Key Information

Speeches by Speaker
Norman T.L. Chan
Peter Pang
Eddie Yue
Arthur Yuen
Zeti Akhtar Aziz
Raymond Li
Edmond Lau
Esmond Lee
Meena Datwani
Vincent W.S. Lee
James Lau
Joseph Yam
Y K Choi
William Ryback
David Carse
Tony Latter
Andrew Sheng
Hans Genberg
Simon Topping
Michael Taylor
The Honourable Donald Tsang
Chen Yuan
Dai Xianglong
Don Brash
Jaime Caruana
Andrew Crockett
Mario Draghi
David Eldon
Stanley Fischer
Timothy F. Geithner
Stephen Grenville
Kenneth G. Lay
William McDonough
Ernest Patrikis
Glenn Stevens
Jean-Claude Trichet
Tarisa Watanagase
Zeti Akhtar Aziz
Press Releases
Press Releases by Category
Bogus Voice Message Phone Calls
Banking in Hong Kong
Fraudulent Websites, E-mails and Telephone System, and other fraud cases
Granting of Banking Licences
Exchange Fund
Table of Multiples of Notes and Payments for Allotted Amount under non-competitive tender
Table of Multiples of Notes and Payments of Application Amount under non-competitive tender
Tender of Exchange Fund Bills and Notes
Tender Results of Exchange Fund Bills and Notes
Tentative Issuance Schedule for Exchange Fund Bills and Notes
Appointments and Departures
HKMA Pay Review
HKMA Publications
The Hong Kong Mortgage Corporation
Hong Kong Note Printing Limited
Hong Kong Institute for Monetary Research
Exchange Fund Investment Limited
Hong Kong Financial Infrastructure
International Relations
Investment Products Related to Lehman Brothers
Monetary Policy
Notes and Coins
Renminbi business
Credit Card Lending Survey
Monetary Statistics
Residential Mortgage Survey
Year 2000
Guidelines and Circulars


The Financial Stability Challenges of an Emerging Asia

by Joseph Yam, Chief Executive, Hong Kong Monetary Authority

(Speech at the DNB Financial Stability Event)

25 October 2004


I feel honoured to have been invited to address this gathering, organised in connection with the founding of the Financial Stability Division of De Nederlandsche Bank. I fear, however, that I may not have much to offer, in terms of enriching the knowledge and expertise of this fine institution in this increasingly popular area of central banking - financial stability. Indeed, there is perhaps more for emerging Asia to learn from Europe than the other way round, and our less than distinguished record in the maintenance of financial stability in the past seven years, compared with that of Europe, is clear testimony of this. But the opportunity of describing to a learned audience the financial stability challenges that we face in Asia and hearing your thoughts on how we should manage such challenges and reduce our vulnerability is definitely not something that I should miss. And so here I am.

The theme of my remarks today is what I would like to call the Asian dilemma. This dilemma arises out of the conflict between the search for financial stability, on the one hand, and, on the other, the need to pursue financial liberalisation necessary to enable economies and markets to grow and develop. I shall describe this dilemma to you in greater detail, examine what measures individual economies have adopted to tackle it and conclude with what I see as a long-term, though by no means easy, solution.


But let me deal first with the concept of financial stability. I am sure you have given a lot of thought to what it is, in connection with the founding of the Financial Stability Division. But I think I would not be misrepresenting my central banking colleagues in emerging Asia to say that we do not really have a consensus on what exactly financial stability means in terms of, for example, its objectives and the instruments for achieving it. Interestingly, at the Per Jacobsson Lecture delivered on the occasion of the AGM of the Bank for International Settlements in June this year, Charles Goodhart drew attention to the fact that "there is currently no good way to define, nor certainly to give a quantitative measurement of, financial stability"1. He disclosed further that, when a group of experts was asked to define financial stability in a survey that he had come across, "the most persuasive responses were that it was just the lack of financial instability".

