Deputy Governor's Luncheon Address at the ADB Institute-BNM Conference on Macroeconomic and Financial Stability in Asian Emerging Markets: "Stability Policy in Asia - Quo Vadis?"Speaker: Governor Muhammad bin Ibrahim, FCB Venue: Kuala Lumpur, Malaysia Language: English Speech Date: 04 Aug 2010
Thank you for giving me this opportunity to deliver this talk. The recent global financial and economic crisis will be remembered as the worst crisis since the post-war period. Fortunately, the impact of the crisis will not go down as the worst crisis in history. In a large part, policymakers have successfully averted a global economic tragedy through swift and unprecedented implementation of extensive policy measures, combined with a remarkable degree of multilateral policy coordination and the willingness to depart from orthodox approach. As we emerge from this crisis, the global economy is ?facing new obstacles to sustain growth and stability, partly due to the ramifications of the policy measures taken during the crisis and partly to the accelerated pace of reconfiguration in the global economic landscape that saw rapid recovery in the emerging market economies ahead of the advanced markets.
Today, I would like to touch on three issues which to my mind affect macroeconomic and financial stability policy in Asia. First, on the key challenges that emerging economies in Asia face in view of the changing global economic and financial landscape. Second, on the importance of placing greater emphasis on the international dimension of stability policy considerations. And finally, on the key imperatives for ensuring continued stability in this region.
The New Global Landscape and Challenges to Stability Policy in Asia
As the world emerges from the worst economic crisis in recent history, we are now witnessing a gradual but certain shift in global economic strength due to the increasing divergence in growth prospects between the advanced and the emerging market economies. While growth in the advanced economies remains modest and uncertain, emerging market economies, in contrast, have rebounded strongly. Emerging Asia, in particular, is leading the global recovery process, marking the first time where its contribution to global GDP growth has outpaced that of other regions1. Emerging Asia today contributes about 32% of global GDP2. With its strong growth momentum expected to continue, Asia's share of global GDP is likely to increase to 40% over the next 10 years3, resulting in a more dispersed overall global growth. Asia's resilience during the recent crisis reflects the region's stronger economic fundamentals and healthier financial systems, the outcomes of extensive reforms that were implemented by the Asian authorities over the past decade. Asia's strong fundamentals, positive structural factors and continuous policy reforms will position the continent as a catalyst for growth for ?the global economy.
For policymakers in Asia, there are probably two key challenges in maintaining macroeconomic and financial stability.
- First, the challenge of balancing domestic and external considerations in ensuring macroeconomic stability. The dynamics of current global growth with continued weaknesses in the advanced economies and the favourable conditions and prospects prevailing in Asia are posing unique challenges in formulating stability policies, in particular monetary policy. In the past year, central banks in Asia have had to navigate through some demanding times, faced with the task of finding an appropriate strategy for normalising monetary policy. Countries in the region have had to cope with the overall weaker external demand, increasing volatility in exchange rates, potential asset price inflation and the prospects of large and destabilising capital inflows.
These developments have challenged the way central banks usually conducted monetary policy, which has traditionally focused on domestic price stability. Prior to the recent financial crisis, the predominant view was that the sole policy strategy of central banks in pursuing macroeconomic stability is to ensure that inflation remains low. This crisis has altered that perception considerably. While maintaining price stability reduces uncertainty and helps to better manage expectations, a dogmatic approach of simply focusing on movements in the price index may well overlook the build-up of other risks or imbalances in the economy. Thus, beyond the focus on low inflation, paying attention to ensuring orderly financial markets has also become an important factor, given the implications that the financial sector has on the functioning and performance of the real economy. Sizeable movements of capital flows, for instance, can overwhelm the ability of small and open emerging economies to effectively intermediate these financial flows as well as their ability to manage them through conventional means.
- Second is
the challenge of maintaining the strength and soundness of the financial system amidst a weak, uncertain and changing global financial system. While Asia's financial system has remained relatively unscathed from the global financial crisis in 2008 and 2009, the? developments in the international financial system will continue to pose challenges in maintaining financial stability. The international financial system remains fragile, a few ?global financial institutions are still relatively weak and require strengthening of its capital, and this problem is compounded by the recent concerns on sovereign debts in the advanced market.
