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Keynote Speech at the 10th China International Finance Forum: Financial Industry and Real Economy Development
Keynote Speech by Lakshmi Venkatachalam, ADB Vice-President (Private Sector and Cofinancing Operations), at the 10th China International Finance Forum (CIFF): Financial Industry and Real Economy Development on 27-28 October 2013 in Shanghai, People's Republic of China
Your excellences’, distinguished guests, ladies and gentlemen,
On behalf of the Asian Development Bank, it is an honor to speak at this 10th China International Finance Forum. The theme of this Forum is timely -- linking the finance industry with the real economy -- indeed, since the 2008/09 global financial crisis and the following sovereign debt crises and recession, this has been the center of attention in both financial and non-financial circles.
Let me begin by flagging a couple of important issues (among several) engaging everyone’s attention in the debate. The first is the generally accepted view that the financial system must serve the real economy. It is observed that sometimes, the world of finance can become so dominant and self-engrossed that it forgets its original purpose - which is transfer of funds from those that have, to those that need. Financial intermediation is said to be successful when we match savings and investments for the purpose of generating economic growth. In recent decades, the weakening of the link between financial intermediation and productive economic activity has caused much anxiety and consternation with several propositions being put forth on how this link can be strengthened.
Looking ahead, the opportunities and challenges for the financial industry, especially with the rise of the emerging markets is another important issue engaging our attention. An additional one billion in the working population and middle class (a large part in the Asia Pacific region) over the next two-to-three decades will have more to spend and more to invest. At the same time, the world needs to address challenges of a massive stress on natural resources arising from higher volume of consumption. We hear a lot about the need for sustainable finance that is predicated on sustainable business and on a more inclusive, greener, sustainable environment.
Fortunately, we see some significant and encouraging sustainability trends emerging in financial institutions in our region. There is an increasing awareness that directing capital flows towards commercial activities that are beneficial towards the environment and society reduces the overall risks and increases long term value.
Ladies and gentleman, against this backdrop, I will speak today on three issues; first the outlook for developing Asia and the risks we face; second, the main challenges finance must address; and finally, what ADB is doing to help.
Economic outlook and risks for developing Asia
Let me begin with our assessment of the outlook for developing Asia, as highlighted in ADB’s latest Asian Development Outlook 2013 Update andAsian Economic Integration Monitor. The external environment for Asia is gradually getting better despite political bumps along the road. Growth in the G3 economies -- the eurozone, Japan, and the United States -- has shown signs of strengthening so far this year. The recovery has led to a discussion on the timing of when to begin tapering quantitative easing, and global and regional financial markets have been fluctuating in response. However, with G3 imports from Asia still weak, there is no certainty that a recovery will immediately translate into higher growth prospects for Asia’s emerging economies.
Thus, ADB forecasts developing Asia to grow by 6.0% in 2013, slightly below the 6.1% growth in 2012, rising to 6.2% in 2014. This largely reflects the slowdown here in the People’s Republic of China, in India, and in Southeast Asia -- all for different reasons.
China’s economy seems to be entering a lower growth trajectory than earlier believed, mainly because domestic demand has waned. But authorities are using this period to adjust China’s economic structure and ensure medium-to-long term growth is sustainable. ADB forecasts GDP growth to slow slightly from 7.7% last year to 7.6 % in 2013 and to 7.4% in 2014. Authoritiesface the major challenge of slowing the recent credit boom and, at the same time, expanding the economy through higher productivity. I understand China has already taken measures to gradually liberalize interest rates, ramp up financial sector oversight, and open up some protected sectors to private initiatives. And these will help financial services better serve the real economy in the future. I am sure we will hear more of this later in the Forum.
India’s economy may continue to suffer from the slow pace of structural reforms needed to return the economy to the higher growth of the mid-2000s. And slower growth in Southeast Asia can be attributed to moderation from above-potential growth last year. These economies are also preparing for the 2015 milestone of the ASEAN Economic Community -- although much remains to be done to reach its targets, even beyond its self-imposed deadline.
Let me now touch on the three major risks Asian economies face.
First is the possibility of increased volatility in global and regional financial markets -- in particular, due to uncertainties over monetary and fiscal policies in advanced economies. With the delay in tapering quantitative easing -- and the US fiscal compromise reached in mid-October -- developing Asia has some short-term reprieve to work on reducing financial or macroeconomic vulnerabilities. Market uncertainty remains high. And the tensions of earlier this month could return in January, affecting Asia’s outlook, even though many countries hold high levels of reserves and current account surpluses.
Second, a more pronounced slowdown could occur in major economies like China, India, or Indonesia -- which would have spillover effects on the rest of the region. Rising financial stress and existing structural imbalances could affect others through more integrated trade and financial channels.
The third risk is that policy missteps could reverse the fragile recovery in those economies and weaken developing Asia’s economic prospects. Such missteps could includeanother fiscal impasse in the US, new financial stress or sovereign risk in the eurozone, or delayed structural reforms in Japan.
