autonomy to Nagaland by accepting the concept of ‘shared sovereignty’. But it is not willing to accept the Naga rebel demand of integrating the Naga-inhabited territories of Manipur, Arunachal Pradesh and Assam with Nagaland to create a ‘Greater Naga state’.

Major population groups in these states are strongly opposed to any redrawing of state boundaries. The Indian government is unwilling to risk a fresh conflagration while trying to resolve an old problem. India has sought to curb these insurgencies through successful military diplomacy. Bhutan and Bangladesh have used their security forces to drive away rebels who had established clandestine bases in those countries from India’s Northeast. India has engaged Myanmar’s military, which has initiated operations against several northeast Indian rebel groups based in Myanmar’s northwestern Sagaing province.

India has continued to keep the main Naga rebel group, the National Socialist Council of Nagaland, at the negotiating table and neutralised its other factions. But other rebel groups in Manipur, Assam, Meghalaya and Arunachal Pradesh remain active and continue large scale extortions that dampen investor confidence and drive away business.

Northeast India is rich in resources with large deposits of oil, natural gas, coal and uranium and a series of thriving tea and rubber plantations. But large scale investment from both domestic and foreign capital has not been forthcoming due to a lack of investor confidence.

Some investment has been attracted in pharmaceutical and agro-processing industries. But the northeast is far from developed as a manufacturing, trading or connectivity hub in the same way that Yunnan has emerged for China’s ‘southward push’. Indeed, India appears unsure about pushing forward with its ‘Look East’ policy due to fears that trade with China or ASEAN countries may become one-sided.

Indian politicians, including Prime Minister Narendra Modi, have said that development holds the key to neutralising the festering ethnic insurgencies in the region. Modi has lent some urgency to the ‘Look East’ policy by rebranding it ‘Act East’. This is more than a change of semantics as critics allege — it is to lend a sense of priority to the policy.

As India turns to a market-driven economy, it has become difficult to attract private sector investment into regions marred by conflict, extortion and abductions. Even the government’s efforts to create critical infrastructure like roads, bridges and rail depend on prevailing law and order conditions. Work on the Silchar–Imphal railway, key to placing Manipur state on the country’s railway map, is delayed because of extortion by multiple rebel groups. By contrast, Tripura’s rail network is fast expanding all the way to Bangladesh after the state sorted out its insurgency problems.

Former Indian prime minister Rajiv Gandhi pioneered a technology mission to modernise India’s decrepit infrastructure and also managed several accords with rebel groups. He was set to achieve more before he lost the 1989 national elections. Modi has the same kind of comprehensive mandate that Gandhi enjoyed. But without a negotiated political closure to these festering insurgencies, the region will not emerge as India’s ‘land bridge’ to East and Southeast Asia.

Subir Bhaumik is a Senior Fellow at the Centre for Studies in International Relations and Development (CSIRD) India and a former BBC correspondent.

 



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ASIAN (H)

Sri Lankan President Sirisena’s political war on drugs

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Author: Shyamika Jayasundara-Smits, Erasmus University Rotterdam

Sri Lankan President Maithripala Sirisena’s answer to drug-related crimes is bringing back the death penalty. According to recent reports, international drug smugglers are increasingly turning to Sri Lanka as a transit hub in Asia, while drug-related arrests are on the rise. On 26 June 2019, Sirisena signed death warrants for four prisoners serving sentences for drug-related crimes. His signature brought an end to a 43-year moratorium on the death penalty which begun following a final capital punishment case in 1976.

A group of Sri Lankans hold placards during a protest condemning signed death sentences for four people convicted of drug-related offences in a decision by Sri Lanka's President Maithripala Sirisena, in front of the Welikada Prison in Colombo, Sri Lanka 28 June 2019. (Photo: Reuters/ Dinuka Liyanawatte).Sirisena’s return to the death penalty has provoked mixed responses. Some point out that Sirisena cannot present evidence to show that the death penalty can save future generations from the scourge of narcotics and drug trafficking. His attempt to link an undisclosed drug mafia with the April 2019 Easter bombings did not prove convincing for most observers. The claim was flatly contradicted by a Special Presidential Committee appointed to probe the Easter attacks and statements issued by Sri Lankan Prime Minister Ranil Wickremesinghe. As Sirisena’s arch rival in politics, Wickremesinghe points the finger at home-grown jihadists. Linking drugs with terrorism is a familiar fable in the history of war in Sri Lanka.