Now if this is the view of experts on financial stability, how do we expect emerging markets, which almost by definition have a shortage of experts, to meet effectively the challenges in the maintenance of financial stability, whatever they are? But I am a little more optimistic than this, and my optimism is built upon the habit of going back to basics whenever I faced the risk, as Hong Kong's Monetary Authority, of getting lost in the complexity of modern-day finance. And there is a clear need for those of us responsible for financial stability in emerging Asia to develop such a habit, especially when international finance, made particularly potent by globalisation and the revolution of information technology, often looks us fiercely in the eye. Furthermore, and crucially, unlike Europe and other developed markets, there are many of us in emerging Asia who are still engaging in financial liberalisation and trying to embrace financial globalisation. They are still walking a path that has many diversions, where, if they are not careful, they could end up with the cart before the horse or the tail wagging the dog, with debilitating consequences. Going back to basics will hopefully enable them to stay on track in the task of financial sector development.

And the basics are really quite simple. The roles of the financial system in any jurisdiction are, on the one hand, financial intermediation - the channelling of savings into investments - and, on the other hand, facilitation of economic transactions. The efficient performance of these basic roles by the financial system promotes economic growth and development, and is in the best interests of the public. Consequently, the maintenance of financial stability can be taken to involve, principally, ensuring that the financial system is structurally stable and efficient in the continuing performance, without disruption, of these basic but important roles.

I am aware of the possibility of such an elementary orientation in the approach to financial stability being a far cry from the pre-occupations of the authorities responsible for financial stability in developed markets. Indeed, in emerging Asia I doubt if any one is yet seriously talking about modelling financial stability, at least not in the same enthusiastic manner as this is being pursued in developed markets, although the publication of financial stability reports, of varying analytical content, may soon become a fashion. But for emerging Asia, where the pre-occupation is more of managing the risky process of emergence, with a stronger emphasis on financial sector development, this different orientation or emphasis is appropriate. It helps individual jurisdictions to steer the right course in facing what I think is a real and difficult dilemma between financial liberalisation and financial instability.


Let me be more specific about that dilemma. One objective of embarking on financial liberalisation of an emerging market is to enhance the efficiency of domestic financial intermediation so as to promote economic growth and development. Basically we are talking about introducing greater competition in the domestic financial system through opening it up to foreign financial intermediaries with the relevant experience and expertise, so that they can help channel domestic savings into domestic investments more efficiently. Indeed, the presence of foreign banks, co-operating or competing with domestic banks in the provision of banking business, sharpens the competitive edge of the domestic banks, which would be translated eventually into higher returns for domestic savings and cheaper costs of funds for the borrowers. There would also be greater efficiency in the pricing of credit and other risks, and therefore in the allocation of credit generally. Equally convincing arguments apply to the participation of foreign financial intermediaries in the equities and debt channels. Foreign experience and expertise in the organisation of Initial Public Offerings, supported by liquidity and an efficient price discovery mechanism in the secondary market, enhance the quantity as well as the quality of the flow of domestic savings into domestic investments.

This argument is not debatable, other than perhaps with regard to the degree and the pace with which the opening of the financial system to foreign financial intermediaries should be pursued. There may be legitimate concerns, at least in the short term, over the chances of survival of domestic financial institutions when they are exposed to intense foreign competition, with consequences for general confidence in the financial system and financial stability. There may also be concerns about the willingness of foreign financial intermediaries, as against that of indigenous ones, to co-operate at times of financial stress, when inevitably the long-term public interests may need to prevail over the short-term private ones. However undesirable it may seem, political pressures, in whatever form, would invariably be brought to bear on; and when this happens, it is likely to be more difficult to obtain the necessary co-operation from foreign financial intermediaries. That is why they are in emerging Asia sometimes, unfairly but understandably, called fair-weather friends. Consequently, experience and expertise of financial intermediation, it may be argued, could, as an alternative, be acquired through other, less risky means, for example, by training abroad or the importation of experts rather than institutions. Furthermore, the pace of liberalisation could be cautiously timed.

