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"Asia's Position in the Financial Power Shift"

Speech By
Liqun Jin
Vice President, Operations 1
Asian Development Bank

At the International Conference on the Changing Dynamics of Global Financial Power

22 January 2007
Chatham House, London

I.  Introduction

Mr. Chairman; distinguished panelists; ladies and gentlemen:

I am delighted to have the opportunity to contribute to this discussion on Asia's position in the financial power shift. Clearly this topic is one of great interest to emerging Asian economies, as well as to the rest of the world.

It is also a very large topic, so in the time allotted I would like to focus on three issues: First, the complexities involving Asia's current account surpluses; second, the development of regional and domestic financial markets as one response to these surpluses; and third, the role of the People's Republic of China as it evolves to an economic powerhouse.

II.  Asia's Current Account Surpluses

I think we all recognize that Asia's emergence in the global economy presents both challenges and opportunities for other regions of the world. On the positive side, the export-oriented growth strategies of Asian economies have generated a steady supply of low-cost goods to developed countries, helping them keep inflation low and giving them more room to support growth than would have otherwise been consistent with price stability.¹ To certain extent, a better-off Asia can afford to import more high-valued consumer goods and capital goods from the developed countries.

On the other hand, however, these same growth strategies have contributed to the widening global payments imbalance. Any sudden unraveling of this imbalance could have significant repercussions around the world.

Most authorities now agree that the burden of reducing the payments imbalance is a shared global responsibility, requiring a shared solution. The US, for example would need to raise national savings, while Europe and Japan could strengthen their growth potential through structural reform. Oil-exporting countries could also make efforts to sustainably increase domestic demand.

For the surplus economies of Asia - particularly China, which also has a high rate of net direct investment - the obvious solution is to reduce large current account surpluses both through efforts to stimulate domestic demand and by allowing greater exchange rate flexibility. And in fact, many Asian policymakers are moving in that direction, including China. Over the last 18 months, the Chinese currency has appreciated by more than 6% against the US dollars. Last year, most regional currencies appreciated due to strong upward pressure from foreign currency inflows on both the current and capital accounts. If such trends continue, then external payments imbalances should be corrected over time.

Many Asian leaders now recognize the need to reduce their reliance on export markets, and exchange rate policies are important for achieving that goal. But allowing currencies to appreciate too much in too short a time would be extremely risky for Asia's export-oriented economies. Market turbulence in Asia will impact upon the rest of the global economy. The 1997 Asian financial crisis is still fresh memory.

Addressing the trade balance issue is not the sole responsibility of the Asian countries. Asia's competitiveness is a wake-up call to the developed countries. The developed countries should also look inwardly to see what should be fixed in their own economy. Obviously, the developed countries should also speed up the restructuring of their own economies in the context of the globalized economy. Asian economies will not remain competitive just in the lower-end products. They will quickly move up the value chain, given their robust growth, increased investment in R and D, and the efforts to protect intellectual property rights and to strengthen legal framework and governance. Asia's competitiveness will extend, and in some cases has already extended, to IT and service sectors, including financial services. For developed countries, they should not just wait for the appreciation of the Asian currencies to solve the trade imbalance problems.

Reducing exports requires substantial domestic restructuring to generate the internal demand necessary for a more balanced economy. Domestic markets don't always respond immediately, and a too-rapid shift away from exports could result in an economic recession, loss of jobs and social unrest. A successful transition to domestic markets might only be achieved after a lengthy period of heavy investment in tertiary education, skills retraining and institution building. Nonetheless, efforts are underway. Just last week, China's Vice Premier Wu Yi announced the Government's intention to focus on addressing its trade imbalance and encouraging domestic consumption.²

Exchange rates are also closely linked with foreign exchange reserve accumulation. When exchange rates are less flexible and capital flight is more likely, larger levels of reserves are required to instill confidence in a period of crisis. After the Asian financial crisis of 1997-98, in which volatile capital flows played a major role, reserve adequacy requirements were increased in several Asian countries. However, after a period of rapid reserve accumulation, most are holding reserves well in excess of what is generally thought adequate.

III.  The Need for Financial Market Development

This situation naturally leads to questions about how best to manage these excess reserves. With emerging East Asia's foreign exchange reserves approaching $2 trillion³, some have suggested that, with proper safeguards and discipline in place, part of these funds could be mobilized for investment in the region. Certainly, the need for such investment is great. In infrastructure alone, it is estimated that Asia as a whole will need as much as $3 trillion over the next ten years to keep up with the growing need for paved roads, water supplies and sanitation, electricity and other vital infrastructure. However, at current rates of investment, less than half of such needs will be met.

To put Asia's reserves to such use, however, would require the development of robust, efficient domestic and regional financial markets. I am not suggesting here that Asian savings should be entirely recycled within the region. Global capital flows are critical to the functioning of the global economy, and it is not realistic to think that Asia can be self sufficient, any more than could any other region. However, a stable, well functioning financial market in Asia would be of benefit to all global investors, while providing a mechanism to deal with excessive surpluses.

Work in this area has begun, but there is still much to be done. Since the 1997 crisis, many Asian countries have undertaken substantial reforms to increase financial sector stability. In the banking sector, privatization, consolidation and the entry of foreign banks have created a more competitive climate and spurred reforms to improve performance. One indicator of progress is the ratio of non-performing loans or NPLs, which has been reduced significantly on a regional basis.

