Good morning, Ladies and Gentlemen.
1. Let me thank Mr Kawai for inviting me to this event. It's my
honour to welcome you to this joint seminar by the Asian
Development Bank Institute (ADBI) and the Bank for International
Settlements (BIS) to mark the launch of the new book, "Managing
Capital Flows: the Search for a Framework". This is a topical
issue right at the centre of attention of policymakers in this
region. And as the title suggests, it is also a subject that we are
still in search for an answer.
2. There is an old Chinese proverb saying that "water can keep a
boat afloat but it can also capsize the vessel". This suitably
characterises the nature of international capital flows - it brings
both benefits and risks to the development process in Asia. Capital
inflows have been playing a key role in the economic development of
the region - funding investments and bringing along technology and
skill transfers. These were conducive to the emergence of the "four
Asian Tigers" in the 1980s, and the rapid modernisation process of
China, India and other Asian economies. On the other hand, the
pro-cyclicality and highly volatile nature of capital flows poses
significant macroeconomic management challenges to policymakers. If
not properly managed, the build-up of excesses amid strong capital
inflows and the subsequent bursting of the bubbles could be
detrimental to financial stability, wreaking havoc on economic
growth.
3. Managing capital flows has been a dynamic learning process
for policymakers in developing economies. Prior to the Asian
financial crisis, Asian economies embraced capital flows with
little wariness of the downside risks. The dominant flow pattern at
that time was for Asian governments to invest their savings in
high-grade government papers of the advanced economies. The funds
were then recycled back to Asia in the form of highly volatile
short-term capital flows. These resulted in serious imbalances in
the balance of payments accounts, and mismatches in currency and
maturity in the balance sheets of banks. The subsequent shifts in
market sentiment and expectations led to abrupt reversals of
capital flows out of Asia. Currency crashes amplified the adverse
effects as capital fled the region in a drove. The Asian Miracle
went bust. The capital flows that had once fertilised the
impressive growth eventually caused a capsize when the Asian
financial crisis hit us in 1997 - a lesson that we all still
vividly remember.
4. The Asian financial crisis gave us a much-needed wakeup call
at a dear price. Yet, looking back, the crisis also has its silver
linings: the painful adjustments that followed prompted governments
to strengthen economic fundamentals, enhance banking systems,
deepen local bond markets, and build up foreign reserves to cope
with potential external shocks. Because of these developments, the
region has been able to emerge from the recent global financial
crisis relatively unscathed and is now one of the key driving
forces supporting the global economic recovery.
5. But we cannot afford to be complacent, as we are now
confronted with a new round of challenges in uncharted waters. The
unprecedented monetary easing in the advanced economies has led to
global excess liquidity. And with the robust recovery of the
emerging markets, there are powerful push and pull factors driving
investors to search for yields in developing economies including
Asia. From Q3 2009 to Q4 2010, the net capital inflows to emerging
Asia1 amounted to US$541 bn, the
largest inflows in recent years.
6. The strong capital inflows and resultant abundant liquidity
have led to exchange rate appreciation, fuelled credit growth and
driven up asset prices in the region. With output gaps closing,
inflationary pressures are accelerating in a number of Asian
economies. Capital flows also complicate the macroeconomic policy
responses. While exchange rate appreciation and monetary tightening
could theoretically cool down the economy, in practice, they may
attract even more speculative inflows to profit from interest rate
arbitrage and currency appreciation.
7. So how should we cope with these challenges presented by the
unprecedented scale of global excess liquidity? Given the global
nature of fund flows and the increasing interconnectedness of the
global financial system, it is obvious that national policies alone
are insufficient to tackle the challenges. We need greater
international and regional cooperation to manage risks posed by
volatile capital flows to global financial stability. I believe
there are three main areas for cooperation.
8. First is enhancing the resilience of the global and regional
financial systems through financial regulatory reforms. A large
amount of work in this area is under way at the G20, the Financial
Stability Board (FSB) and various standard setting bodies -
including but not limited to strengthening banks' capital and
liquidity requirements, reducing moral hazard posed by systemically
important financial institutions, and reforming the OTC derivatives
markets. Recently, the FSB decided to set up regional consultative
groups, including one for Asia, to bring together central banks,
finance ministries and regulators in different regions. These
groups are expected to serve as a platform for us to discuss and
cooperate on issues of interest to regional financial stability,
and to reflect the region's collective views to the FSB in the
international standard setting process.
9. The second area is enhancing the global and regional
financial safety nets. We welcome the recent significant
augmentation of IMF's resources and lending facilities. These
enhancements will allow the IMF to respond more effectively and
speedily to member countries in need. Regionally, the establishment
of the Chiang Mai Initiative Multilateralisation (CMIM) further
enhances the regional capacity to cope with capital flows and
safeguard financial stability of the region. The HKMA fully
supports this important regional initiative, and indeed we have
played an active role in its development and participated directly
in the arrangement.
10. The third area is enhancing the capacity of regional capital
markets to absorb capital inflows and channel them to productive
uses. In this regard, the HKMA took the lead in developing the
Asian Bond Funds (ABF) under the aegis of the Executives' Meeting
of East Asia Pacific Central Banks (EMEAP). The ABF, as a pioneer
product, aimed to provide a convenient low-cost local-currency
instrument for investment, and at the same time help identify and
remove the impediments to bond market development. In parallel,
with the strong support from the ADB, ASEAN+3 members have
undertaken a range of projects under the Asian Bond Markets
Initiative to promote the development of the local currency bond
markets. Notwithstanding these regional efforts, we still have a
long way to go in developing a regional bond market that is broad
and deep enough to channel the region's abundant savings to meet
its huge investment needs. Continued national and regional efforts
in this regard are much needed.
11. At the domestic level, there has been growing recognition
that there is no one-size-fits-all approach to capital flows
management. While conventional macroeconomic policies are useful in
containing overheating in the overall economy, their deployment is
often constrained by their broad-brush nature and the concern about
attracting even more speculative inflows. Therefore, many
developing economies have also adopted other prudential and capital
account measures to manage capital inflows and to contain the
build-up of excesses in specific sectors of the economy and the
banking system. For example, some regional economies have recently
tightened the mortgage underwriting standards of their banks, and
limited banks' foreign currency borrowing and derivatives
positions.
12. To effectively manage capital flows, policymakers would need
to improvise with the apparatuses in their policy toolkit and apply
a policy mix tailored to their domestic circumstances. It is like
the use of "Chinese herbal medicine" - we feel the pulse, carefully
calibrate a combination of remedial herbs (i.e. policies), and
follow through with continuous fine-tuning in the light of market
reactions. The process is pragmatic and, to a large extent,
interactive.
13. Given the need for customised solution at the national
level, the sharing of experience is therefore very important. We
welcome the timely publication of this book, which provides a good
basis for studying the different approaches to managing capital
inflows by different economies. Individual countries' experiences
would, collectively, help shed light on the formulation of an
effective policy framework.
14. Ladies and gentlemen, let me end my remarks by quoting a
line from the book: "Risk of crisis as financial integration
increases will never disappear, and countries must pursue
protection from risks of volatility and sudden stops"2. We should always be vigilant, even in peace
time. To Mr Kawai and other authors, congratulations yet again on
the launch of this new and important book.
15. Thank you.
1. Emerging Asia includes China, Hong Kong,
India, Indonesia, Korea, Malaysia, the Philippines, Singapore and
Thailand.
2. Chapter 4: "Managing
large capital inflows: taking stock of international experiences"
(by Susan Schadler).