But in practice the luxury of such flexibility is not often available to emerging markets. Reputable foreign financial institutions of international standing are a scarce commodity. They have to be lured principally by the potential for profit into establishing a presence. They are not something that keeps knocking at the door of just any emerging market. Only the largest emerging markets, the business potential of which international financial intermediaries simply cannot afford to ignore, have the privilege of their attention. An example that comes readily to mind is the Mainland of China, now already the seventh largest economy in the world and growing rapidly. There the emphasis on gradualism in financial liberalisation is obvious, although accession to the World Trade Organisation required a firm commitment to a specific programme for opening up the financial system, among other things. But for the emerging markets with less economic clout, attracting foreign financial intermediaries into establishing a presence requires bigger incentives than the mere opportunity for participation in domestic financial intermediation. These bigger incentives invariably take the form of cross-border and cross-currency financial intermediation, mobilising foreign savings into domestic investments and domestic savings into foreign investments, and for this sometimes to be topped up with tax concessions and exclusive franchises, formal or informal. And this - the proper functioning of the financial system with a liberalised capital account - is where most of the challenges in the maintenance of financial stability in emerging Asia lie.

It is not difficult to see the benefits of a liberalised capital account. Apart from the use of foreign expertise to enhance the efficiency of financial intermediation, there is the attraction of a possible net inflow of foreign savings into domestic investments, which would be particularly welcomed when there is a scarcity of domestic savings. Furthermore, the free mobility of capital on a global basis promises more efficient allocation of scarce funding globally, as capital is allowed to look for the highest risk-adjusted return, whether in the form of deposits, debt or equities. These arguments are convincing, at least from a theoretical point of view. In practice, however, financial globalisation is a lot more complicated than that, involving different risk profiles for financial systems of different characteristics.

Basically, the difficulty in assessing the risks of different financial instruments in different jurisdictions, and of the jurisdictions themselves, makes it difficult to calculate with confidence what the risk-adjusted rates of return are. This is notwithstanding the gallant (and now much improved) monitoring efforts of the international financial institutions, such as the International Monetary Fund, with some responsibility over financial stability, and the valuable work of the commercial rating agencies. As a consequence, some jurisdictions get more, others get less capital flow, in either direction, than justified, and financial markets overshoot. They can do so to such an extent as to lead to systemic problems, as, for example, the weaker, domestic financial institutions of emerging markets, hampered by their inability to identify and manage risks under the potent influence of globalisation, collapse. Alternatively, domestic macro-economic issues, considered to be benign one day, all of a sudden become malignant the next, triggered possibly by some unexpected external events, and then sharp, destabilising reversals of capital flow ensue, with debilitating consequences to the financial system and the economy.

All this, of course, sounds familiar, with the Asian financial crisis of 1997-98 still fresh in our minds. And so we all come to realise, and were told, that for financial liberalisation to produce the benefits desired it has to be accompanied by much greater discipline in pursuing prudent macro-economic policies, including flexible exchange rates, and improved robustness in the financial system, including the financial infrastructure. This advice was given also to those jurisdictions with liberalised financial systems, as the revolution of information technology and financial innovation have enhanced greatly the potency of international capital, particularly portfolio capital. Indeed, a leading central banker in a post mortem of the Asian crisis said that: "if you wish to play major league baseball, you'd better get used to the strong pitching". This is quite a telling description of the reality.

And the reality is often harsh, particularly for those with financial markets that are small relative to the amount of international portfolio capital that could be mobilised by foreign investors but big enough to whet their appetite for profit. They may have to tolerate concentrated market positions and lack of transparency, in the hope of retaining foreign interests, but at the expense of increasing their vulnerability to the reversal of flows. Furthermore, the versatility of foreign funds and their higher sensitivity (than domestic funds) to shifts in market sentiment and policy changes, are such that, arguably, the market discipline imposed on macro-economic policies of emerging markets may de facto be more stringent than that imposed on developed markets. Indeed, what is acknowledged by many as an unsustainable, large current account deficit has been sustained in the United States for some time now2, probably for a lot longer than if one of equivalent size relative to GDP were run by an emerging market.