Bank supervision is also being improved in accordance with the Basel Core Principles to reduce the risk of systemic crisis. And many countries are strengthening their legal, judicial and institutional frameworks and enforcement mechanisms for secured transactions and debt recovery.

An important challenge ahead will be to achieve a proper balance between the banking sector, the bond market and the equity market - a balance which is critical to ensure the financial health and stability of any emerging economy.

Asian economies continue to depend to a large extent on the banking sector. Given the fact that the three elements are important to an economy in their own way, it is hard to imagine that any one of them will be strong enough without the support, in the sense of providing impetus to compete, of the other two.

Robust bond markets are essential for ensuring that firms can secure appropriate sources of long-term financing. In Asia, domestic bond markets have been developing rapidly since the 1997 crisis, supported by domestic and regional initiatives.

ADB, for example, has been working closely with the ASEAN+3 countries to develop domestic bond markets with a view to establishing a better balance in the financial sector, and to encourage regional savings to be directly channeled into regional investment. We have provided considerable technical assistance to the Asian Bond Markets Initiative (ABMI). And we have developed a unique web site - AsianBondsOnline - as a one-stop information center on Asian bond markets.

ADB also prepares bi-annually Asian Economic Monitor, which assesses the current condition of the East Asian economies, and the Asian Bond Monitor, which keeps track of key developments in East Asian bond markets. While building up bond markets is a long-term process, progress is being made.

Research has shown that economies with well-developed capital markets are stronger overall and develop more rapidly. Equities - the third element of a well developed capital market - are essential to bring buyers and sellers together, to mobilize savings, allocate capital and risk, and exert external discipline on issuers.

But many countries in the developing world are still grappling with the managerial challenges of the equity market. In China, getting a company listed is always considered an effective means to bring its management under the close watch of the shareholders, as well as raising capital. Investors tend to feel comfortable when they have put the money in a listed company which operates according to corporate governance. But a change in ownership structure means little if it is not accompanied by shareholder control, which in turn depends on a regulatory system that can be enforced. In an encouraging development, the 1,200 companies listed on the Shenzhen and Shanghai stock exchanges are now required to adopt accounting norms similar to the International Financial Reporting Standards.⁴

To be sure, much remains to be done in Asian economies to create a supportive environment for capital market development, establish basic market structures, and improve disclosure, transparency, governance and enforcement. But just as surely, the region's financial architecture is stronger today than it was in the pre-crisis years.

IV.  The Impact of China and its Evolving Role

Moving now to China and its evolving role in the region, I think it is safe to say that the rise of China complements the economic strength of countries like Japan and Korea, creating yet another cornerstone to underpin the region's economic stability.

With a population of 1.3 billion and a growing middle class, China offers huge market potential for its trading partners, particularly its neighboring economies that have the ability and commitment to adapt and respond. China need not overshadow smaller Asian economies. Indeed, it has been noted that as production costs in China's industrialized eastern coastal regions rise, new opportunities are opening up for other countries in the region.

China can also play a major role in promoting regional integration, thereby helping to shape the future of East Asia's economic architecture. At the recently concluded 2nd East Asia Summit, Chinese Premier Wen Jiabao pushed for increased cooperation among Asian nations. He said - and I quote:

"We should create a new community of common destiny whose members can enjoy common development in times of peace and meet challenges together in times of crisis.⁵"

He also confirmed China's commitment to an Asia that remains open to the world, and welcoming to countries and organizations outside the region. Of course, China is already making significant contributions to regional development by investing in neighboring economies.

China is also investing in developing economies outside of Asia and its role as a donor country is growing. Admittedly this has not been without controversy. But it is important to note that China has benefited from its experience with the Bretton-Woods institutions, and from ADB. Its approach to development reflects both this history and philosophy, and China's own experience as a developing country. In order to maximize the development impact of China as an emerging donor, it will be increasingly important for multilateral development partners to coordinate with each other and with China.

As China's weight in the regional and global economy grows, it is hoped that it will also assume a more proactive role in supporting trade, investment and financial cooperation, as well as regional institution-building. China would benefit enormously from participating in the region's multilateral frameworks, and, more specifically, by intensifying its strategic and comprehensive partnership with ASEAN.

If China moves to strengthen its support for trade facilitation, capacity building and technical assistance support, it could play an important role in facilitating the eventual establishment of an Asia-wide FTA. Given its large foreign exchange reserves, China could also provide funds for infrastructure development to improve physical connectivity in developing Asia. And, through greater engagement with the ASEAN+3 framework, the Asian Bond Markets Initiative and the Economic Review and Policy Dialogue, China could strengthen its role in regional monetary and financial cooperation. A more proactive stance in regional cooperation would without doubt benefit not only China but the Asia and Pacific region as a whole.

V.  Concluding Remarks

Ladies and gentlemen, Asia's unprecedented rise in the global economy has driven global efforts - and global success - in reducing poverty and raising standards of living for the poor. At the same time, it has caused a massive shift in global wealth distribution, forcing all of us to continually adjust the lens through which we view the world.

I commend and thank Chatham House for this conference, and for its continued commitment to improving international relations. If all players respond to these changing global dynamics in a spirit of cooperation and shared responsibility, there is no doubt we have it in us to build a more balanced, more prosperous and more peaceful world for future generations.