Fearing that he might lose the support of his own government, President Sirisena has announced that he will declare a day of ‘national mourning’ if the government does not agree to his reinstatement of capital punishment or seeks to abolish it. For many in Sri Lankan politics, whatever the scale of the drug problem at hand, bringing back capital punishment for drug offences sounds like an over-reaction.

Legal experts point to pitfalls in the road ahead. Reinstating the death penalty requires approval both from an extremely divided national legislature and the Supreme Court. Their legal–moral appeal seems to have had some effect on Sri Lanka’s majority Sinhala–Buddhist population. But the President’s efforts to convince the public by citing blessings he received from a number of Buddhist clergymen have mostly fallen on deaf ears.

Sirisena’s move to bring back the death penalty is not out of character. Almost immediately after being sworn into office in 2015, Sirisena started a morality-inspired war against narcotics. He launched an anti-drug elite task force and increased police powers to deal with drug offenders. An island-wide anti-drug awareness campaign led to the establishment of thousands of committees in schools and villages to combat drugs. Yet in December 2018, Sri Lanka voted in favour of a final moratorium on the death penalty at the United Nations General Assembly. This vote was retracted just six months later. The background to this turn is developing dynamics in Colombo’s political settlement and the huge political stakes involved in the gamble to bring back capital punishment.

Sirisena has tied the war to his personal as well as political agenda. Like his predecessor Mahinda Rajapaksa, who won the ‘war against terrorism’, Sirisena wants to go down in history for having saved Sri Lanka in the war on drugs. One can attribute President Sirisena’s toughness and bravado of his resolve to an inspirational meeting with Philippine President Rodrigo Duterte in January 2019. This ‘toughness’ is an effort to politically re-brand himself as stronger and more powerful than Gotabhaya Rajapaksa, a competitor in the December presidential elections.

As a former defence secretary, Rajapaksa has already earned a reputation for being ‘tough on crime’. Contrary to Rajapaksa’s hard-man political image, Sirisena is often depicted as softly spoken and temple-worshipping — an ordinary man of the village. Although Sirisena has yet to officially declare his intention to contest the presidency, his decision to bring back the death penalty could be a sign that he is preparing such an announcement. Reinforcing a reputation for ‘toughness’ is vital for Sirisena given his rapidly declining public approval ratings following the disastrous Easter bombings.

The question is whether the war on drugs is winnable and whether the death penalty will help. Framing the anti-narcotics efforts as a war has been a selling point for the public who are getting weary of everyday drug abusers and dealers. Considerable political momentum was created by the ending of almost 25 years of civil war, and people are accustomed to the warfare frame of reference.

As intended, the reintroduction of the death penalty received the expected reaction from local and international civil society organisations, the United Nations and Western governments — the so-called ‘coalition of enemies’ of the majority Sinhala–Buddhist constituency. Ultimately Sirisena’s political fate will depend on this constituency, which so far seems supportive of his gambit.

Although there are no clear signs that Sirisena will be re-elected, he is making small gains by drawing political attention to himself, while distracting the electoral mass away from compelling issues of national security and economic development. Sirisena’s choice of battleground has been executed with almost military precision, reminding us of Clauzewitz’s claim that ‘war is politics by other means’.

Shyamika Jayasundara-Smits is Assistant Professor in conflict and peace studies at the International Institute of Social Studies (ISS), Erasmus University Rotterdam.



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Sogavare shakes up Solomon Islands’ development strategy

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Authors: Charles Hawksley, University of Wollongong, and Nichole Georgeou, Western Sydney University

On 1 June this year, newly-elected Prime Minister of Solomon Islands Manasseh Sogavare launched his Democratic Coalition Government for Advancement’s (DCGA) First 100-Days Policy Framework in the country’s capital, Honiara.

Workers inspect a fleet of earth-moving trucks, Solomon Islands (Photo: Reuters/James Regan).

No government ministry is spared in the 106-page document that sets out a matrix of programs and activities to be achieved. The framework may simply be political rhetoric by an incoming government keen to impress the voters — but, as the document notes, these strategies will be the ‘litmus test of the DCGA four year policy and development priorities’.

The creation of such a document provides an interesting insight into Solomon Islands government’s view of its own development ambitions and trajectory. Sogavare has said the framework should be ‘simple, precise and achievable’, though it seems to be none of these. The document is mostly concerned with reviewing existing programs, particularly long-standing, donor-funded large development infrastructure projects. These include the Tina River hydropower project funded by the World Bank, an undersea fibre optic cable to enhance telecommunications funded by Australia, an international terminal for the new Munda International Airport funded by New Zealand, and a Japanese project to extend the improved Kukum Highway out to Honiara International Airport.