This then is the dilemma, as I see it, confronting much of emerging Asia - a dilemma between financial liberalisation and financial instability. It is also a dilemma in which the size and the degree of openness specific to individual financial systems interact against the trend of financial globalisation to present risk profiles specific to each of those systems. Asian economies are still, in many ways, a rather heterogeneous group. But given the increasing economic integration of the region, as intra-regional trade and cross-border direct investments grow rapidly, the fates of each are bound together to a significant degree by inter-dependency and the possibility of contagion. And so there has been much soul searching; but regrettably I think, done more individually than collectively, and there is therefore a lack of consensus on whether there is a need for a regional, long-term solution to what I think is an unhappy situation. To be sure, there has been much progress, for example, on improving corporate governance and I do not wish to belittle the earnest efforts made at this important, micro level, through the promotion, and the interaction, of individual, regulatory and market disciplines. There is also much greater discipline in pursuing prudent macro-economic policies, to the extent of attracting criticisms of excessive conservatism, particularly in respect of the running of substantial current account surpluses and the accumulation of large foreign reserves, which do not contribute to addressing the global imbalance. I am sure these independent efforts of individual jurisdictions, reflecting their different pre-occupations, arising from different domestic circumstances, will, in the fullness of time, make the situation of emerging Asia a less unhappy one. But the question that should be asked is whether they are sufficient, particularly for reducing the vulnerability of emerging Asia to financial instability. My answer, for what it is worth, is that they are not. But before I offer what I think may be a long-term solution, let me describe to you four interesting phenomena of emerging Asia that are highly relevant to the maintenance of financial stability there.


The first of these I call the "band aid" phenomenon. As I have argued, learning from the experience of the crisis of 1997-98, among the many factors contributing to the vulnerability of emerging Asia to financial stability were, significantly, size and openness. There is, of course, no quick fix for addressing the size factor and grow the small and fragmented markets quickly to a size where they can comfortably absorb the volatility of international capital and not be tossed around by it. And so, perhaps quietly but somewhat regrettably, there has been greater caution towards financial openness. You are, of course, aware of the case where exchange controls were re-introduced as a defensive measure against the exchange rate and possibly the financial system being subject to extreme, and some would say, unwarranted stress. And this was done with considerable success, as financial stability was quickly re-established. What is even stronger evidence is the overall economic performance that has been sustained since. The move also did not disrupt the flow of foreign direct investments, not that there is a strong need for them, given the high domestic savings rate. Malaysia has, indeed, continued to be very much a success story, after the brutal shock caused by the Asian financial crisis.

You may not have noticed the more discreet, but quite common, drift of the other smaller economies of emerging Asia away from financial openness. This has taken the form of a variety of formal or informal measures supported, where necessary, by supervisory authority, to regulate the outflow and inflow of funds. There are two types of measures. The first type limits convertibility of the domestic currency, in either direction, as circumstances require. The second type limits the ability of banks, domestic or foreign, again as circumstances require, to expand their assets or liabilities denominated in the domestic currency, if necessary on a selective basis, possibly targeting a specific group of market participants or activities of a specific purpose. The measure that has become quite popular, right after the crisis of 1997-98 was one that caps the availability of the domestic currency to non-residents, without approval from the authorities, to a specific amount, which undermines the borrower's ability to short the currency, for whatever reasons. This is what I call the Singaporean formula, which has been proven there, over the years, to be a highly successful measure contributing to financial stability, although the Singaporean authorities have recently relaxed this restriction. More recently, as capital inflows returned to a number of economies in the region, we have seen measures introduced to limit the amount of non-resident deposits in the domestic currency or the amount of lending in the domestic currency by non-residents.

