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The following is a speech by the Chief Executive, Mr Donald Tsang, at the Luncheon Session: Asian Financial Integration at the Boao Forum for Asia's Annual Conference 2006 held in Hainan Province today (April 22):
Distinguished guests, ladies and gentlemen,
Good afternoon. It is a pleasure for me to speak at this distinguished regional gathering, and on the very important subject of Asian financial integration.
Finding ourselves in one of the most rapid periods of economic growth this region has ever seen, we increasingly ask ourselves: Is this pleasing trend sustainable? What risks may disrupt it, as in 1997-98? And how might these risks be managed, or at least mitigated? Those of us who have lived through the last half-century or so cannot forget how economic growth has dramatically reduced poverty in the region and brought opportunities and a better life to hundreds of millions of people. Over the past two decades, the Asian region* has grown at roughly twice the rate of the US and Europe. But we also cannot forget how brutally and suddenly economic progress was often brought to a standstill or sharply set back, with debilitating consequences for all. And the worst of these disruptive episodes have a financial label attached to them, with the latest one distinctively named the "Asian Financial Crisis".
As leaders in business and government in Asia, we have a responsibility to ensure that the rapid economic growth we are enjoying and sharing is balanced, stable and sustainable. In "driving growth to the next level", we must therefore focus on improving the quality, and not just maintaining the speed, of economic growth. The unpleasant experience of financial crises in this region tells us that one central area requiring greater attention is finance. Indeed, as our great leader Deng Xiaoping once said: "Finance is very important; it is the nucleus of the modern economy". We must get that nucleus to function properly, harness its energy, make it more potent by applying modern information technology, and direct its development towards the best interests of our increasingly economically integrated region. Most of all, we must minimise the chances of being thrown badly off track again. In this regard, I believe that few cross-boundary challenges are more meaningful and important than the promotion of financial integration in the Asian region.
I would describe the current financial arrangements in Asia as an incongruous state of affairs that cannot sustain economic growth in the region. A few aspects are worth mentioning. First, many domestic financial systems are still rather backward, and do not mobilise savings efficiently and channel them into the hands of those who are credit-worthy or in need of funds to finance their economic activity. Financial intermediation is not well developed and lacks diversification. The result is over-concentration and over-reliance on the banking system. A banking failure for whatever reason will cause serious disruptions to economic activities across the board. And in a few jurisdictions, even the banking system itself is weighed down by the familiar problem of non-performing loans. This reflects the general inefficiency of those institutions in these jurisdictions in allocating financial resources and in risk management. The conventional remedy requires injections of capital, often using official resources, to write off the stock of non-performing loans while the flow of those loans regrettably continues. Notwithstanding brisk primary as well as secondary market activity in a few stock exchanges in the region, capital markets, in particular the debt market, are relatively under-developed.
Second, perhaps reflecting the low rate of return of domestic savings trapped in the banking system and the all-too-frequent sharp turns of economic fortune in this region, there has been a need to save more for a rainy day (or a tsunami) and to spend less. Indeed, the savings rate in the region is very high. In the Mainland of my country, for example, it is over 40%. With the rate of investment being considerably lower, a large savings and investment gap emerges. Macroeconomics tells us that this will lead to an equally large current account balance-of-payments surplus. Consequently, we are at least partly blamed, rightly or wrongly, for the so-called global imbalance that is now getting bigger and bigger. The general consensus is that this large global imbalance is unsustainable, and I agree with that. There is now considerable global interest in facilitating an orderly adjustment rather than chancing a disorderly one, which the global financial system is quite capable of producing. Somewhat regrettably, this desire for an orderly adjustment has been translated into rather intense political pressure for exchange rate adjustments. Such adjustments are of doubtful effectiveness in addressing the global imbalance. In any case, there are clear limits to how much you can adjust exchange rates without causing unacceptable financial instability in any national economy.