In addition to these projects, the framework calls for greater efforts to achieve better government services, improve tax revenue, implement state-of-the-art health, sewerage and power, and develop  a better-trained bureaucracy. Other agenda items also appear particularly ambitious, for example settling outstanding compensation and land issues in the vicinity of Honiara’s international airport, which is unlikely to be achieved quickly.

Donors continue to play a large role in Solomon Islands’ economic development. In 2018 Australia provided roughly 55 per cent of all aid to Solomon Islands, and invested around AU$2.8 billion (US$1.9 billion) into the Pacific Islands Forum’s Regional Assistance Mission to Solomon Islands (RAMSI), which operated from 2003 to 2017. Australian aid to the Solomon Islands in 2019–20 will increase to AU$198.3 million (US$138.4 million), making it the second-largest Pacific Islands recipient of Australian aid after Papua New Guinea.

Australia’s Pacific Step Up program aims to create regional growth in the Pacific through an AU$2 billion (US$1.4 billion) infrastructure facility, ‘focussed free trade’ through the Pacific Agreement on Closer Economic Relations (PACER) Plus, and a labour mobility scheme.

Despite these actions, the 100-days framework indicates that Solomon Islands is looking to broaden its mix of development donors, with the United States to be ‘re-engaged’ as a development partner and a ‘Comprehensive Assessment on the China Question’ to follow. This signals a potential diplomatic shift from Taiwan to China.

The framework announces the adoption of a ‘friends to all and enemy to none’ foreign policy, which involves extending relations to ‘all UN members’. Taiwan, which provides AU$8.85 million (US$6.18 million) in Constituency Development Funds to members of parliament, is mentioned twice (in relation to labour mobility schemes and stadium construction for the 2023 Pacific Games) — but if a foreign policy shift occurs, China will likely not tolerate Taiwan remaining as an aid partner.

A shift in diplomatic relations to China would build on an existing strong trade relationship. From 2007 onwards, China has purchased more Solomon Islands exports than any other country. In 2017 China purchased two-thirds of all Solomon Islands exports (valued at US$456 million), and Solomon Islands takes 13 per cent of its imports from China (US$79.1 million).

While 62 per cent of Solomon Islands imports come from Asia — with China and Singapore both at 13 per cent and Malaysia at 12 per cent — Australia remains the single largest source of imports at 17 per cent. Australian products cost Solomon Islands around US$100 million in 2017, but Australia bought just US$13.3 million (1.9 per cent) of Solomon Islands exports — well down from the US$121 million of 2012.

RAMSI aimed to induce economic development through engagement with the global market and promoting tourism and export crops. Solomon Islands exports are now over 10 times their 2000 value, and export agriculture now accounts for 10.9 per cent of exports. Despite this growth, the main exports remain rough wood (68 per cent), and processed fish (7.5 per cent), neither of which is sustainable in the long term.

Sogavare’s 100-Days Policy Framework seems to recognise that internally-focussed development — built on an expanding domestic population and growing internal markets — can induce long-term, sustainable growth. Stronger infrastructure through improved road and maritime transport linking rural and urban sectors can help to consolidate economic growth, as well as enhance urban food security in Honiara. As a recent study of the Honiara Central Market shows, 82 per cent of market producer–vendors are women, and smallholder production for domestic consumption enables asset creation among rural communities.

In a country where the population of around 660,000 is still predominantly rural, Sogavare’s focus on completing large-scale infrastructure projects bodes well for the nation’s development. The possible addition of China to Solomon Islands’ existing aid donor mix would likely result in new infrastructure projects. Such a move would raise questions for Australia about the emphasis of its priorities in Solomon Islands and the extent of its post-RAMSI influence.

Charles Hawksley is Senior Lecturer in Politics and International Studies at the University of Wollongong.

Nichole Georgeou is Associate Professor in Humanitarian and Development Studies at Western Sydney University.



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ASIAN (H)

A roadmap for India’s 15th Finance Commission

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Author: Ashima Goyal, IGIDR

Successive finance commissions have upheld the Indian federation by adjusting the financial relationships between its central government and its states. As non-political independent bodies, India’s finance commissions have been one of the sterling institutions that sustain Indian democracy. But, in the ‘planning’ era, as plan expenditures were prioritised, the original constitutional mandate — which was to equalise opportunities for every citizen by ensuring uniform delivery of public services — became diluted.

Finance Commission of India Chairman NK Singh attends a meeting at the Reserve Bank of India headquarters in Mumbai, India, 9 May 2019 (Photo: Reuters/Francis Mascarenhas).

