Singapore, 20 October 2009
“Prospects and Challenges of Financial Integration in ASEAN”
Ms. Saima Farooqi, Editor of FX Week
Distinguished Speakers, Guests and Participants
Ladies and Gentlemen,
It is my pleasure to be here today and to have this opportunity to address such a distinguished audience of foreign exchange professionals and experts. First I would like to congratulate FX-Week Asia for making this event possible especially since the world attention is now on Asia, which is seen as an engine for global recovery from the current financial and economic crisis. The topic of this Conference is particularly timely given the importance of exchange rate and liquidity in today’s financial markets.
Slightly more than a year ago, we all witnessed how global financial stability has been seriously tested. Today, financial stability has improved significantly in the past six months, thanks to unprecedented policy actions implemented by many countries. But despite the significant reduction in systemic risks, indicators of financial stress remain elevated. In its October 2009 Global Financial Stability Report, the IMF still considers the on-going market dysfunctions as drags on economic recovery.
We live today in a world of financial globalisation. The extent of cross-border capital flows and surges of financial transactions are staggering. The increasing financial linkages and global spill over are a clear testament to rising interdependence of our global economy. No country or region can stop this process. Financial globalisation carries with it opportunities and costs, and it is now the task of every country to manage financial integration and make it work for its constituents.
Distinguished Participants, Ladies and Gentlemen,
My remarks today will touch on the many benefits and risks from the integration of financial markets. In particular, I would like to focus on financial integration in the context of Asia and ASEAN, especially the profound changes globalisation has introduced in the way financial systems operate in the region. More importantly, I will discuss regional initiatives on financial integration, particularly the Roadmap for Monetary and Financial Integration of ASEAN and the Chiang Mai Initiative Multilaterisation (CMIM).
Benefits and Costs of Financial Integration
Let me begin by highlighting the benefits from financial integration – for Asia and for the world. Chief among these benefits are the prospects of higher growth and living standards that financial integration can bring to the region. By encouraging financial flows, countries in the region can make use of savings from external sources, making possible more investment. Financial integration allows investors to seek higher returns and lower risks through diversification, and it enables borrowers to finance themselves in deeper and more complete financial markets. Moreover, financial integration will help deepen financial markets and strengthen the resilience of our economies to external shocks.
Of course, no one can deny that financial integration can also be costly, especially if not managed properly. In fact, some critics have argued that the current global financial crisis was caused by financial integration. However, I would like to defer and argue otherwise. We all know that financial integrated markets will always allow the transmission of shocks. Thus, the problem, in my view, is not because financial integration has caused these shocks, but the absence of adequate financial stability framework and regulations that could have addressed the issue of excessive risk taking, for example.
Over the years financial integration in the region has been increasing. Since the Asian financial crisis of 1997/98, cross-country interbank rate differentials of selected East Asian economies from the US rates dropped considerably after 1999. Similarly, government bond yield spreads over benchmark US treasury bonds has increasingly converged since the Asian financial crisis. Bilateral correlations of equity-price indices across markets have also risen over the past decade. To be sure, the convergence of bond yields and overnight rates, as well as increased bilateral correlations of equity prices, are indicative of financial integration with regional markets. A number of factors can explain this increased convergence. Among these factors are the increased capital market opening in East Asian economies, better financial market infrastructure, and significant differences in exchange rate and credit risks.
Qualitative indicators of financial integration also show some promise as evident in cross-border holdings of international portfolio assets and liabilities in East Asia. In 2006, portfolio asset holdings of East Asian economies reached US$941.6 billion, compared to only US$324.8 billion in 2001. Intra-regional financial integration also increased significantly. For example, around 24.3% of total assets held by East Asian economies in 2006 were sourced from the region, compared to only 14.8% in 2001. In contrast, the share of East Asian assets going to the United States declined, from 19.6% in 2001 to 14.5% in 2006. In terms of regional output, total asset holdings by East Asian economies accounted for 4.5% in 2006, from 1.7% in 2001.
Despite the encouraging trends, it is important to highlight that while Asian financial integration has been rising, it remains limited. Many studies show that Asia has integrated more fully with global financial markets than within the region. Evidence suggests that Asian equity markets track the US markets more closely, although the extent of linkages of Asian bond markets with the US bond market appear to be weak. This seems to be confirmed in Asia following the global financial deleveraging. As the crisis intensified in September last year, equity prices in Asia plunged, triggering substantial portfolio outflows from the region.
Financial Integration from ASEAN’s Perspective
As you all know, ASEAN has experienced deepening regional integration over the last fifteen years. Many countries in the region have seen the share of intra-regional trade in total trade rise during the last decade. In fact, intra-regional trade now accounts for a quarter of ASEAN’s trade or about US$460 billion. In addition to trade, liberalisation is also pursued strongly in the areas of services and investment. Efforts are also underway to remove non-tariff barriers, harmonise standards, enhance market connectivity, and improve customs – all of these to support a single market and production base by 2015. We are also building our networks of free trade areas with our Dialogue Partners to ensure that our region is well plugged into the global economy.
