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359.3404

Speeches

Mobilising Asia's Savings

by Joseph Yam, Chief Executive, Hong Kong Monetary Authority

(Speech at the World Economic Development Congress, Washington DC, reprinted in the HKMA Quarterly Bulletin Issue No. 9)

26 September 1996

INTRODUCTION

It is a great pleasure for me to speak in front of such a distinguished audience. The discussion topic for this session is about savings and investments. Coming from Asia, let me present an Asian view on these issues. Let me give you a few facts on Asian savings and investments to begin with.

ASIAN SAVINGS

  1. I am sure many of you are aware of the fact that Asia has been for some time the fastest growing region in the world. Since 1960, the region has grown at one and a half times the global average and the World Bank projects that Asia will grow at an average annual rate of 8% in the coming decade. The impetus to this rapid growth is the expansion of external trade, in particular intra-regional trade. Whilst trade between Asia and the rest of the world rose by 210% in the past decade, intra-regional trade in Asia grew by 430%.
  2. Such prosperity has led to exceptionally high savings rates for economies in the region of well above 30% of their GDP and over 40% in the case of China (table 1). In terms of official savings, defined as foreign currency reserves, the figures are even more startling. About 40% of the world's foreign exchange reserves belong to the economies in the Asian region (table 2). Five out of the seven largest foreign exchange reserves holders in the world are in the Asian region, with Japan holding over US$200 billion at the top of the league table and China holding around US$90 billion in second place. Then come Germany, Taiwan, the United States, Singapore and Hong Kong.
  3. So, when one talks about savings in the Asian region, the focus is not so much on how they could be increased, as the title of this discussion session implies, but on how they should be effectively mobilised. But before going into that, let us look briefly at the corresponding facts about Asian investments.

ASIAN INVESTMENTS

  1. Asian investment rates are also high at around 30% of GDP (table 3). At its present stage of economic development, Asia has an immense need for infrastructural investments, both in terms of the quantity as well as quality of physical and human capital. The World Bank has estimated that the infrastructure needs of East Asia alone amount to $5 trillion in the decade to 2004. The business sector and households are also undertaking massive investment.

ASIAN FINANCIAL INTERMEDIATION

  1. The bulk of this huge investment demand in Asia will obviously have to be funded through domestic savings which do not seem to be lacking in absolute terms. The focus, as I mentioned earlier, is how savings could be mobilised. We should therefore look at the effectiveness of financial intermediation in the region. Here I am afraid to say there is much to be desired.
  2. Take a look at savings in the official sector. I am quite sure that the bulk of foreign reserves are invested in assets of OECD countries. I cannot speak for other economies, but insofar as Hong Kong is concerned, in excess of 95% of our over US$60 billion of foreign reserves are invested outside Asia. Specifically, in the management of our foreign reserves, we work against a preferred neutral position of about 75% in US dollar assets, mostly in US Treasury securities.
  3. The corresponding picture for savings in the private sector varies between economies in the region. For those who are relatively more sophisticated in financial management and to the extent that they operate with liberalised financial systems, there is significant diversification of savings into foreign assets. This is particularly the case for economies where savings have been and are being institutionalised through pension and provident funds that are professionally managed. And there are those economies where there are captive domestic markets for domestic savings as financial liberalisation is still at a relatively early stage.
  4. The overall picture therefore seems to be that a significant part of Asian savings have gone to OECD markets. At the same time, nevertheless, there has been much foreign direct investment and foreign portfolio investment from OECD countries in Asia. A commentator rather cynically said in this context that Asia is financing much of the budget deficits of developed economies, particularly the United States, but at the same time has to try hard to attract money back into the region through foreign investments. And foreign portfolio investments can be volatile in nature, with the tendency of being abruptly withdrawn when there is a slight hint of trouble, thereby causing major disruptions to the monetary and financial systems of some of the Asian economies. It is as if the Asian economies are providing the funding to hedge funds in non-Asian centres to play havoc with their currencies and financial markets.
  5. This commentator is perhaps a little unkind, given the important role that is being played by the international financial community in the globalized financial environment. He should probably ask why there is such a phenomenon in Asia in the first place. And as the channelling of savings into investments is one important role of domestic financial systems, perhaps central bankers who have responsibility over their own financial systems should also ask themselves this question. Is financial intermediation adequately effective in Asia? From the small savers to the large institutional investors, their decisions would all take into account the risks involved in choosing where to invest their savings. If the risk profile is unacceptable, having regard to the return that may be available, the money will simply go elsewhere. Have central bankers in Asia provided an environment in which investors feel adequately comfortable, about such things as currency risk, interest rate risk, liquidity risk, payment risk, settlement risk, legal risk, etc.? This is where I think the focus in Asia should be when talking about savings and investments.