Past finance commissions were reluctant to rock the boat and potentially lose credibility by doing anything very different to what they were doing in the past. As a result, the average Indian continues to suffer due to poor public service provision. The level and uniformity of public service improvement is a useful gauge by which one can measure the success of the terms of reference of the current 15th Finance Commission.

The emphasis in the Commission’s terms of reference on incentives is creating considerable unease among Indian states. Tax sharing is regarded as a right and so states resist introducing conditionalities when funds are devolved to states. But states often do not devolve funds and functionaries further, even though they are required to by the 73rd and 74th amendments to the Constitution. In some cases, even the state finance commissions (SFCs) that serve this function are not set up.

But there are no limitations from the Constitution to introducing conditionalities on grants-in-aid or on centrally sponsored schemes (CSS). Such conditionalities can be designed to incentivise future action or to reward capacity building, as well as improve institutions.

States delay upgrading their rapidly growing towns to urban status because of tax and municipal service provision issues. Towns themselves do not want to lose rural development funding. One reason that public service provision is so poor is that facilities tend to be cut to match the funds available, which dis-incentivises the provision of uniform levels of public service.

The 13th Finance Commission introduced incentive payments but capacity constraints prevented some states from utilising them. The 14th Finance Commission therefore shifted payments to capacity building.

The 12th Finance Commission had the most success because it used a combination of carrots and sticks — debt restructuring conditional on accepting state-level fiscal responsibility and budget management (FRBM) legislation. The 15th Finance Commission could give funds conditional on implementing devolution, with payments made for improvements rather than simply for provision.

The CSS can be rationalised and revised further. The Rs 3.5 trillion (US$49.7 billion) currently paid could be partly replaced by well-targeted central direct benefit transfers to individuals. Achieving economies of scale by pooling and coordinating efficiencies may reduce health and education costs where dual responsibilities between the centre and the states have eroded the successful delivery that the Constitution mandates.

A major issue is balancing independence and uniformity for states. Richer states, those with their own competitive schemes, may want to opt out of the CSS. They could be given a choice — conditional on threshold outcomes being achieved — which may encourage healthy competition. Distributing appropriate compensation when funds are devolved could be on the basis of quality-adjusted least-cost schemes.

A permanent fiscal council could be set up and made responsible for conditional data-based fund devolution to states. This body could also function as a non-political fiscal watchdog. The Inter-State Council could be revived in order to improve participation and feedback from states. The smooth working of the GST Council shows that something like this is possible. Reviving the Council could also reduce sanctioning delays.

Research at IGIDR suggests that incentives work. Intergovernmental transfers, given tax capacity, have a negative association with the tax efforts of states. FRBM improved states’ tax efforts. Despite the introduction of the GST, states still have work to do when it comes to user charges. Larger expenditure responsibilities are followed by higher tax effort. Ring fencing productive expenditure could also raise revenue efforts.

An award in line with broad principles of justice such as linking incentives to delivering constitutional responsibilities for public service delivery would generate less resistance.

The second term of reference of the 15th Finance Commission covers reducing state debt. The FRBM review committee’s focus on debt and fiscal deficits led to a rise in revenue deficits. It is necessary to safeguard expenditure which creates future income. Encouraging higher growth brings down debt ratios as growth rates normally exceed interest rates on catch-up growth paths. Fiscal deficit directly adds to borrowing but a rise in revenue deficit decreases growth and therefore slows the reduction in debt ratios. Any deficit path should itself have some counter-cyclicality built in.

There is now also more market discipline in states. There are plans to increase discipline further by releasing data more frequently on state finances, which will enhance ratings. Currently, borrowing costs remain similar despite widely varying debt levels. There is no default risk and an automatic debit from the Reserve Bank of India on payment dates. Earlier, the states relied on finance commissions to cover the gaps. Now they have FRBM mandated caps.

To borrow from markets, states have to get consent from the central government under Article 293(3) of the Constitution. An indicator of the hard budget constraints they face is that while state-revised expenditure estimates often exceed budget estimates, actuals are less than revised.

Expenditures are cut and often these are developmental and capital expenditures. Incentives must also protect the quality of expenditure. It seems clear that incentives contained in the 15th Finance Commission, despite the apprehension they generate, could prove vital to ensuring the adequate provision of public services across India’s federated states.

Ashima Goyal is Professor at the Indira Gandhi Institute of Development Research (IGIDR), New Delhi.

A version of this article was first published here by The Hindu Business Line.



