Remarks by President Takehiko Nakao at the 7th Asian Financial Forum - Asia: Powering World Growth on 13 January 2014 in Hong Kong, China (as drafted).
Chief Executive Hon. CY Leung, Hon. Sec. K C Chan, distinguished fellow panelists, ladies and gentlemen; it is an honor to join you at the 7th Asian Financial Forum.
One often hears of Asia’s economic resurgence--that this is the Asian Century. In 1990, Asia accounted for about 20 % of the world economy. Today it is nearly 30%. According to one ADB study, by 2050 it could account for more than half. Importantly, Asia has contributed more than half of global economic growth since 2007. This growth has come with a huge reduction in poverty. All but five of ADB’s developing member countries are today considered at least middle income. Over the past 5 decades, there has been clear economic convergence with advanced economies.
But many also say that much of this convergence has come via economic tailwinds--from technology transfer to foreign direct investment, exports, and most recently, the ample liquidity flowing from post-crisis quantitative easing. Now, they warn, things are changing. Those tailwinds are becoming headwinds. While advanced countries are turning the corner, the external economic environment for emerging economies may be less favorable than before. QE tapering has begun, and this means tighter global liquidity conditions. Growth in the People’s Republic of China is moderating after 3 decades of close to double-digit growth, partly due to rising wages. Its support for growth in other emerging countries is also moderating. Commodity prices are stable or dropping. Inequality is on the rise. So is pollution. Rapid credit expansion must slow. Some say the next economic crisis may well start in Asia.
I don’t think things will necessarily go that way. True, there are new challenges Asia must face. But I remain positive for the coming decades. This morning, let me first explain why. Then I will touch on the risks we face. And finally, I want to talk about how Asia can bolster its financial resilience--even as it undergoes structural transformation--by expanding and deepening its financial markets.
Asia’s short-term economic outlook
Let me start with the economic outlook. Our December Asia Development Outlook Supplement estimates last year’s GDP growth at 6.0% for ADB’s 45 developing member countries, improving to 6.2% in 2014. The recovery in the US and Japan appear to have taken hold. And even if the Eurozone recovery is slower than expected, the 1.9% growth we forecast for advanced economies in 2014 will help buttress growth in developing Asia as well.
Yes, we have to accept that the era of 10% annual growth in China, or 8% annual growth in India, is behind us. Our region may be seeing some moderation in growth. But there are two things to remember: first, despite the moderation, growth remains robust by anyone’s standards. And second, that moderation is occurring alongside the critical structural reforms needed to strengthen the sustainability of robust growth in a more equitable and environmentally sound fashion. In short, moderation is fine if it comes with greater economic resilience.
In China, the structural reforms proposed during November’s Third Plenary Session will help private consumption and private investment starting in 2014. However, the upside growth potential will be countered by reining in credit growth as the central bank works to deleverage and to curtail local government borrowing. We now see GDP growth reaching 7.5% in 2014, somewhat stronger than previously forecast, supported by structural reforms and better economic conditions in advanced economies. I must add, the moderation of China’s growth from the double-digit level a few years ago also reflects a shift in the government’s policy from pursuing fast growth to improving the quality of growth through structural reform.
Despite its current account and fiscal deficits--and still high inflation--we think the Indian economy is likely to have bottomed out. Economic growth accelerated to 4.8% in the second fiscal 2013 quarter from 4.4% in the first. Growth was spurred by higher output in both industry and agriculture and a rebound in exports, while domestic demand remains weak on sluggish consumption and investment. Although growth will remain soft the first quarter of fiscal year 2014, some export recovery, strong agriculture, and capital expenditures after the elections should raise growth to 5.7% in FY 2014. In order to ensure a stronger footing for sustainable growth, India needs to address a number of structural weaknesses, especially in the areas of infrastructure, business environment, macroeconomic management, and manufacturing productivity.
Southeast Asia has surprised some with its robust growth since the global crisis. The region will continue strong with 5.2% GDP growth forecast for 2014. Indonesia’s strong domestic demand may moderate somewhat on rising interest rates. And political tensions in Thailand and the typhoon devastation in the Philippines may temporarily slow growth. But we see a pickup in the second half of this year, particularly in the Philippines as reconstruction to build back better begins in earnest. Also, Myanmar continues its reemergence--as it becomes ASEAN Chair for 2014.
I should add that the highly open economies in the region--including Hong Kong--will strengthen this year as the recovery in advanced economies boosts export demand somewhat, and financial transactions continue to grow. Hong Kong is estimated to have grown by 3.2% last year. We project Hong Kong will grow 3.8% in 2014.
However, as with any forecast, there are downside risks.