The financial challenge
Despite these concerns, however, we believe Asia’s economies are well placed to sustain solid growth and continue to drive global growth. Finance has had much to do with this. In response to the 1997/98 Asian financial crisis, ambitious reforms were carried out on many fronts -- including fiscal consolidation, monetary policy management aimed at price stability, improving of financial supervision and regulation, and financial market development across the region. These reforms must continue.
But there are new challenges as well. One is demographics. Asia’s luxury of mobilizing its vast labor force is changing rapidly. Longer lives coupled with lower birth rates will inevitably alter the picture -- as early as the next decade or so. Ratios of working-age people 1 to total population are nearing their peaks in many Asian countries 2. China is not an exception. That means social safety nets must expand -- and training and education must ensure labor is more productive. Innovation is very important here. Nonetheless, demographic change could constrain economic growth from both supply and demand sides.
One way to prepare for these challenges is to promote financial inclusion and innovation in financial services. This can be done by taking advantage of the rapid expansion of Asia’s middle-income population, and by promoting small and medium size enterprises. Again, innovations such as internet and mobile banking can provide far greater access to financial intermediation, including payment and settlement services. Aside from accessibility, modern-day banking improves customer service and efficiency, allowing banks more ways to engage with clients. But it must come alongside greater customer protection. Financial literacy is just as important in building the all-important trust needed to galvanize savings for greater productivity.
Another challenge for Asia’s financial institutions is to strengthen risk management amid the increasing demand for longer-term credit. Because of rapid urbanization and industrial agglomeration, Asia needs well-functioning infrastructure -- in transportation, energy, and telecommunications, among others. ADB estimates roughly $500 billion in infrastructure investment is needed annually to accommodate current levels of economic growth. Meeting this need will require effective mobilization of the private sector. Normally, infrastructure loans have maturities above 10 years -- xceeding average deposit maturities by wide margins. Unless these mismatches are managed well, banks will shy away from long-term infrastructure lending -- and also, for example, from mortgage lending.
That is why capital market development is so important. Corporate bond markets will play a key role. I want to mention two points here. First, if banks can diversify funding by issuing bonds, they can better manage maturity mismatch risks. And second, corporate bond markets can facilitate direct infrastructure funding. Infrastructure projects, because of their long-term nature, are prone to unexpected shocks. If both bond issuance and bank loans are available, financial stability can be enhanced.
Unfortunately, Asia’s corporate bond markets are far from fully developed. Asia has excess savings, and its investment is still below pre-1997 levels. Corporate bond market development is an effective way to align savings with investment within the region. I might add they can also be conduits for the investments required by contractual savings institutions in support of social safety nets.
ADB support to the real economy
So where does ADB fit in? I discussed ADB’s position and practice in supporting the real economy at last year’s Forum. Allow me to underscore its main points again.
ADB is Asia’s premier multilateral development bank, with the vision of an Asian and Pacific region free of poverty. Our long-term strategic framework, Strategy 2020, focuses on three complementary development agendas of inclusive economic growth, environmentally sustainable growth, and regional integration. Strategy 2020 also identifies five core areas of operations: infrastructure, environment, regional cooperation and integration, finance sector development, and education.
Historically, ADB project approvals in finance account for about 10% of total lending in terms of both project numbers and value. But approval figures fluctuate significantly each year depending on the needs of our developing member countries. To give you a concrete example, the average annual project approvals in the past 2 years (2011-2012), including public and private sector loans, technical assistance, grants, equity investments, and guarantees, totaled $14.2 billion. The financial sector accounted for $0.74 billion, or about 5% of this total. Compared with infrastructure, financial sector development does not require a large amount of financing, but it does call for more knowledge-intensive support.
Within the financial sector, ADB takes into account the relevance for the real sector. This can be seen in our 2011 Financial Sector Operational Plan. The plan identifies two priority areas for ADB financial sector operations -- financial inclusion and capital markets for infrastructure finance. This is because, among other reasons, these two areas support three key pillars of the real economy -- households, small and medium enterprises, and infrastructure.
To conclude, despite global challenges, developing Asia continues to do well in helping drive world economic growth. But the risks and challenges we face remain daunting. Finance is critical to maintaining economic growth, and to making growth more inclusive and environmentally sustainable. We must use innovative products available to galvanize the region’s savings into productive investment. But that investment must also be better attuned to the needs of our people as well as our national and regional economies. As financial development evolves, we must manage risk well and minimize potential vulnerabilities.
As a knowledge bank, ADB can play a key role in disseminating best practices and facilitate greater spread and integration of key finance sector initiatives such as green credit, development of capital markets, carbon markets, insurance, guarantee and credit enhancement, energy efficiency finance. We are already very active in these spaces and going forward will make best uses of finance flows from global climate funds to fast forward the green growth agenda, particularly to catalyze private sector investment in clean tech, clean energy, energy and resource efficiency.
We at ADB will always be there to help with development finance, and with the knowledge we have gained over the past 47 years of operations.
I wish all a very informative forum and productive discussions to follow.