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Trump’s currency war without a cause

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Author: Yiping Huang, Peking University

The greatest economic damage of the ongoing trade war between China and the United States is caused by policy uncertainty, not import tariffs. In early August 2019, US President Donald Trump introduced some new shocks. Amidst the new round of trade talks between the two countries, Trump announced that the United States will start putting tariffs of 10 per cent on the remaining US$300 billion of goods imported from China. Quickly following that, the US Treasury Department designated China as a ‘currency manipulator’.

US Dollar and China Yuan notes are seen in this picture illustration 2 June 2017. (Photo: Reuters/Thomas White)

This currency war reminds me of an old Chinese saying: ‘Even when right a scholar cannot win an argument with a soldier’ — because it defies any common sense about currency manipulation. At one of the earlier G20 meetings, a US official warned that the United States would name China a currency manipulator if it did not intervene to hold up the value of Chinese renminbi (RMB). In fact, it would have been more appropriate to label China the ‘currency non-manipulator’.

The US Treasury Department usually follows three criteria to determine if a trading partner is a currency manipulator — the first is a bilateral trade surplus with the United States of more than US$200 billion; the second is a current account surplus of more than 3 per cent of GDP; and the third is a total purchase of foreign exchange equivalent to more than 2 per cent of GDP within 12 months.

Of these, China only satisfies the first criterion. And even this one needs to be looked at with caution. It is widely known that China’s bilateral trade surplus with the United States is a result of the global supply chain, as its overall trade account is almost balanced. And even this bilateral surplus is shrinking rapidly.

The US Treasury’s action might have been triggered by the weakening of the RMB on 5 August, with its bilateral exchange rate against the US dollar (USD) exceeding 7.0 for the first time in more than ten years. But this depreciation was a direct result of Trump’s announcement of additional tariffs that could deteriorate China’s external account. Several months ago, a senior IMF official suggested to me a hypothetical scenario, in which Trump would push down the value of the RMB by escalating trade tensions and then would call China a currency manipulator. This was exactly what happened.

If there was a cause for the new currency war, it was single-handedly created by Trump.

In July 2005, China started the managed floating exchange rate regime with reference to a basket of currencies. The People’s Bank of China’s (PBoC) pursues a policy agenda trying to make the exchange rate more market-determined over time but attempting to avoid excessive volatility in the short term. The RMB appreciated gradually before mid-2014 but suffered from periodical depreciation pressures after that. But since the beginning of 2017, the PBoC has avoided intervening heavily in the foreign exchange markets.

‘Management’ of the exchange rate is done mainly through the application of the ‘counter-cyclical factor’ by setting central parity at the start of trading days. The 12-month moving average of exchange rate volatility of the RMB increased steadily from late 2010 and was already close to those of major global currencies — such as the US dollar, the Euro and the Japanese yen — in early 2019.

By and large, the purpose of the ‘management’ is to reduce excessive exchange rate volatility, not to lower the currency value. The perception that a weaker currency strengthens economic growth is also outdated since it only considers the trade channel of the exchange rate effect on growth. But the effect of the finance channel could be the opposite — a weaker currency encourages capital outflow and weakens economic growth. During the second half of 2015, for instance, RMB depreciation was accompanied by sharp declines of net capital inflow.

Empirical analyses also confirm that, in China today, the finance channel already dominates the trade channel. Therefore, it is no longer in China’s own interest to single-mindedly pursue a policy of a weak RMB.

Likewise, a US policy of a weak US dollar would likely be futile, because US comparative advantages are more concentrated in the service sectors rather than in manufacturing industries. As C Fred Bergsten pointed out, Trump’s trade wars with China and many other countries reduced US imports, but did not boost US exports or bring back manufacturing facilities from overseas.

Unfortunately, such an unreasonable currency war would bear serious consequences for China. Given limited options, China could consider the following options. First, it should avoid the temptation of waging a full-scale financial war with the United States. Previously, some experts recommended dumping US treasury bonds and crashing the RMB exchange rate. This is bad advice as it could inflict more pain on China than on the United States.

Second, the PBoC should accelerate its process of moving toward a ‘managed free float regime’. This should be useful for reducing both uncertainty and misunderstandings of China’s exchange rate policy, especially as the IMF will start the new round of Special Drawing Rights review in 2020. And, finally, China’s should accelerate economic reform00, including realising competitive neutrality domestically and opening the economic doors wider to the outside world — especially to the non-US world.

Yiping Huang is Chair Professor of Economics at the National School of Development and Director of the Institute of Digital Finance at Peking University.



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