If you look at non-Japan Asia now, excluding the two significant economies down under, it is a matter of fact that limitations to financial openness of one type or another, perhaps not practised in the developed markets of Europe and North America, exist to varying degrees. The only market that has steadfastly adhered to financial freedom of the highest order is Hong Kong, where, by the Basic Law adopted by the National People's Congress of the People's Republic of China, the Government of the Hong Kong Special Administrative Region is required to "safeguard the free operation of financial business and financial markets" (Article 110) and to "safeguard the free flow of capital within, into and out of the Region" (Article 112). Furthermore, the Basic Law specifies that "no foreign exchange controls shall be applied" and that "the Hong Kong dollar shall be freely convertible" (both in Article 112).

We believe in financial freedom, including the free mobility of capital on a global basis, and the greater efficiency in the global allocation of scarce funding. It is ironic, of course, that we had to protect that freedom through the rather high profile, and at the time highly controversial, market intervention in 1998. This, of course, is not the occasion for getting into the details of that episode, which was a successful one in terms of the maintenance of financial stability and in terms of the market criterion of profitability. I would only say that there is a responsibility for the authorities to ensure that free markets are not manipulated and that interventions by the authorities are sometimes necessary when free markets threaten to fail the public interest. The intervention does not detract us from adhering to financial freedom. But we have now become the exception rather than the rule, as individual economies have been forced to resort to somewhat ad hoc impositions of various limitations to financial openness in the interest of financial stability. I have chosen to describe this phenomenon as a "band aid" approach to financial stability. I very much hope that this is merely a temporary phenomenon before a path could be found for emerging Asia to move again towards and adhere to financial freedom.

Let me turn to the second phenomenon, the China phenomenon. The Mainland of China is increasingly serving as the manufactory of much of Asia's exports, with other Asian economies supplying raw materials, semi-manufactured goods and machinery. Indeed, intra-regional trade in Asia now represents about half of total trade3. Although there is still much processing trade geared towards meeting import demand outside of the region4, this reliance of the region on final demand in the developed economies has been decreasing, and is likely to continue to decrease over time5. The Mainland of China, in view of its track record and prospects for rapid economic growth, has also been a magnet for foreign direct investment in the region. For a number of economies in the region, Mainland China now is one of the largest trading partners and destinations for outward direct investment. Outward portfolio investments, to the extent that these opportunities are available, for example, in the stock market of Hong Kong, are also in great demand. Clearly, the place of Mainland China in the world economy, in particular in the region, is now of such importance that what happens there has significant, and increasing, implications for others.

For this reason, there is I think a common view, at least among central bankers in the region, that one significant factor affecting financial stability in emerging Asia would be the financial stability of Mainland China. This is notwithstanding a much lower degree of financial integration in Asia when compared with trade integration, and therefore a lack of clarity as to how exactly financial contagion might be transmitted. Indeed, capital controls in Mainland China mean that there is a lack of portfolio investment flows between it and the rest of emerging Asia, at least in theory, and therefore financial contagion should be lower than would otherwise be the case. But the ingenuity of the investment banking community can I think be relied upon to establish linkages through which financial contagion can be readily transmitted. The economic integration of emerging Asia provides fertile grounds for imaginative financial instruments to get around controls and to provide, what we usually hear, a perfect hedge or, more modestly, a proxy hedge, for various exposures. So, even though the dynamics are not clear, it is generally expected that financial contagion within emerging Asia is quite high. Furthermore, the dynamics could be such that financial crises do not necessarily erupt and manifest themselves at source - quite often somebody sneezes and others get pneumonia.

The financial stability challenges in Mainland China, in which the rest of emerging Asia has a keen interest, are regrettably something that we know very little about and have little influence over. One hears rather worrying comments, mainly from observers from outside of the Mainland, about the fragility of the banking system there, citing the relatively high NPL and low (some would say negative) capital adequacy ratios. Given the preponderant role the banking system in Mainland China is playing in domestic financial intermediation, it would be very destabilising indeed, and not just financially so, if the domestic banks were left to compete in a free market. But, thankfully, the domestic banks there are not, at least for the time being, subject to the same market discipline as banks in a market economy are. Depositors' faith in the state support of the banks is also unwavering, since no individual depositor has ever lost any money in the People's Republic of China6, as far as I can recall. As a result, the risk of a banking crisis, again of the type that we are familiar with, occurring in the Mainland of China is probably very low by our standards.