THE THREE S'S AND THE THREE I'S

  1. Having raised these questions, I think I should also attempt to provide answers. There is definitely a need to improve upon the effectiveness of financial intermediation in the Asian region so as to facilitate the mobilisation of savings into investments. As to how this could be done, let me use a simple acronym. Since we are talking about savings and investments, or S and I, let me present you with three S's of preconditions for effective financial intermediation and three I's of priority areas for greater efforts for all concerned. The three S's of preconditions for effective financial intermediation are:
    • for stability in the monetary system;
    • for supervisory prudence; and
    • for soundness of the public finances.
  2. I am sure these so called preconditions are familiar to you. I would therefore only speak briefly on each of them.

Stability of the monetary system

  1. Stability of the monetary system, in particular currency stability, is of crucial importance to investors. An annual increase of 100% in the stock market will not be adequate to compensate for a daily depreciation of 1% in the currency, in terms of either its internal or external value. A clear and credible monetary policy with transparent monetary policy operations conducted independently is the cornerstone to monetary stability. This is true for all economies regardless of their monetary objectives and exchange rate regimes. There is common understanding amongst central bankers on this. There is also much attention paid on this amongst the central banking fraternity in Asia, given the huge and often volatile flows of funds into and out of the region. You will have heard about the central banking co-operation that is being promoted in the region. Although many of them are backed by large foreign reserves, they have come together and agreed to provide each other with liquidity to deal with exchange rate volatility through bilateral repurchase agreements of US Treasury securities.

Supervisory prudence

  1. Supervisory prudence in the various avenues of financial intermediation of banking, debt and equity is also important for the smooth and safe flow of savings through these avenues into investments. It would also raise the "disturbance tolerance level" of the financial system and therefore enhance investors' confidence. Supervisory authorities in Asia are working together to upgrade prudential standards to levels consistent with those of the developed markets. There are also efforts to harmonise standards amongst the rather heterogeneous group of domestic financial markets in the region. We aim to achieve a level of integrity in our markets comparable to that of the leading world financial centres. In banking, for example, most Asian central banks now apply the Basle supervisory guidelines. In Hong Kong, the capital adequacy ratios of banks average 17% which is twice the BIS minimum. There is also close central bank co-operation in the region on supervisory issues. Regional central bank forums such as the SEANZA1 Group, the SEACEN2 Group and the EMEAP3 Group of central banks regularly meet to enhance regional and international efforts at raising the standards of supervision. The recent admission of a number of Asian central banks and monetary authorities, including the Hong Kong Monetary Authority, to the BIS would also be extremely helpful for Asia to take a more active role in formulating policies and guidelines in these areas.

Soundness of the public finances

  1. Soundness of the public finances is a precondition to almost anything that is economically and socially desirable, including of course effective financial intermediation. The anchor of monetary and financial stability, and therefore confidence in financial markets, when developing and liberalising them as part and parcel of the development process in many Asian economies, lies in the adherence to sound public finances. This means balanced budgets, small government and a non-interventionist attitude to private sector initiatives. This is an essential ingredient not only for enhancing confidence of domestic savers but also for attracting foreign direct investments as well as portfolio investments.
  2. It is not difficult to have consensus about the importance of these three S's of preconditions for effective financial intermediation. I shall not dwell on the subject any longer other than to advertise that Hong Kong possesses all of them and the Hong Kong Monetary Authority will endeavour to ensure that they will be maintained into the future. The reversion of sovereignty over Hong Kong back to China will not affect this as there are adequate safeguards in place for Hong Kong's monetary and financial autonomy under the concept of "one country, two systems". After 1 July 1997, there will be one country, two currencies, two monetary systems and two monetary authorities that are mutually independent.
  3. So much for the advertisement. Just as we would like to turn our savings into investments, let me turn from the three S's to the three I's of priority areas for greater efforts to make financial intermediation in the Asian region more effective. They are:
    • I for instruments;
    • I for institutions; and
    • I for infrastructure.

Instruments

  1. First, instruments. Banking and equity markets of Asia have developed relatively well. Particularly in East Asia, they are comparable in size and depth with those in OECD countries, measured for example against the GDP. Hong Kong, playing the role as a major financial centre in the region, has a banking system and an equity market which are respectively seven times and twice the GDP, much higher than the corresponding figures in OECD countries. But financial intermediation through the bond market is found lacking in Asia. Its size relative to the GDP is on average only about one-fifth that in Europe or America. Even in Hong Kong, the bond market was only 9% of GDP in 1994, although it has since increased to 17% (table 4).
  2. One reason for this, at least in the case of Hong Kong, is that there is no need for the government to borrow because we seldom run budget deficits. As a result, there had been no reliable benchmark yield curve for reference by private sector borrowers, and so they relied on traditional bank finance and equity finance, to a disproportionate degree. In view of the vast investment funding needs in the region, there is a clear need for much greater funding through debt instruments. The World Bank projects that in the next decade, total private investments in East Asia financed by bonds will double to over US$1 trillion.
  3. For the investors, they have clearly been deprived of debt instruments as an outlet for their savings. They either have to deposit their money with banks for fairly low interest and low risk, or to invest it in the equity market and incur significantly higher risks. There is a serious lack of suitable instruments in between to make up the whole risk and return spectrum that investors need. Yet with the increasing affluence of the Asian economies, many with ageing populations, and the continued rapid accumulation of savings in both the private and the official sectors, debt instruments with a conservative risk profile will continue to be in great demand. If this is not adequately satisfied in the domestic markets, there will continue to be large leakages of the much needed funds for productive investments in the region.
  4. Central banks in the region are addressing this shortage of debt and related instruments. To rectify this requires efforts on the official side to develop debt markets, even if there is no need to borrow to finance budget deficits. There may be a need in any case for instruments to facilitate the proper conduct of monetary policy, as greater cross border flows of funds interact with continued financial liberalisation. This is the approach we took in Hong Kong, belatedly only a few years back. We now have a debt market which is fairly liquid with a whole spectrum of instruments of varying maturities. And we also managed to make a small turn on the money that we borrowed.

