Current levels of financial integration among the Asian economies do not reflect their increasing trade and economic relationships and give some cause for concern.
I recently took part, together with representatives of other Asian central banks, in a seminar on Asian Financial Integration, organised in Singapore by the International Monetary Fund and the Monetary Authority of Singapore. Over the next two weeks, I would like to share with you some thoughts on an issue which should be of concern to us all. First, I will look at some interesting phenomena that I observe when looking at the regional economies. Next week I will suggest some elements which a strategy for greater Asian financial integration might include.
In any discussion of Asian financial integration, the first step should be to understand what financial integration is, and what its benefits are. Put simply, I take the view that international financial integration, whether regional or global, is a situation in which savings can be readily mobilised and channelled into investments across jurisdictions rather than just domestically. The principal benefit is, of course, greater efficiency in the use of capital on an international level. Savings achieve a higher rate of return and those in need of funds incur lower costs, resulting in the happy outcome of faster economic development and higher economic growth for all concerned.
I would like to focus on financial integration within Asia, as opposed to international financial integration generally. The Asian economies are probably less integrated with each other than with the major economies in the rest of the world. All of them have probably lent more individually to, for example, the United States than they have collectively to other Asian economies. But more than half of total trade in Asia is intra-regional. Increasingly, we in the region are becoming more economically dependent on each other than on the western world. Yet our financial relationship is disproportionate to our economic and, in particular, our trade relationship. There is therefore a need to ask ourselves whether we are happy with this situation. I for one am not and I am specifically not happy with five phenomena that I have observed.
First, we in Asia save a lot of money - too much, some say - and this is a reflection of our conservative culture, because we do have typhoons and heavy rains, earthquakes and tsunamis, and we like to be able to help ourselves as much as possible in case of need. Most of us are also small, in terms of our economies and our political influence, and the reality of this world is that, when you are small, you are more likely to be tossed around. So we need to be more cautious in our finances. But, for a variety of reasons, we now find ourselves holding a substantial part of our savings in the financial liabilities of an economy that does not save. I find this phenomenon rather strange, perhaps inherently unstable.
Granted, the economy of the issuer of the financial liabilities is sophisticated and vibrant, and the rating agencies tell us the credit risk is as good as you can get. But is this the only choice we have? This is a particularly relevant question when – and this is the second phenomenon that I am concerned about – a significant part of our savings is recycled back into the region in a much more volatile form with a tendency to assume a predatory character, possibly creating financial havoc and monetary and financial instability in the region. Yes, we have ourselves to blame, as many of us were told when the financial downturn began here in 1997 and 1998, for not pursuing macroeconomic policies that are adequately prudent for our circumstances.
We accept that, although we also note, not without considerable frustration, the third phenomenon to which I would like to draw your attention, which is that monetary and financial vulnerability is not just a function of the quality of macroeconomic policies, but also of the size and openness of the financial markets concerned. As some of you may know, I have been advocating greater efforts in the region to address the size issue, through monetary co-operation, so that our financial markets can attain the critical mass needed to absorb the volatility of international capital as effectively as the US and European markets. This I believe is the long-term solution for Asia and would also help to address the global imbalance.
The size issue cannot, of course, be resolved overnight. Even if there is the political will to move towards monetary integration, it will take years. Meanwhile, and this is the fourth phenomenon I observe, I sense heightened conservatism towards financial openness, particularly as a consequence of the financial downturn of 1997 and 1998. I find this somewhat regrettable for the simple reason that it slows down the desirable process of financial and, eventually, monetary integration in Asia. But it is also understandable, for the authorities do have a duty to safeguard monetary and financial stability and prevent a recurrence of the type of debilitating financial problems experienced at the end of the last decade. And so capital mobility remains tightly restricted and the availability of credit in domestic currencies to non-residents has become a popular control lever.
The fifth phenomenon I observe is that, since the Asian financial downturn, there has been a rather rapid accumulation of foreign reserves in Asia. Stockpiling ammunition gives considerable comfort to the authorities, particularly those engaging in financial reform and liberalisation, which is a risky process. But this build-up also serves to reinforce, rather than to resolve, the global imbalance. It postpones the inevitable adjustment, whatever form it may take, and may make it a more destabilising one. I cannot imagine any of those in the region having the responsibility either for managing foreign reserves or for sterilising foreign exchange intervention being happy with the ever increasing volumes that have to be dealt with. Indeed, having too much of anything can be problematic. Holding foreign assets that earn a return lower than the cost of sterilisation is, I am sure, an unhappy feeling, particularly with the now famous conundrum of long-term bond yields hanging out there waiting for a trigger to work itself out. The same applies to the possibility of diversifying, say, 10% of what you have and seeing the value of the other 90% fall sharply as a result.
These five phenomena, I think, argue for us taking Asian financial integration much more seriously as a desirable objective than we have in the past. I have no intention of belittling the efforts made so far in the many regional forums in this direction. Indeed, the Asian Bond Fund initiative, which the Hong Kong Monetary Authority has the honour of leading as Chairman of the very productive EMEAP* Working Group on Financial Markets, is a very good example of the on-going co-operative effort. But perhaps the Asian economies should be thinking about an overall strategy for Asian financial integration, if monetary integration is too ambitious a goal for the time being, and seeking support for it among their political establishments and peoples.
15 September 2005
* EMEAP is a forum of central banks and monetary authorities in the East Asia and Pacific region established in 1991. EMEAP's primary objective is to strengthen co-operation among its members. The 11 members include 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.
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