The question, particularly important for those responsible for financial stability, is, of course, whether that risk will remain low as, ironically, market reform and banking reform in the Mainland of China, which we all enthusiastically support, continue apace. The question is relevant not just for the authorities in the Mainland of China but also for those in jurisdictions having a high degree of economic integration with it. The answer, very frankly, is no. Market discipline, particularly if we are talking about an emerging market in the context of globalisation, can be quite brutal. The task of managing the increasing risks to financial stability associated with financial liberalisation in the Mainland of China, given the sheer size of China and the implications for others, is a most challenging one. And it is not a task, I dare say, just for the Mainland of China. It is for others in emerging Asia as well. Whether it takes the inward looking form of trying to limit possible contagion to the domestic market, or the proactive form of contributing, through appropriate assistance and co-operation, to the effective performance of that task in the Mainland of China, or both, is a matter of choice for individual jurisdictions. The reality of the situation is that no one in emerging Asia can afford to ignore the China phenomenon in the maintenance of financial stability.

The third phenomenon is the exchange rate phenomenon. One outcome of the Asian financial crisis of 1997-98 is the adoption of more flexible exchange rates for a number of Asian currencies. Whether or not this has contributed to greater financial stability remains to be seen. Theoretically, it seems difficult to argue against having an additional degree of freedom in economic adjustment. In practice, there must be doubt about whether, in view of the possibility of severe over-shooting, this is a luxury that all economies can afford. There is also the question of whether the relationship between the current account balance and the exchange rate is always the same across different economies so that exchange rate adjustments are a panacea for correcting external imbalances. Regrettably these questions are simply not asked, or, if asked, they are drowned by political noises that appear to be made on the basis of narrow, political concern over bilateral, rather than multilateral, trade imbalances. I am confident that you are in a position to appreciate the alternative view, given that you have chosen to operate with a fixed exchange rate for a long time, to the extent of doing away with your own currency on the birth of the euro.

But flexible exchange rates, in practice, do not necessarily mean exchange rates being determined freely by the market, as proponents would have it. As it turned out, the flexible exchange rates of most of the currencies of emerging Asia are determined in a flexible manner by the authorities, through intervention, at levels that are considered in their best interests. And success in meeting these best interests, for the time being, seems to be manifested in the substantial accumulation of foreign reserves. I would not venture into the possible reasons or strategies used, other than to point to one possibility, and this is for better protection or defence in the event of recurrence of financial turmoil. This approach to financial stability, having regard to recent history, is understandable, but I fear it is an unsustainable one, as much as the current global imbalance, or rather the US external imbalance, is unsustainable. Indeed, they are arguably the two sides of the same problem.

I will not go into how this imbalance might in the end be corrected, or the likelihood of the process being a destabilising one. These are subjects that have been discussed at length in international financial forums. They are particularly relevant to the euro area, given the role of the euro as the other prominent reserve currency. But in case you have not considered them relevant, I would just like to point out two aspects that may have a bearing on the dynamics of the correction. First, with flexible exchange rates, and particularly when there is pressure for those exchange rates to appreciate, in managing foreign reserves individual managers of emerging Asia are likely to be more proactive in currency allocation than when exchange rates were fixed against the US dollar. Second, with domestic interest rates of some Asian currencies higher than that of the US dollar, the costs of sterilisation associated with the accumulation of foreign reserves likewise demand a more proactive approach in the management of foreign reserves. With emerging Asia and Japan holding the bulk of the foreign reserves of the world7, a significant change in their investment behaviour, whether or not arising from the adoption of more flexible exchange rates, could mean new or at least different dynamics in the global foreign exchange market. This will add further challenges to emerging Asia in the maintenance of financial stability.

