ASIA
26 March 2014
Towards stable, efficient, and inclusive finance in Asia
Asia's 1997-98 financial crisis, and the current global financial crisis have taught Asia tough lessons, above all, the need for stable, efficient and inclusive finance to realize the Asian Century.
Asia's 1997-98 financial crisis, and the present global financial crisis emanating from the US and Europe, have taught Asia tough lessons. In particular, the region must now make greater efforts to secure stable, efficient and inclusive finance to realize the Asian Century.
When the Asian Financial Crisis (AFC) struck in 1997, emerging Asian economies, whose rapid development had been described as a miracle by many, felt the full brunt of fickle global capital.
In the 1990s, deregulated banks in rich Western countries drove an unprecedented surge in private capital flows, especially short-term, to emerging economies including East Asia. For their part, the Asian economies welcomed this surge of short-term, unhedged, foreign currency-denominated capital as a source of even stronger growth. (It takes two to tango.)
Many Asian countries had indeed liberalized their domestic financial sectors. But they did not at the same time implement adequate regulation of the financial sector. And domestic banks happily supplied cheap foreign capital to domestic corporations which were already highly indebted. This led to over-investment in real estate and manufacturing sectors.
When the Thai baht was devalued in July 1997, panic and contagion spread, especially to Indonesia and Korea. The result was a withdrawl of more than $100 billion from the ASEAN countries and Korea in the ensuing 18 months. The impact of the crisis was then exacerbated by misdiagnosis, and inappropriate policy conditionality, imposed by the International Monetary Fund, which provided financial support to Indonesia, Korea and Thailand.
The Asian financial crisis spurned a vast array of analysis of the lessons for crisis prevention, crisis management and resolution, and improving regional and global frameworks. And the crisis-affected countries, and others in the region have made great efforts to respond to these lessons of crisis.
Short-term external debt has been greatly reduced. More flexible exchange rate regimes have been implemented. Sizable foreign exchange reserves have been accumulated by some countries. Significant supervisory and regulatory reforms have been implemented to improve the quality of balance sheets and risk management practices of their banking institutions. Asian financial firms have taken a conservative approach to risk taking, partly due to the authorities’ prudent regulation and supervision. And improvements have also been implemented to corporate governance and competition policies.
Important efforts have been employed to establish the Chiang Mai Initiative (a regional financial safety net to complement the IMF), and the Asian Bond Market Initiative and the Asian Bond Fund to develop the local currency bond markets.
But initial efforts to strengthen social protection have faded. In too many countries in the region, social protection is woefully inadequate for Asia's growing urban population, whose manufacturing sector jobs are exposed to the volatility of global markets.
Overall, when the Lehman shock hit in September 2008, Asia was better armed than before. But still not well enough armed.
Countries with sound economic and financial policies like Indonesia, Korea and Singapore suffered sudden US dollar liquidity shortages. They would not turn for help to the IMF, which still suffers from a "stigma" in the region, dating back to the AFC. The Chiang Mai Initiative proved to be ineffective. In the event, Korea and Singapore received support from the US Federal Reserve, while Indonesia was supported by a consortium of several countries.
Asian financial sectors were not significantly affected by the global financial crisis, as they had very low holdings of toxic assets.
The main direct impact of the crisis was through trade, as Asia's exports to the US and then Europe took a big hit. Those countries most open to trade like China, Japan, Korea and Singapore were sharply affected, and suffered sharp jobs losses in export sectors, highlighting the inadequacy of social protection in most countries.
Governments responded to the crisis with substantial fiscal and monetary stimulus, especially in the case of China. Sound public finances and manageable public debt meant that they had sufficient "fiscal space" to do so. This has softened the impact of the crisis on the economy and jobs, with the result that Asia seems to have sailed through the crisis. But again especially in China, large stimulus has resulted in inflationary pressures, real estate and asset bubbles, and much low quality lending which threatens the stability of the banking sector.
The American subprime and European sovereign debt crises have led to other challenging consequences. As these countries employ "quantitative easing" to stimulate their economies, and Asia remains the strongest part of the global economy, the region finds itself once again exposed to large and volatile capital flows. Managing these capital flows requires a mix of exchange rate, capital controls and other economic policies. The fear is that once again, these capital flows will reverse direction back home as the US and European economies progressively recover.