Third, the large current account balance-of-payments surplus means a rapid accumulation of foreign assets by Asian economies. In the public sector, this takes the form of larger and larger foreign reserves, in order to keep exchange rates stable or on a stable path. Most of the foreign reserves are held in US Treasury securities. In the private sector, where domestic outlets for savings are scarce and its management is institutionalised, much of the money also finds its way into financial obligations of the developed markets. Thus, we have the phenomenon of putting Asian savings mostly in the financial markets of the developed economies, notably those in the United States. And the United States continues to be the home of the reserve currency of the world. We are, of course, all familiar with the form and character of the money that we see coming back to this region from the markets of the US and other developed economies. The nature of this returning money is exceedingly alert to small shifts in risks and opportunities, or fickle and volatile, depending on how you look at it. It is focused much more on short-term profits than on the long-term prospects of the region. At times, this returning money takes on a predatory character as well. As a result, Asian economies become more vulnerable to financial instability caused by money which belongs to us in the first place. They have to work against rather more stringent or perhaps unfair macroeconomic discipline than would otherwise be the case.
Fourth, in an attempt to safeguard financial stability, individual jurisdictions in this region have been forced to err on the side of conservatism regarding financial openness. For some, restrictions on the availability of the domestic currency to non-residents have become an essential part of the monetary armoury. For others, the pace of financial liberalisation has been slow, thereby reducing the widespread benefits that might be derived from greater freedom and efficiency in allocating their financial resources in the global arena.
To me, this strange state of Asian finance sits uneasily with the rapid pace of economic, and particularly trade, integration taking place in the region. About half of Asia's total trade is now intra-regional. And it is fully market-driven, motivated by the mutual benefits derived from comparative advantage in production and trade. Although about 56% of trade among non-Japan Asia still goes towards meeting import demand among economies outside the region, this proportion has been declining, and is likely to keep declining as regional demand grows. And there are many other aspects of growing economic partnership associated with trade integration in this region. By contrast, the pace of financial integration, however you choose to define it, seems to be lagging seriously behind.
The benefits of financial integration in the region seem so obvious now. They are obvious in terms of greater efficiency in financial intermediation, greater financial stability and greater sustainability of economic prosperity - in other words, attaining the type of quality growth, or "growth at the next level", that we are attempting to drive the region towards. Perhaps financial integration is still too far-fetched an idea today, if we define it as taking small, fragmented markets that can be easily tossed around by international capital, and pool them into one large and highly liquid market capable of absorbing volatility, through the use of a common currency, or monetary union. In this context, Hong Kong's experience in operating a currency board system for nearly 23 years shows that conceding the sovereign right over monetary policy is not as big a deal as it sounds. I am glad to see increasing interest in the subject in various established forums in the region, and I understand that the Asian Development Bank is keen to structure an Asian Currency Unit in an effort to contribute to research and discussion on it.
But we need not arrive at a consensus now on monetary union as the final goal. There are areas of financial integration well worth pursuing in their own right. They lead to some of the benefits that I have mentioned, without committing individual jurisdictions to something that may be politically difficult to deliver. I can think of five such areas. The first involves linking financial infrastructures across jurisdictions. This aims to facilitate the safe and efficient flow of funds across jurisdictions arising from the many trade, investment and other transactions taking place on a day-to-day basis. Advances in information technology have made it relatively easy to establish linkages between the trading, payment, clearing, settlement and custodian systems for money and financial instruments across jurisdictions. They also enable the payment, settlement and other associated risks to be managed and possibly eliminated. Achieving finality of payment and settlement real time, in our time zone, will further contain financial contagion and reduce vulnerability to financial instability.
The second area of financial integration concerns the relaxation of restrictions on access of foreign financial intermediaries to domestic financial markets. Often, stringently high quantitative licensing thresholds admit only the developed markets' household names and keep out the smaller financial institutions of neighbouring economies in the region. Size, of course, is not necessarily a good indication of strength and commitment. There are other objective measurements of financial robustness, such as capital adequacy ratios. And financial institutions from jurisdictions with close economic links may be more committed, in terms of their continuing presence, through thick or thin. That may simply be due to a greater understanding of the needs of customers from their home countries doing business in the host country. I hasten to add that I am not belittling the contributions of the international household names to the development of domestic financial systems in this region, or calling them fair-weather friends. Their presence has been valuable in promoting competition and providing sterling examples of how financial institutions should function. But the region could do with a greater diversity of providers of financial services, in reflection of the degree of trade and economic integration of the region.