The ongoing financial reforms, where significant measures are being proposed to restructure the international financial system, are introducing an additional element of uncertainty. These include proposals to require banks to hold more capital and liquidity, reduce overall leverage, while also subjecting systemically-important banks to greater regulatory scrutiny. While the aim of these reforms is to build the foundation for a stronger international financial system, concerns arise as to whether some elements of these reforms may adversely impact Asia through unintended consequences that may materially impair the ability of the financial system to effectively intermediate funds and play its role as an enabler of economic growth. The race to meet higher capital and liquidity requirements by banks may be constrained by less-developed debt and equity markets in many parts of Asia, and could potentially impair the availability of funding and capital for other sectors in the economy. Similarly, the relatively more stringent treatment of trade financing under the leverage ratio proposal could discourage cross border trade, potentially impeding the critical function that cross border trade serves in the post-crisis recovery process.
In outlining these two key challenges, an obvious fact emerges - the challenge to ensure overall domestic macroeconomic and financial stability for Asia comes primarily from external developments. Indeed, most of Asia's past experiences of macroeconomic and financial instability have been due largely to the region's deep inter-linkages with the rest of the world. Asia's experience more than a decade ago was an example of how Asia's financial openness can lead to a severe financial and, subsequently, economic crisis. The recent global recession also highlights the vulnerability of the Asian economies to the high level of trade openness. This is not to argue that the openness of Asia is a negative characteristic. Far from it, in fact I strongly believe that Asia's integration with the world has been a key reason for the region's economic development and success.
The most significant lesson of recent crisis is that Asia's economies are even more open and its financial markets are increasingly larger and relatively more integrated than before.? For one, we must recognise and act proactively to the constant changes in the international dimensions of macroeconomic and financial stability. We need to be both constantly vigilant of global developments that may impact domestic stability, and have the capacity to effectively manage these external challenges when they arise. Unfortunately, the traditional and commonly accepted frameworks for maintaining macroeconomic and financial stability are heavily focused on domestic factors, given that the thinking behind these frameworks are mostly borne from intellectual models built around closed systems. Recent experience proves that it is essential to complement these frameworks with greater emphasis on cross-border influences the on stability of the system.
Ensuring Stability for Asia Going Forward
Asia's approach to macroeconomic and financial stability policy has often been pragmatic rather that dogmatic, and I think, this pragmatism on the part of policy makers will continue to serve Asia well. From Asia's own experience, there are several policy imperatives that we can further embody in our pursuit of stability. They are: first, to continue to build strong economic and financial foundations in periods of stability; second, the significance to foster regional cooperation and coordination in maintaining stability; and third, the importance to ensure that policies formulated and agreed at global institutions are appropriate when applied to the regional and domestic context.
Experience has shown that strong financial and macroeconomic fundamentals strengthen the resilience of countries against external shocks. The flexibility, capacity and effectiveness of countries to implement counter-cyclical measures, particularly in times of crises, also greatly depend on the existence of solid fundamentals. As such, building solid fundamentals for macroeconomic and financial stability during good times is very important. This is indeed a key lesson that Asia learned following the Asian Financial Crisis, where the region has taken significant measures at the national level to develop more resilient financial sectors, including instituting sound regulatory regimes, strengthened prudential regulations as well as enhanced governance and risk management practices. Macroeconomic fundamentals, in particular external and fiscal positions, were also fortified and concerted efforts were taken to diversify sources of growth towards domestic demand. Indeed, Asia entered the recent global crisis from a position of strength. The region's strong macroeconomic and financial fundamentals not only cushioned the impact of the global crisis on the domestic economies, but also allowed Asia to implement counter-cyclical policy measures swiftly and effectively to mitigate the impact of the crisis.
In addition to building strong fundamentals of individual country, equally crucial is the need to collectively strengthen resilience at the regional level. In this regard, greater regional economic and financial integration is critical. Economic linkages, in the form of greater intra-regional trade and investment, is key, particularly in allowing Asia to reduce the dependence on final demand from traditional markets. Over the past decade, various efforts have been undertaken to further facilitate greater trade and investment within Asia. Among others, the implementation of the ASEAN Free Trade Area (AFTA) was accelerated, while the ASEAN Investment Area was adopted to promote greater flows of capital, skilled labour and technology within the region. Free Trade Agreements (FTA) have also been rapidly established among the Asian economies. Most notably, the ASEAN-China FTA, established in April 2009 is the world's largest free trade area consisting a population of 1.8 trillion and gross domestic product of USD2 trillion. These initiatives have contributed to increase trade within the region, where intra-regional trade as a share of total exports has risen from 32% in 1995 to exceed 50% in 2008, with intra-regional trade for final demand had also increased in tandem. Indeed, robust intra-regional trade to meet the rising domestic demand in the region is one of the contributory factors to Asia's strong recovery from the global crisis.
