Co-author:  Jose Adlai M. Tancangco
 
The Regional Comprehensive Economic Partnership (RCEP) was established in 2020, with effect in 2022, for the purpose of deepening regional economic integration among members of the Association of Southeast Asian Nations (ASEAN) and the association's free trade agreement partners (ASEAN.org). RCEP comprises 15 Asia-Pacific economies: Brunei (BRN), Cambodia (KHM), Indonesia (IDN), Laos (LAO), Malaysia (MYS), Myanmar (MMR), the Philippines (PHL), Singapore (SGP), Thailand (THA), Vietnam (VNM), Australia (AUS), China (CHN), Japan (JPN), Korea (KOR), and New Zealand (NZL). The world’s largest trading bloc, RCEP accounted for 11.9 percent of goods exports and 5.5 percent of services exports globally in 2021.

All good intentions notwithstanding, agreements to reduce trade barriers and harmonize regulation can go only so far in achieving economic integration as long as disparate monetary and exchange rate policies among members continue to generate uncertainty and impose costs on doing business. Advancing to a higher stage of integration would require binding economies together under a currency union. Short of that, fluctuations in exchange rates and interest rates cause perpetual disturbances to cross-border trade and capital flows with inhibiting effects on engagement.

Within RCEP, monetary policy and exchange rate frameworks span the gamut. Some members are inflation targeters; some anchor monetary policy to an exchange rate, others to a monetary aggregate. Some float their currencies; others stabilize to varying degrees against one or another reference. Our work, reported in a discussion paper of the Bangko Sentral ng Pilipinas, sheds light on the implications of such differing approaches to policy for trade within the RCEP bloc.

Figure 1 shows that in the decade or so leading up to RCEP's establishment, exports of goods within the region were more or less stable for most member economies with notable exceptions in China and Vietnam whose bursts into global trade were echoed locally. Cambodia and Laos also saw rapid growth in exports within the region although from much lower bases. Within-region services exports, by contrast, showed broad expansion accross the board, at least until the pandemic hit. Despite more rapid growth, however, services continue to claim a small share of total exports. As of 2021, they amounted to 11.6 percent of all RCEP exports within the region, down from 14.9 percent in 2019.

Within-region exports figure much more importantly for some countries than others relative to their totals, as Figure 2 reveals. While China overwhelms in absolute terms, only a quarter of its exports go to the RCEP region with this proportion little changed through its era of explosive export expansion. Notable increases in regional export shares over the 2005-2021 period have accrued to Korea, up from 39.9 percent to 46.5 percent; New Zealand, from 48.7 percent to 59.1 percent; Thailand, from 46.2 percent to 51.3 percent; and Japan within an overall declining export trend, from 36.1 percent to 43.0 percent.

Our interest is in the role of monetary and exchange rate policies in fostering trade within the region. Previous work on this subject by Wong and Chong (2016) applied a gravity model to goods trade for a sample of 186 countries for the period 1974-2009. The study found that adoption of an inflation targeting regime had a positive effect on trade comparable in magnitude to the effect of exchange rate targeting. Since the period examined in that study, regional supply chains have taken on much greater importance and services trade has grown rapidly. In light of this, we extend the analysis to consider both goods and services trade within a region oriented toward supply chain development.

We distinguish between inflation targeting (IT) and non-IT regimes and between exchange rate (ER) floating and non-floating arrangements as classified de facto by the IMF (AREAER). "Floating" includes both floating and free-floating categories. The expectation is that inflation targeting will reduce uncertainty surrounding prices and thus increase exports to all trade partners. Regarding exchange rates, the expectation is that volatility will inhibit exports although a secular decline in the value of an exporter's currency relative to the value of of the importer's currency should increase exports.

The results of our gravity model estimations are presented in Table 1 with attention limited to exchange rate and monetary policy variables. In addition, standard gravity model variables were included as controls and yielded results consistent with norms. A parsimonious Model 1 focuses on IT adoption by exporters, which is found to be statistically significant for both goods and services. As for exchange rates, an increase in the REER ratio implies appreciation in the currency of the exporting country relative to that of the importing country so its effect is expected to be negative. This is indeed the case for goods, but a statistically positive sign is obtained for services. In Model 2 with inclusion of other variables, the positive sign remains but becomes statistically insignificant. Exchange rate volatility and a policy of floating by both trade partners, along with interaction between the two variables, all yield negative coefficient estimates, although statistical significance pertains only to services when both partners float.

Model 2 adds a slate of inflation policy and outcome variables. Differentiating inflation targeting between one and both trading partners yields positive and signficant coefficient estimates on both counts for both goods and services. Separately, higher inflation tends to reduce exports of goods while increasing imports of goods, as expected given the effects on price competitiveness, although no consequences register for services.

Inflation targeting emerges as a trade enhancing force, the more so when both parties are adopters but even when only one is. Consistent adopters within our sample include Australia, Indonesia, Korea, New Zealand, the Philippines, and Thailand, with Japan signing on in 2013. All of these countries also maintained floating exchange rates as of 2021, although exchange rate arrangements showed more variation over time than did monetary policy frameworks. Intervention to stabilize a currency against shocks is not inconsistent with inflation targeting and may indeed serve the goal of price stabilization. But countries that in a sustained way anchor their monetary policies on exchange rates or monetary aggregates or pursue objectives other than price stability would appear to be creating conditions that are less favorable to trade than those that commit foremost to stable prices.

RCEP as a free trade area has only just begun its journey. Time will tell how effective market opening measures can be in facilitating trade. But history provides some guidance as to the importance of monetary policy frameworks for countries to take advantage of any trading opportunities afforded.

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Co-author Jose Adlai M. Tancangco is a Research Associate II at the BSP Research Academy specializing in international macroeconomics and monetary Policy.