But the major lesson for Asia from the current global economic crisis is that the region's export-oriented development strategy, which targeted US and EU markets, must now be rebalanced. The next phase of Asia's development must be more home grown, relying more on domestic demand, and regional markets. And Asia's financial scene must become more stable, efficient and inclusive finance to realize the vision of an Asian Century.
Asia's export-oriented development was financed in part by foreign direct investment in manufacturing export operations. Bank finance for large enterprises was the other important leg of the region's finance -- although it did not always result not very efficient investments, as finance was it often based on "connections" and government directions, rather than sound project analysis. And countries with large surpluses, like China, Japan, Taiwan and Hong Kong, invested much of these surpluses in the US (rather than Asia), thereby underwriting its US credit binge leading to the sub-prime crisis.
In this context, the need to rebalance Asia's economic development towards domestic and regional demand has many implications for financial markets.
-- For consumer demand to become an important driver of development, consumers need greater access to financial services. And yet, about half of Asia's population does not have access to the formal financial sector, meaning that "financial inclusion" remains a major challenge in the region. And as consumers secure greater access to the formal financial sector, this will need to be complemented by financial education and appropriate consumer protection.
-- Greater domestic consumption necessarily means that the services sector will assume greater importance in the economy, something which is natural as countries climb the development ladder. This implies a greater role for Asia's small and medium businesses (SMEs), a large share of which remain in the informal sector, and do not have access to the formal financial sector.
-- As intra-regional trade continues to grow in importance, consideration should be given to establishing a regional payment and settlement system to minimize the risks of global liquidity shortages, and interest and exchange rate volatility.
-- Corporate bond markets need to be further developed to enable corporations to access long-term local currency funding, and for households to diversify their financial assets through long-term investment instruments. The establishment by ASEAN Plus 3 of the Credit Guarantee and Investment Facility can provide a boost local currency bond markets. But more is necessary.
-- With enormous infrastructure deficits being a break on development in many countries in South East Asia and South Asia, greater financial market integration, especially through bond markets, is also necessary to attract more of Asia's savings to the investment potential of the region. To this end, well-sequenced opening of capital accounts and harmonization and/or mutual recognition of rules, regulations and market practices would be important.
-- It will also be critical to employ high quality human capital in Asia's finance industry, where trust and competence are key. Disturbingly, it is reported that banks and other financial institutions are increasingly relying on "irregular employees" hired through temporary work agencies. Experience shows that these employees receive less training, lower salaries and often have short-term placements. Such "short-termism" can compromise the quality of service offered, and ultimately the stability of the institution. Similarly, it will be important to be vigilant regarding the quality of financial service delivered through Internet and mobile telecommunication platforms.
Overall, with a few exceptions, Asian financial markets and market infrastructure are still underdeveloped in much of the region. And barriers to capital flows mean that markets are also weakly integrated.
Asia's ongoing vulnerability to external and home-grown financial crises highlights the necessity of having adequate international safety nets in place.
For its part, IMF has recognized the mistakes it made in the management of the Asian financial crisis. It has adopted a much softer, less doctrinaire, approach to the management of capital flows. It can now accept capital controls as a last resort measure. It has also made major efforts to win back the confidence of Asian governments and public opinion, by becoming a partner with the region.
But it would still be political suicide for most any Asian government to accept an IMF program, with its attendant conditionality. All the more so, given that the IMF has admitted that its work on the European sovereign debt crisis has been less than stellar. Moreover, the IMF is still seen by many to be peddling Wall Street ideology that financial markets are inherently stable and self-regulating.
Since the outbreak of the global financial crisis, the ASEAN plus 3 countries have strengthened the CMI regional safety net into the Chiang Mai Initiative Multilateralized, and increased the available funds. They have also created a fledgling regional surveillance organization, AMRO (ASEAN Plus 3 Macroeconomic Research Organization). But these efforts remain work in progress, and are still not adequate as financial safety nets some 16 years, after the AFC. The region's only real defense remains foreign exchange reserves (an expensive option) and bilateral swap arrangements (an ad hoc, and potentially unreliable solution).