Institutions

  1. The second "I" stands for institutions. The effectiveness of financial intermediation in Asia can be enhanced on the one hand by institutionalising savings and on the other hand by creating institutions to securitize illiquid assets on the books of financial intermediaries. This may have to involve efforts from governments, working closely with the financial community. These institutions are quite a common feature in developed economies, but regrettably not in the Asian region, at least not to a comparable degree.
  2. In a number of other economies in the region, there have been moves towards the formation of provident funds and pension funds. Some are centralised and some are not, but they are usually of a mandatory nature, with prudential guidelines laid down by regulatory authorities. We in Hong Kong are hoping to implement a mandatory provident fund scheme by next year which will be privately managed, in line with our free market philosophy of leaving matters as much as possible to the private sector. We are also establishing a secondary mortgage corporation, similar to and with the advice of the US Fannie Mae. This is an important institution which will facilitate securitization, improve financial intermediation and also improve risk management for the banking system.
  3. Another type of institution that may facilitate effective financial intermediation is rating agencies. I do not think the region is adequately served in this area. The region is rather fragmented geographically and many of the economies do not really have the critical mass of large business enterprises to justify a domestic rating agency capable of establishing the necessary professional reputation for objective analyses and in depth understanding of the political, economic and social development of the region. There may be a case for pulling resources of the region together to create an economically viable rating agency for the region. But this is a matter that should be left very much to the private sector. Involvement of the public sector would undermine the credibility of such an institution.

Infrastructure

  1. Let me turn to the third "I" which stands for infrastructure - the financial infrastructure. As we all know, the Eurobond market took off when the Euroclear settlement and clearing system was put in place in the 1960s. Markets function well when they have, amongst other things, a robust and efficient clearing and settlement infrastructure. Investors, particularly the institutional investors, favour markets in which the risks associated with payment and settlement are minimised. Asian economies have been exerting great effort in improving their financial infrastructure. Japan, South Korea and Thailand have already implemented Real Time Gross Settlement (RTGS) interbank payment systems. By the end of this year, Hong Kong will also have one of the most modern, streamlined RTGS interbank payment systems in Asia. It will be fully integrated with our paperless debt securities clearing system, allowing for delivery versus payment for securities transactions.
  2. These efforts at developing domestic payments and securities clearing and settlement infrastructure will no doubt enhance the effectiveness of domestic financial intermediation. However, to facilitate cross border and cross currency financial intermediation, these payment and settlement systems should usefully be linked up as a network. Payment versus payment for foreign exchange transactions could then be achieved and Herstatt risk eliminated. The networking of financial markets in Asia is now being actively pursued by central banks in the region.
  3. For example, I have suggested recently at the ADB Annual Meeting that we should look closely at the development of AsiaClear, a network of Asian domestic securities clearing depositories. Such a network would allow the settlement of Asian and international bonds in the Asian time zone. It is not intended to compete with other clearing and settlement networks in Europe or America. It aims to offer easy access to bond markets scattered around different parts of Asia. An AsiaClear network would greatly reduce the transaction costs and the risks involved in investment in Asian bonds.

CONCLUSION

  1. In conclusion, I would just like to say that Asian central banks are committed to making financial intermediation in the Asian region more effective. They are working closely with each other and building a powerful network. Hong Kong, as an international financial centre in Asia, is ready to play a major role in this. The future for financial business in Asia is bright, and we welcome the participation of the international financial community in building what promises to be an exciting and growing market. I shall see you all in the next Bank/Fund annual meetings in Hong Kong. By that time, I am sure there will be more to report about the progress in mobilising Asia's savings. Thank you.
Notes:
1. SEANZA stands for South East Asia New Zealand and Australia Central Banks, comprising 18 members.
2. SEACEN stands for South East Asian Central Banks, comprising ten members.
3. EMEAP stands for Executive Meetings of East Asian and Pacific Central Banks, comprising 11 members.
Last revision date: 1 August 2011
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