Monetary authorities in emerging Asia are aware of these and the many other challenges they face. They are aware of their increasing inter-dependency arising from greater trade and economic integration, and consequently the need for co-operation, and this is the fourth, and last, phenomenon that I wish to talk about. There is a rather big network of bilateral and multilateral forums. They have gone back to basics and have come to a consensus on at least two issues of fundamental importance to the maintenance of financial stability in emerging Asia. The first issue simply is the general need to promote more efficient domestic financial intermediation and greater financial intermediation among emerging Asia, rather than relying too much on the recycling or transformation through the developed markets of domestic savings into inward foreign portfolio investments. Domestic savings are of course much more stable, less potent and less likely to take on a predatory character than hedge funds or institutionalised portfolio investment funds from the developed markets that are served by the versatile, international investment banks. The second issue is, more specifically, the need for diversification in the financial intermediation channels through the development of the debt market.

There are probably as many forums and initiatives on these fronts as there are Asian economies. But with the passage of time three clusters of co-operative initiatives have emerged - the Asian Bond Fund (ABF) Initiative of the EMEAP central banks8, the ASEAN+39 Asian Bond Market Initiative (ABMI) and the APEC Initiative on the Development of Securitisation and Credit Guarantee Markets. Under these initiatives, individual economies will make efforts to develop their domestic bond markets and their market infrastructures. These efforts should lead to harmonisation and standardisation of legal, regulatory and tax regimes for regional bond markets, paving the way for a more integrated Asian bond market. Studies are also being carried out to explore the feasibility and desirability of establishing region-wide infrastructure, such as a regional rating agency and regional settlement and payment systems.

I do not wish to belittle these co-operative efforts or underestimate the difficulties of mobilising financial co-operation in such a diverse region, in terms of stages of economic development, culture, geography, economic openness, size distribution and political structure. Much has been achieved so far and this co-operative phenomenon will deepen and become more focused. But financial markets never fail to spring surprises, and when they do, the surprises are almost invariably unpleasant ones. In the maintenance of financial stability there is a need to be ahead of the game rather than behind, but regrettably the track record of emerging Asia has not been that good. My personal view is that this co-operative phenomenon of emerging Asia, having regard to the complex circumstances, is inadequate.


Perhaps this is the convenient point for me, as promised earlier in this speech, to turn, briefly, to what I think might be a long-term solution. This is something that you are quite familiar with here in Europe - monetary union. I have argued that the smallness of the markets of emerging Asia, relative to international capital, has, under the influence of financial globalisation, made them vulnerable to financial instability, to the extent that they had to resort, among other things, to the band aid approach of restricting financial openness. If one agrees with that argument, then one alternative, long-term strategy is obviously to build a bigger integrated market that is capable of absorbing the volatility of international capital and reducing dependence on it through enhancing financial intermediation within that common market. In other words, in the interests of greater financial stability, emerging Asia should consider monetary union.

Let me hasten to add, however, that as yet there has been no formal and serious discussion among Asian authorities that I am aware of on monetary integration or monetary union. To be sure, there have been some monetary co-operation efforts. The first was the collection of EMEAP bilateral swap facilities that provide US dollar liquidity secured against US Treasury securities that were put together in November 1995. The second was the idea of Japan for an Asian Monetary Fund in 1997, which came to nothing because of opposition by some leading economies. The third was the collection of ASEAN+3 bilateral swap arrangements (between the US dollar and domestic currencies) under the Chiang Mai Initiative. But I think it is fair to say that the case for monetary union in Asia is not yet clear. To some, I suppose there is doubt as to whether the benefits of greater financial stability and greater efficiency in financial intermediation justify the cost, in terms of autonomy over macro-economic policies, in particular monetary policy. The financial crisis of 1997-98 notwithstanding, some may feel that Asia has been doing reasonably well. The potency of international finance under globalisation, they might say, can be further harnessed, through macro-economic discipline and the building of robust institutions, and tamed through greater surveillance and judiciously applied restrictions on financial openness.