Regional financial integration is also moving ahead. Although progress is more muted, the region is aware that to establish an ASEAN Economic Community (AEC), it is crucial that well-functioning financial and capital markets exist for economic integration to work. In fact, a number of successful initiatives, under the Roadmap for Monetary and Financial Integration of ASEAN, are underway.
One important element of ASEAN financial integration is the liberalisation of financial services. ASEAN is committed to liberalising financial services by 2015, covering all
sub-sectors and modes, except for those sub-sectors and modes where pre-agreed flexibilities will be determined. Four rounds of negotiations have so far been concluded with binding commitments by each ASEAN Member State to liberalise their financial services regime. The fifth round of negotiations was launched last April and would be concluded in 2010. The aim is to create free flow of services, including financial services, in the ASEAN region by 2015.
Another element is capital market development. ASEAN is working towards ensuring that well-functioning capital markets exist to support the economic integration of the region. The objective is to build capacity and lay the infrastructure for the development of ASEAN capital markets, with a long-term goal of achieving cross-border collaboration between the various capital markets in ASEAN. Toward this end, a “Medium-Term Strategic Framework (MTSF)” has been adopted to guide the work of the Working Committee on Capital Market Development and to align capital market development to the AEC Blueprint. Currently, the Working Committee is looking at enhancing market access, linkages and liquidity through such proposed initiatives as ASEAN Exchanges linkages, Bond Markets linkages, and promoting credit ratings comparability between domestic and international credit rating agencies.
To support an integrated capital market in the region, a Capital Market Implementation Plan was developed early this year, with clear milestones and core strategies on how to further deepen the region’s capital markets. Under the Plan, the integration of capital markets will be undertaken through a series of strategic actions, including the mutual recognition and harmonisation of standards for cross-issuance, building infrastructure for cross-border trading and market liquidity, promoting new products and market intermediaries, and relaxing regulations that restrain the role of institutional investors. Currently progress toward integration of regional capital markets has been constrained by the large differences in the levels of development, including differences in regulatory standards and fragmented infrastructure. The Capital Market Implementation Plan is geared towards providing a coherent approach to capital market integration in ASEAN.
ASEAN also recognises that increasing financial integration at the regional and global levels brings with it the challenge of liberalising capital flows. To advance financial integration, the region needs to further liberalise cross-border capital flows. So far, efforts toward capital liberalisation have been encouraging, but more needs to be done. Among the key priorities are the maintenance of exchange rate flexibility and removal of restrictions on purchases of foreign exchange for current account transactions. Over the longer term, further liberalisation of restrictions on outflows, both FDI and portfolio, can also support deeper integration and potentially offset swings in capital inflows.
ASEAN is also looking at intensifying exchange rate cooperation as part of the overall strategy toward regional financial integration. Under the ASEAN currency cooperation, Member States are exploring ways that could further facilitate intra-regional trade and investment, and economic integration, including through some forms of currency arrangements. As preconditions for closer currency cooperation, efforts have been made toward maintaining appropriate macroeconomic policies and foster greater macroeconomic convergence.
In all these initiatives, the role of the private sector is crucial. Recognising that financial integration is a market-driven process, ASEAN has engaged, and will continue to do so, with the private sector. Private sector engagement is critical to building an inclusive economic community. Appropriate mechanisms have been put in place and new ones are being developed to bring about more focused dialogue and implementation of commitments among ASEAN Member States and market players under the AEC. Without a strong private sector support, both trade and financial integration will be difficult to achieve. For example, under the ASEAN Infrastructure Financing Mechanism (AIFM), the development of private sector capacity will be promoted – particularly to facilitate fund-raising and risk mitigation for infrastructure projects through developing products and deepening capital markets in the region.
Chiang Mai Initiative Multilateralisation and Asian Bond Markets Initiative: Progress to Date
Let me now discuss two regional initiatives that I think hold a lot promise for the region’s financial integration, namely the CMIM, and the Asian Regional Bond Markets Initiative (ABMI) under the ASEAN Plus Three finance process.
Since the decision by the ASEAN and the Plus Three Finance Ministers of China, Japan and South Korea in May 2009 to launch the US$120 billion swap arrangements under the CMIM by end of this year, the ASEAN Plus Three senior finance officials have been discussing the legal agreement that will operationalise the CMIM. In addition, discussions are also underway on the proposed establishment of an independent regional surveillance unit to support the decision-making process of CMIM.
