Foreign Investment and Offshore Financial Centres

inSight

10 Mar 2005

Foreign Investment and Offshore Financial Centres

This third in the series of articles on alternative views on financial markets examines the questions of foreign investment and offshore financial centres.

Foreign Investment

There is a perception that foreign (direct and portfolio) investment is always a good thing to have. Indeed, the channelling of foreign savings into domestic investments, whether directly into projects or indirectly through financial intermediation channels, promotes economic growth and development. Foreign direct investment can also help bring in new production technology and foreign portfolio investments promote financial sector development. But in an economy with a high domestic savings rate of, say, 30% to 40% of GDP, it is questionable whether the need to attract foreign savings into domestic investments is that great. There is a need to consider whether priority should not be given to developing and safeguarding the stability, integrity, diversity and efficiency of domestic financial intermediation. Indeed, if all domestic savings are effectively channelled into domestic investments, implying a rate of investment of 30% to 40% of GDP, the problem to be tackled is over-investment rather than under-investment.

From a global perspective, the ideal situation is, of course, the free flow of capital, ensuring that savings are attracted to the highest risk-adjusted investment opportunities. But the world is far from ideal, and capital account liberalisation is a risky process, in terms of the maintenance of monetary and financial stability. In the reform and liberalisation of an economy with a high savings rate, as in the case of the Mainland, greater attention should be given to the effective channelling of domestic savings into domestic investments. Attracting foreign expertise will certainly help, but I am not sure about attracting foreign savings, particularly when we cannot always comfortably expect foreign savings to behave other than as fair-weather friends.

Offshore Financial Centres

Depending on the context, offshore financial centres are considered both good and bad. Within the international financial community, the label "offshore financial centre" is something to be avoided. There has in fact been continuing discussion in the Financial Stability Forum established by the G10 governments soon after the financial turmoil of 1997-98, about the need for offshore financial centres to upgrade their supervisory and disclosure standards. Unfortunately, Hong Kong has been included in the Forum's list of offshore financial centres, although we are placed at the top of the list as a model for others to follow. But the label is irksome in that, simplistically, offshore financial centres are considered as those thriving on financial activities that cannot be conducted onshore for regulatory reasons. While, as one of a few non-G10 members of the Financial Stability Forum, I have been pressing for Hong Kong to be taken off the list, sometimes that label has been used in relation to the conduct of renminbi business in Hong Kong. It is important to note that we are not seeking to engage in regulatory arbitrage. I would like to think that our regulatory standards are of international status and there are no opportunities for regulatory arbitrageurs. What we are angling for is both to serve as the testing ground for financial liberalisation for the renminbi and to position ourselves in capturing a significant share of renminbi financial business (certainly the lion's share of the international aspect of that business) in Hong Kong as liberalisation progresses. If in the process our sophisticated and robust financial infrastructure enables us to play a significant role also in domestic financial intermediation of the Mainland, that would be a welcome bonus. But I much prefer not to call Hong Kong an offshore financial centre for the renminbi.

 

Joseph Yam

10 March 2005

 

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