Indeed, the diversity of economies in the region, in many respects, makes monetary union of the European type a non-starter. But is there a need for convergence before monetary union, or is it possible for some form of monetary union, or integration, or co-operation to force the convergence? In contrast to the European case, there is no intra-regional currency anchor that precedes monetary union. Where there is an anchor, it is invariably the US dollar, the currency of a trading partner outside the region. To be sure, it is still a very large trading partner, but its relative importance has been reducing. Is there a case for creating an anchor within the region? Is it possible to use hard pegs of domestic currencies to a synthetic, floating Asian Currency Unit as the anchor and the interim step to monetary union? Is there a need for another financial crisis to jolt us into focusing our mind more on this subject? Will one of the many currencies in the region emerge eventually as a de facto anchor? These are questions that I think need to be answered, and any advice from those with the relevant experience in monetary union would be valuable.


And so I conclude this long speech by this series of questions. I understand that the Werner Plan for monetary integration in Europe was put forth back in 1970, but that EMU was not achieved until 29 years later. My view is that, for something that takes so long, we'd better start early. For something that takes so long, we can also afford to be imaginative. Thank you.


1 See "Some New Directions for Financial Stability?", a lecture by Charles Goodhart on 27 June 2004, available at

2 The US current account deficit has exceeded 4% of GDP since 2002, and rose to over 5% of GDP in the latest two quarters.

3 In Asia, regional trade accounted for 49% of total exports in 2003.

4 According to an internal study by the HKMA, about 56% of intra-regional trade is processing trade geared towards meeting the demand of developed countries while 44% is for meeting domestic regional demand.

5 The reliance on developed markets will likely decrease over time because intra-regional trade will increasingly be driven by demand growth in the region and the dismantling of trade barriers under free trade areas within the region.

6 Under the Regulation on Revocation of Financial Institutions in China, there is a provision which protects the lawful property of a natural person which effectively obliges the authorities concerned to pay off the financial loss of an individual in the events of failure of a financial institution.

7 Over US$2 trillion as at May 2004.

8 EMEAP, the Executives' Meeting of East Asia and Pacific Central Banks Group, comprises 11 central banks and monetary authorities in the East Asia and Pacific region. They are the Reserve Bank of Australia, People's Bank of China, Hong Kong Monetary Authority, Bank Indonesia, Bank of Japan, Bank of Korea, Bank Negara Malaysia, Reserve Bank of New Zealand, Bangko Sentral ng Pilipinas, Monetary Authority of Singapore and Bank of Thailand.

9 ASEAN comprises ten countries, namely Brunei, Cambodia, Indonesia, Laos, Malaysia, Mynamar, the Philippines, Singapore, Thailand and Vietnam. "ASEAN+3" includes also China, Japan and Korea.

Last revision date: 1 August 2011
Tender Invitations
Legislative Council Issues
The HKMA Information Centre
Monetary Stability
Banking Stability
International Financial Centre
Exchange Fund
Annual Report
Half-Yearly Monetary & Financial Stability Report
Quarterly Bulletin
HKMA Background Briefs
Reference Materials
CMU Bond Price Bulletin
Economic & Financial Data for Hong Kong
Monthly Statistical Bulletin
Monetary Statistics
Press Releases
Guidelines & Circulars
Forthcoming Events
Information in Other Languages (Bahasa Indonesia, हिन्दी, नेपाली, ਪੰਜਾਬੀ, Tagalog, ไทย, اردو)
Account Opening
Consumer Corner
Consumer Education Programme
Complaints about Banks
Complaints about SVF Licensees
Internet Banking
Fraudulent Bank Websites, Phishing E-mails and Similar Scams
Be Careful of Bogus Phone Calls and SMS Messages
Authenticate the Callers and Bank Hotline Numbers
Register of AIs & LROs
Register of Securities Staff of AIs
Register of SVF Licensees
Investment Products Related to Lehman Brothers
Photo Gallery