The legal agreement contains operational details of CMIM such as terms and conditions of drawings, warranties and condition precedents, covenants, etc. To date, countries are working closely with their legal department to ensure that there is no discrepancy between the draft legal text and their national constitution. The draft legal text is scheduled to be finalised by the senior finance officials in November 2009 and signed by the Finance Ministers, hopefully, before the end of 2009. Subject to parliamentary procedure of each ASEAN Member State, the agreement is projected to be fully implemented and CMIM to become effective in the first quarter of 2010.
Of course, to be an effective regional financing arrangement, the CMIM has to be supported by a credible surveillance mechanism. As the region moves toward greater financial integration, the close monitoring of risks and formulation of strategies to deal with emerging vulnerabilities become critical.
Thus, the establishment of regional surveillance for the CMIM signifies further commitment by the region to be closely integrated. This surveillance body is supposed to conduct regional economic monitoring in ASEAN Plus Three countries to facilitate prompt activation of the CMIM. During non-crisis period, it will be responsible for undertaking comprehensive macroeconomic assessment of the region and identifying emerging vulnerabilities through rigorous country consultations and conduct of early warning systems. In time of crisis, the regional surveillance unit will assume a more crucial role in supporting the collective decision-making process prior to any disbursement of funds as well as in monitoring the use and impact of the funds post-disbursement.
As earlier mentioned, a real test of how far the region can go in relation to financial integration can be seen on how deep and liquid local capital markets can become. Since 2003, the region has an active and growing interest in developing local-currency denominated bond markets, and creating more accessible and well-functioning regional bond markets both for issuers and investors.
So far a new ABMI Roadmap has been in place since last year to examine in a comprehensive manner all issues related to ABMI, and consequently to achieve its objectives. Four key areas are to be addressed by the new Roadmap: (1) Promoting issuance of local currency-denominated bonds; (2) Facilitating the demand for local-currency denominated bon
ds; (3) Improving regulatory framework; and (4) Improving related infrastructure for the bond markets. The new Roadmap has been created to speed up implementation of ABMI and produce tangible results. So far, one important and concrete result of the ABMI is the proposed US$500 million Credit Guarantee and Investment Mechanism (CGIM) to be established hopefully by next year, to encourage corporate bond issuance and increase investment in regional bond markets.
Prospects and Challenges of ASEAN Financial Integration
I would like to turn now to the subject of accelerating regional financial integration in ASEAN. As earlier mentioned, ASEAN financial integration has gone a long way, but more efforts are still needed. Given the increasing demands of financial globalisation, the reality is the region has to make sure that the necessary policies and infrastructure are in place so that ASEAN is ready to manage the increasing complexity of financial globalisation. So, how can we enhance regional financial integration in ASEAN?
Looking ahead, the immediate challenge for the region is to keep regional economic integration on track. Coping with globalisation and harnessing the benefits it can deliver will be crucial. As the experiences of Europe and North America suggest, trade integration can serve as an anchor for closer financial integration. As trade barriers continue to be dismantled, firms are likely to increase FDI flows and other financial flows in the region. Consequently, larger FDI flows can lead to a strengthening of domestic financial markets through greater domestic borrowing. The establishment of AEC by 2015 can be a real trigger to the deepening of regional financial integration, not only in terms of capital and financial flows, but also the flow of services, especially financial services. Given the close linkage between trade and financial integration, policies that support both trade and financial liberalisation have to be seriously pursued and coordinated.
Another challenge is for the region to remain committed to financial sector reforms. So far, the region is doing a lot in this area. But given the need to deepen and ensure liquidity in domestic markets, domestic financial policies must be adequately enhanced. Efforts should focus on areas that can establish a liquid and well functioning market for government and corporate debts. These include priorities such as the development of regional benchmark instruments, creation of broader and deeper bond and derivatives markets, and establishment of regionally recognised credit rating agencies. In addition, there is a need to focus on other critical financial policies related to corporate governance, investor rights, and credit information.
Lastly, in as much as the market stresses and risks in global financial markets remain elevated, the challenge is for ASEAN to remain flexible to change, particularly in adopting to new financial stability framework and financial architecture. While this is more of a long-term response, it is important that ASEAN sets its priorities toward greater financial regulatory reforms and enhanced surveillance and policy coordination.
In conclusion, I believe the best possible strategy to spur financial integration is to remain committed to reforms. As I have mentioned earlier, there are huge opportunities and possibilities for the region to achieve financial integration. But these would require unwavering commitment and political will to pursue such integration. At the same time, the Asia and ASEAN will have to stay vigilant to global financial and economic developments and coordinate their policies, especially exit strategies now, to ensure early recovery from the current crisis and return to the growth trajectory that the region is well-known for. Asia and ASEAN can certainly make a big difference to the emerging new global economic order.
I wish your Conference a great success and productive deliberations ahead.