The reaction in May last year to just the hint of QE tapering disrupted markets, especially in India and Indonesia. Vulnerabilities were exposed as a warning signal. But while QE tapering will affect all, I think governments are more prepared now, and the relatively smooth market reaction to the December Federal Reserve announcement means its affects were already priced in. Most important is that the region’s financial markets are much more resilient than they were during, for example, the 1997 Asian financial crisis. Developing Asian economies have added resilience since then. They now pursue sound fiscal and monetary policies with independent central banks. Many countries continue to have current account surpluses, low external debt, and high foreign reserves. Most of the region’s banking systems are sound, with a high capital base and low nonperforming loan ratios. Bond markets are playing a stronger role. Still, preparing for any contingency is crucial. Policymakers cannot be complacent.
While advanced economies underwent structural reforms during the QE period, Asia held back on some of its most pressing reforms. As the amount of new liquidity in the system slows, the need to focus on structural reform becomes more urgent, and policymakers need to confront these issues now. Commitment to carry out needed reforms and the ability to sustain robust growth are the best guarantee for continued positive market sentiment and financial resilience, contributing to better financial stability.
The list of reforms is long. But we all know what they are. And most governments have plans for implementing them. The point is that we can’t delay. Reforms must be targeted toward rebalancing the sources of growth, reducing inequality though greater inclusion, establishing or upgrading social safety nets, protecting the environment while better using its resources, and heightening disaster preparedness and disease control.
It goes without saying that governments must reinforce their efforts to (1) pursue sound macroeconomic policies, (2) maintain open investment and trade, (3) build high quality infrastructure, (4) invest in human capital, and (5) enhance the quality of public service including through appropriate deregulations. As I will discuss next, policies to strengthen functions of financial sector should also be pursued.
Need for further development of the financial sector
Since this is a financial forum, let me now focus the rest of my talk on financial sector development issues facing Asian countries.
Asian developing countries cannot be complacent about their financial systems. It is true that the Asian banking sector weathered the global crisis better and remains more stable. But this may also reflect a lack of sophistication, innovation, narrower business scope, and underdevelopment outside traditional banking.
For example, in many Asian middle income countries, the markets for repos, securitization, and derivatives are underdeveloped or nonexistent. Although the danger of moral hazard in the originate-and-distribute model must be addressed, the region should explore the benefits of securitization when it is done prudently.
Developing Asia also needs to provide more inclusive finance to reach unbanked households and small and medium enterprises, or SMEs. The region should aggressively take advantage of technology to enhance financial access via mobile banking and other innovations. It also needs to ensure that trade finance, especially for SMEs--which should be regarded as relatively short-term and safe finance--will not be compromised by leverage limits imposed by Basel III.
Regional integration of financial systems is in a way the process of creating systemically important financial institutions operating across national borders. These regional SIFIs need higher capital requirements. ASEAN--on its way to becoming an economic community in 2015--needs to build arrangements for cross-border resolution of distressed banks, including a well-defined role for deposit insurance. At the moment, not all ASEAN members have deposit insurance schemes.
Asian middle income countries also need to diversify financial services beyond traditional banking. To support SME development, for example, leasing and factoring should be developed to enhance access to finance. Frontier economies must focus more on improving banking foundations such as payments systems, interbank money markets, and central bank monetary operations. And they must build a core financial legal framework.
Another important challenge for Asia is to develop its capital markets and investor base--to mobilize long-term resources to finance infrastructure while diversifying risks concentrated in the banking system. Although a high saving region, Asia is actually short of long-term savings, because much of Asia’s savings is concentrated in short-term bank deposits.
Many middle income countries in the region successfully developed equity markets and--more recently--bond markets, which have grown 15 times in size since the 1997/98 Asian financial crisis. Until recently, however, this growth has been largely in government bonds. Asia’s massive infrastructure investment requirements cannot be met by public finance alone. The region now needs to focus on promoting local currency corporate bond markets to finance infrastructure--particularly those supported by public private partnerships, or PPPs.
Under its Asia Bond Markets Initiative, or ABMI, ASEAN+3 established a Credit Guarantee and Investment Facility--designed to support the issuance of local currency corporate bonds by enhancing their creditability. They are working on harmonizing corporate bond issuance, streamlining cross-border trade processes and processing, and enhancing cross-border settlement of bond trades.
Since the Global Financial Crisis, the region’s corporate bond markets have grown quickly--as banks were faced with acute liquidity contractions and needed to deleverage. This has helped the region’s corporate bond markets show their “spare tire” function when banks are under stress. However, to ensure corporate bond markets can continue to expand, a strong investor base is needed. I believe the role of pension funds and insurance companies will be particularly important here. These businesses are expected to grow in the face of aging demographics and need good long-term investment opportunities.
In concluding my speech, I would like to stress again the imperative to implement needed reforms to attain Asia’s high, sustained, responsible growth. The perceived headwinds we face must be used as opportunities to accelerate and solidify the region’s ongoing economic transformation. Asia should continue to follow the path for more innovative, more inclusive, and more integrated development. By doing so, I am confident that we can cement Asia’s role as driver of global growth.