A natural progression to complement the already strong trade and investment linkages within the region is to have greater financial integration. While recognizing the associated risks, more regionally interconnected financial systems and markets, and a greater presence of regional institutions in our domestic financial sectors would ?allow for a more efficient and effective recycling of Asia's high savings to meet the significant investment, ?especially infrastructure, within the region. It is estimated that in the next ten years, Asia will require USD8 trillion for infrastructure development, and with an average savings rate of about 35% of GDP, Asia can easily meet these financing requirements internally. The Asian Bond Market Initiative, the Credit Guarantee and Investment Facility and the Asian Infrastructure Fund are among the initiatives being pursued to forge greater financial integration within the region.
Given the increasing regional and global dimension to issues regarding stability, individual countries' efforts to build strong economic fundamentals and the region's initiatives to foster greater economic and financial integration might not be sufficient in guaranteeing resilience and securing stability. Regional ?arrangements and mechanisms need to be institutionalized to foster closer cooperation among regional policymakers with mandates over national stability, to facilitate joint surveillance and information sharing. This would not only help to increase awareness on emerging risks, but also facilitate regional cooperation to pre-empt such risks.
The second policy imperative is one that we have fostered and must continue to embrace - that is - regional cooperation in ensuring stability. Asia has leveraged on existing regional groupings to forge greater cooperation, mainly through the ASEAN+3 and EMEAP which comprise the East Asia Pacific central banks. For example, the EMEAP Monetary and Financial Stability Committee has been established to undertake regional surveillance, risk management, crisis management and crisis resolution. Through this Committee, efforts are being enhanced to identify regional sources of risks as a preventive measure against financial crises and to enable prompt corrective actions. These efforts are further complemented with mutual support arrangements and liquidity support mechanisms within the region, such as the Chiang Mai Initiative (CMI) where the total size of the CMI facility was increased in 2009 to USD120 billion.
With the growing trade and financial inter-linkages within the region and the rest of the world further entrenched, there is increasing concern on the effectiveness of our existing approach to implementing financial regulations. Today, decisions taken or the so called international consensus are not broad enough to take into consideration cross-border influences and the impact on emerging economies. In a financially globalised world, differences in regulations open up opportunities for capital to be deployed to markets and jurisdictions that are more lightly regulated. Such regulatory arbitrage not only results in an unlevelled playing field by giving advantage to players in one jurisdiction over others, but can also lead to destabilising flows that increase the overall riskiness of the global financial system. Additionally, as is the reality today, global regulatory standards, and the most recent wave of reforms in particular, have been largely influenced by the conditions and experiences of the advanced economies. The reforms being considered assume the existence of developed financial infrastructure and institutions, including deep and liquid debt and equity capital markets, well-equipped market participants capable of exerting market discipline as well as the availability of alternative financing channels aside from banks. Well, this conditions and assumptions are not true for most market in Asia.? These conditions cannot be created overnight, and many of these will only be realistically achievable in the medium- to long-term for most emerging markets economies in Asia.
This brings me to the third imperative on the importance of ensuring that policies, while internationally consistent, are appropriately phased in from a domestic and regional perspective. As Asia commands greater influence through greater representation in the international standard setting bodies, it is crucial that Asia continues to advocate the need for an appropriate level of flexibility in the implementation of the new global standards. Within the region, groupings such as EMEAP have assumed considerable roles to bring about greater understanding on international reform initiatives and promote the exchange of views to fully appreciate the implications on the regional financial system. There is much space for greater coordination in policy implementation, just as demonstrated in the introduction and phasing out of exceptional policy measures in response to the global financial crisis.
Asia entered the recent global recession from a position of strength and recovering from it rapidly, leading and supporting global growth in the process. Nevertheless, many challenges remain for Asia in maintaining both macroeconomic and financial stability going forward. We must continue to work together, drawing from our experiences in the past, carry on with our pragmatic approach to maintaining stability and not beholden to any dogma and remain vigilant in the face of a changing global environment to ensure our region remain stable and secure.
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