In conclusion, Asia has a big agenda to deal with in order to secure stable, efficient and inclusive finance for the Asian Century.
Executive Director
Asian Century Institute
www.asiancenturyinstitute.com
When the Asian Financial Crisis (AFC) struck in 1997, emerging Asian economies, whose rapid development had been described as a miracle by many, felt the full brunt of fickle global capital.
In the 1990s, deregulated banks in rich Western countries drove an unprecedented surge in private capital flows, especially short-term, to emerging economies including East Asia. For their part, the Asian economies welcomed this surge of short-term, unhedged, foreign currency-denominated capital as a source of even stronger growth. (It takes two to tango.)
Many Asian countries had indeed liberalized their domestic financial sectors. But they did not at the same time implement adequate regulation of the financial sector. And domestic banks happily supplied cheap foreign capital to domestic corporations which were already highly indebted. This led to over-investment in real estate and manufacturing sectors.
When the Thai baht was devalued in July 1997, panic and contagion spread, especially to Indonesia and Korea. The result was a withdrawl of more than $100 billion from the ASEAN countries and Korea in the ensuing 18 months. The impact of the crisis was then exacerbated by misdiagnosis, and inappropriate policy conditionality, imposed by the International Monetary Fund, which provided financial support to Indonesia, Korea and Thailand.
The Asian financial crisis spurned a vast array of analysis of the lessons for crisis prevention, crisis management and resolution, and improving regional and global frameworks. And the crisis-affected countries, and others in the region have made great efforts to respond to these lessons of crisis.
Short-term external debt has been greatly reduced. More flexible exchange rate regimes have been implemented. Sizable foreign exchange reserves have been accumulated by some countries. Significant supervisory and regulatory reforms have been implemented to improve the quality of balance sheets and risk management practices of their banking institutions. Asian financial firms have taken a conservative approach to risk taking, partly due to the authorities’ prudent regulation and supervision. And improvements have also been implemented to corporate governance and competition policies.
Important efforts have been employed to establish the Chiang Mai Initiative (a regional financial safety net to complement the IMF), and the Asian Bond Market Initiative and the Asian Bond Fund to develop the local currency bond markets.
But initial efforts to strengthen social protection have faded. In too many countries in the region, social protection is woefully inadequate for Asia's growing urban population, whose manufacturing sector jobs are exposed to the volatility of global markets.
Overall, when the Lehman shock hit in September 2008, Asia was better armed than before. But still not well enough armed.
Countries with sound economic and financial policies like Indonesia, Korea and Singapore suffered sudden US dollar liquidity shortages. They would not turn for help to the IMF, which still suffers from a "stigma" in the region, dating back to the AFC. The Chiang Mai Initiative proved to be ineffective. In the event, Korea and Singapore received support from the US Federal Reserve, while Indonesia was supported by a consortium of several countries.
Asian financial sectors were not significantly affected by the global financial crisis, as they had very low holdings of toxic assets.
The main direct impact of the crisis was through trade, as Asia's exports to the US and then Europe took a big hit. Those countries most open to trade like China, Japan, Korea and Singapore were sharply affected, and suffered sharp jobs losses in export sectors, highlighting the inadequacy of social protection in most countries.
Governments responded to the crisis with substantial fiscal and monetary stimulus, especially in the case of China. Sound public finances and manageable public debt meant that they had sufficient "fiscal space" to do so. This has softened the impact of the crisis on the economy and jobs, with the result that Asia seems to have sailed through the crisis. But again especially in China, large stimulus has resulted in inflationary pressures, real estate and asset bubbles, and much low quality lending which threatens the stability of the banking sector.
The American subprime and European sovereign debt crises have led to other challenging consequences. As these countries employ "quantitative easing" to stimulate their economies, and Asia remains the strongest part of the global economy, the region finds itself once again exposed to large and volatile capital flows. Managing these capital flows requires a mix of exchange rate, capital controls and other economic policies. The fear is that once again, these capital flows will reverse direction back home as the US and European economies progressively recover.