The third area of financial integration involves the harmonisation of financial standards within the region. This means adopting minimum international standards while striving to achieve best international practices -- rather than developing regional standards that are different and therefore inevitably perceived as inadequate. This would bolster the confidence of all investors, and especially those in Asia, so that a greater proportion of the abundant investment funds originating from this region would feel more comfortable staying here. International and regional financial institutions have an important and objective role to play in this, particularly those involved in setting standards and financial sector surveillance, including the rating agencies. I am glad to see the increasing attention of such fine international institutions as the Bank for International Settlements, the IMF and the World Bank strengthening their presence in the region and offering their services. There is a corresponding need for these institutions to engage the region more intensively and interactively in the consultation and setting of international financial standards, rather than having them handed down to "all these other markets" after they have been finalised.
The fourth area of financial integration concerns strengthening co-operative efforts between jurisdictions in developing their domestic financial systems. There is valuable experience to be shared among ourselves. Because of our geographic proximity and close economic relations, we have a good understanding of each other's requirements, strengths and limitations. Financial architects need to have intimate knowledge of the environment to produce the architecture that works best in that environment. The indiscriminate replication of financial architecture from the developed markets is the wrong approach. And, if we look carefully enough, there is synergy across jurisdictions in the region that obviates spending a lot of resources to reinvent what our neighbours have already invented. Perhaps there is an effective platform next door that could be used to enhance the efficiency of domestic financial intermediation, which is so important for sustaining economic growth and development. We certainly see this between the two financial systems of the Mainland and Hong Kong. For the region, I am happy to see that our central banking institutions are making progress of strategic importance. The various components of the Asian Bond Fund, introduced over the past two years, provide an excellent example of regional co-operation in debt market development and a promising precedent for future co-operative ventures.
The fifth area of financial integration is quite crucial. It concerns the promotion of greater cross-boundary capital flows, which for some would mean relaxing capital controls. The freer mobility of capital is essential to achieve greater efficiency in the allocation of financial resources in an international dimension. Obviously there are risks associated with financial liberalisation. But as in banking, risks are to be managed, not avoided. Foreign reserves are at very high levels and still growing rapidly, giving rise to considerable difficulties in the management of domestic monetary conditions. This presents us with a golden opportunity to embark confidently on financial liberalisation. Prudently organised, through for example well-defined channels such as the Qualified Domestic Institutional Investors scheme that we have proposed for the Mainland of my country, the risks should be well contained. And I believe that the benefits will be readily seen. There would be a relative shift in the accumulation of foreign assets from the official sector to the private sector. Private sector investors are generally less risk averse than those managing foreign reserves. And as our dynamic region promises more attractive rates of return, a larger proportion of Asian savings would eventually find their way into financial assets in this region, thus promoting financial integration and financial stability.
I have set out these areas of financial integration in general terms because, while they require co-operation and co-ordination, there is perhaps no single model to apply to every jurisdiction. It is a feature of regional economic integration that we each develop our comparative advantage. We are also a geographically and culturally diverse region. This diversity presents an extra challenge to integration, but it makes it all the more worthwhile. Whether greater regional financial integration will ultimately lead to a common Asian currency is, perhaps, a question that many of us will not be able to answer in our lifetimes. But, at least the subject is now attracting discussion in wider circles, which is encouraging.
For our part, Hong Kong is working with other jurisdictions in the region towards increasing infrastructural linkages and implementing initiatives such as the Asian Bond Fund. We are fortunate to have the free flow of capital in and out of Hong Kong, and the free operation of markets generally, guaranteed by law. We have recently been using these advantages, and our position as an international financial centre, to develop an efficient, low-cost, multi-currency regional clearing platform for fund transfers in the US dollar, the euro and the Hong Kong dollar. In contrast to Europe and North America, this is traditionally a region with very little government debt. From what I have seen in the growing diversity of financial instruments and the booming IPO market in Hong Kong in recent years, I know the private sector is also playing its part - and will continue to do so.
In driving Asia's growth to the next level, I believe we should focus on the quality of growth and aim to make it more balanced, stable and sustainable. I also believe that greater regional financial integration in the five areas that I have discussed will contribute significantly to achieving this aim. When Asian finance is better organised, we will collectively be less vulnerable to sharp and costly disruptions to economic progress. With enhanced efficiency in financial intermediation and greater financial stability, growth will become more sustainable - and the people we serve will feel more confident about spending more and saving less, thus achieving more balanced growth. Perhaps all this will also contribute to reducing or eliminating the global imbalance.
Thank you.
* Japan, Mainland China, Hong Kong, Taiwan, Korea, Singapore, Malaysia, Indonesia, the Philippines, and Thailand.
Ends/Saturday, April 22, 2006
Issued at HKT 15:49
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