But the major lesson for Asia from the current global economic crisis is that the region's export-oriented development strategy, which targeted US and EU markets, must now be rebalanced. The next phase of Asia's development must be more home grown, relying more on domestic demand, and regional markets. And Asia's financial scene must become more stable, efficient and inclusive finance to realize the vision of an Asian Century.
Asia's export-oriented development was financed in part by foreign direct investment in manufacturing export operations. Bank finance for large enterprises was the other important leg of the region's finance -- although it did not always result not very efficient investments, as finance was it often based on "connections" and government directions, rather than sound project analysis. And countries with large surpluses, like China, Japan, Taiwan and Hong Kong, invested much of these surpluses in the US (rather than Asia), thereby underwriting its US credit binge leading to the sub-prime crisis.
In this context, the need to rebalance Asia's economic development towards domestic and regional demand has many implications for financial markets.
-- For consumer demand to become an important driver of development, consumers need greater access to financial services. And yet, about half of Asia's population does not have access to the formal financial sector, meaning that "financial inclusion" remains a major challenge in the region. And as consumers secure greater access to the formal financial sector, this will need to be complemented by financial education and appropriate consumer protection.
-- Greater domestic consumption necessarily means that the services sector will assume greater importance in the economy, something which is natural as countries climb the development ladder. This implies a greater role for Asia's small and medium businesses (SMEs), a large share of which remain in the informal sector, and do not have access to the formal financial sector.
-- As intra-regional trade continues to grow in importance, consideration should be given to establishing a regional payment and settlement system to minimize the risks of global liquidity shortages, and interest and exchange rate volatility.
-- Corporate bond markets need to be further developed to enable corporations to access long-term local currency funding, and for households to diversify their financial assets through long-term investment instruments. The establishment by ASEAN Plus 3 of the Credit Guarantee and Investment Facility can provide a boost local currency bond markets. But more is necessary.
-- With enormous infrastructure deficits being a break on development in many countries in South East Asia and South Asia, greater financial market integration, especially through bond markets, is also necessary to attract more of Asia's savings to the investment potential of the region. To this end, well-sequenced opening of capital accounts and harmonization and/or mutual recognition of rules, regulations and market practices would be important.
-- It will also be critical to employ high quality human capital in Asia's finance industry, where trust and competence are key. Disturbingly, it is reported that banks and other financial institutions are increasingly relying on "irregular employees" hired through temporary work agencies. Experience shows that these employees receive less training, lower salaries and often have short-term placements. Such "short-termism" can compromise the quality of service offered, and ultimately the stability of the institution. Similarly, it will be important to be vigilant regarding the quality of financial service delivered through Internet and mobile telecommunication platforms.
Overall, with a few exceptions, Asian financial markets and market infrastructure are still underdeveloped in much of the region. And barriers to capital flows mean that markets are also weakly integrated.
Asia's ongoing vulnerability to external and home-grown financial crises highlights the necessity of having adequate international safety nets in place.
For its part, IMF has recognized the mistakes it made in the management of the Asian financial crisis. It has adopted a much softer, less doctrinaire, approach to the management of capital flows. It can now accept capital controls as a last resort measure. It has also made major efforts to win back the confidence of Asian governments and public opinion, by becoming a partner with the region.
But it would still be political suicide for most any Asian government to accept an IMF program, with its attendant conditionality. All the more so, given that the IMF has admitted that its work on the European sovereign debt crisis has been less than stellar. Moreover, the IMF is still seen by many to be peddling Wall Street ideology that financial markets are inherently stable and self-regulating.
Since the outbreak of the global financial crisis, the ASEAN plus 3 countries have strengthened the CMI regional safety net into the Chiang Mai Initiative Multilateralized, and increased the available funds. They have also created a fledgling regional surveillance organization, AMRO (ASEAN Plus 3 Macroeconomic Research Organization). But these efforts remain work in progress, and are still not adequate as financial safety nets some 16 years, after the AFC. The region's only real defense remains foreign exchange reserves (an expensive option) and bilateral swap arrangements (an ad hoc, and potentially unreliable solution).
In conclusion, Asia has a big agenda to deal with in order to secure stable, efficient and inclusive finance for the Asian Century.
Author
John WestExecutive Director
Asian Century Institute
www.asiancenturyinstitute.com