Speech

Address by Michel Camdessus
Managing Director of the International Monetary Fund
at a conference sponsored by the Hong Kong Monetary Authority and the IMF on
"Financial Integration in Asia and the Role of Hong Kong"
Hong Kong, March 7, 1997

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Thank you, Ministers, Governors, ladies and gentlemen. I would especially like to thank Governor Patten for his welcome and Mr. Yam and the Hong Kong Monetary Authority for their generosity in cosponsoring this conference with the IMF.

The theme of my remarks this morning is globalization. Hong Kong is an ideal location to discuss this topic, since many of the East Asian economies, and Hong Kong in particular, represent the very essence of globalization—open, dynamic economies that continue to amaze the world with their rapid economic growth and development. It is this success—the so-called "Asian miracle"—that so many countries the world over are trying to emulate today. I would add that today’s discussion takes place less than 120 days before the resumption of Chinese sovereignty—a historic event that highlights the benefits of combining further world economic integration and local adjustment within a sound policy framework.

It is plain to see that globalization has changed Asia’s role in the world. Less obvious, perhaps, are the changes that globalization is bringing about within Asia. What does the increasing integration of world trade and financial markets mean for Asia? What are the key challenges for Asian policymakers arising from globalization? And what can Asia, as a region, do to enhance its bright prospects in the global economy? These are the questions I would like to discuss with you today. I will then turn to the role of Hong Kong and explain why I have great confidence in the bright future of this city and its people.

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Clearly, globalization has had a major impact on Asia’s role in the world economy. As recently as a decade ago, the developing countries of Asia accounted for only one-sixth of world output. But with many countries in the region having followed sound domestic economic policies, mobilized large amounts of domestic savings, and attracted substantial private capital inflows, Asia, excluding Australia, Japan, and New Zealand, now accounts for about one quarter of world GDP on purchasing power parity-adjusted terms. On this trend, the region could account for one-third of world output by the year 2005.

Similarly, over the last decade the developing countries of Asia have seen their share of world exports nearly double, to about one-fifth of the total. These countries are also taking a growing share of industrial country exports, a factor that helped cushion the impact of successive recessions in industrial countries during 1990-93. These developments have been very positive, not only for Asia, but for the global economy as a whole.

But what of the changes that globalization is bringing about within Asia? To begin with, there is an ongoing transformation in the composition of production and trade as the comparative advantage of many Asian economies continues to change. In particular, economies with relatively high wage costs are shifting toward higher value-added products, including services. The shift of labor-intensive manufacturing out of Hong Kong into mainland China and the associated boost to Hong Kong’s economy from the growth of trade and financial services is perhaps the most dramatic example of this process.

Similar trends are also evident in the financial area. The continued growth in net private capital inflows to the region—to over $100 billion in 1995, or well over half of total private capital flows to developing countries—has been accompanied by a change in the composition of these flows. Between 1990 and 1995, foreign direct investment in the region increased more than fourfold. Portfolio investment flows have also risen dramatically and, in the process, have helped deepen domestic capital markets in Asia. In fact, in some countries the relative size of the equity markets now matches that in many industrial countries. For example, in Hong Kong, Malaysia, and Singapore, stock market capitalization as a share of GDP, exceeds that of France, Germany, and Italy.

At the same time, financial flows within the region have become more significant. True, the developing countries of Asia still rely heavily on London and New York to intermediate foreign savings to the region. But Japan is, and is likely to remain, the world’s largest exporter of capital, and the far-reaching reforms recently announced by the Japanese government are likely to enhance Tokyo’s role as an international financial market. Moreover, Hong Kong and Singapore—with their well-capitalized banks, efficient clearing and settlement systems, and expanding range of financial products—have also emerged as major financial centers. Increasingly, these centers are intermediating savings within Asia, as well as channeling saving to Asia from other parts of the world. In particular, Hong Kong is the main conduit for investment in China and arranges a significant proportion of Asia’s syndicated borrowing. Singapore, for its part, has evolved into the main banking center for Southeast Asia.

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What do these trends—Asia’s increasing integration into the global economy, on the one hand, and its increasing regional integration, on the other—suggest for the future? Although a number of countries in the region face some important policy challenges, their record to date suggests that they will make the necessary policy adjustments which have been the secret of their success, enabling them to continue to perform well.

In this connection, I would note that the recent slowdown in economic activity in east Asia represents primarily a cyclical correction that is not expected to be deep or prolonged. Indeed, in a number of cases, the slowdown has been a welcome response to policy tightening aimed at reducing inflationary pressures. However, the slowdown has been accentuated by a weakening of the external environment and, hence, in export demand. This has left some countries in the region with high current account deficits, suggesting a need for further policy correction.

But beyond these short-term developments, increasing trade and financial sector integration—in the global economy and in the region—offers enormous potential benefits, but will also pose new challenges for Asian countries. Why? First, because as these economies develop, their comparative advantages will continue to change. Moreover, these changes are likely to occur more rapidly in a globalized economy. Thus, efficiency and flexibility will become all the more important for continued economic success. Second, as the trade and financial links within Asia intensify, developments in one economy will have a larger impact on the others. Accordingly, individual economies will have an increasing interest in the economic stability and prosperity of the others. Of course, this is also true at the global level, particularly as Asia’s share in the global economy increases.

In my view, these considerations point to challenges in three related areas: trade, financial flows, and regional cooperation. Let me say a few words about each.

First, on trade. Here in Hong Kong, there is no need to preach the merits of open trade regimes. Although a number of countries in the region still have someways to go on trade liberalization, much of Asia’s dynamism can be traced to the openness of its economies, and to the competitiveness and transfer of technology that this openness has encouraged. Countries that have yet to open their economies significantly should do so, so that they too can reap these benefits. By the same token, countries that have already benefited from trade liberalization must ensure that the openness that has served them so well in the past is extended to the new trade frontiers, notably services. At the same time, it will be important to increase transparency and the free flow of information on which the service and financial sectors—and, indeed, the modern economy—depend. And as production shifts to higher value-added products, countries will need to develop effective "exit" policies for noncompetitive industries.

These structural changes will inevitably require other adjustments, as well. To sustain growth, a number of countries will need to improve their infrastructure, especially in transportation, telecommunications, and power supply. The challenge will be to do all of this without unduly straining public finances or external positions. In this regard, private sector participation can be very helpful, although some countries will need to increase the transparency of their regulatory regimes and clarify pricing policies in order to attract substantial private interest in such investment. In any event, the public sector is likely to continue to have a role to play in the development of infrastructure. This, in turn, points to the need to strengthen public finances by reducing outlays in other, less productive areas, such as military expenditure.

Meanwhile, it will be important to ensure that regional trade initiatives are compatible with further global trade liberalization. In this regard, I am optimistic that Asia’s emphasis on a cooperative approach to trade matters will complement and enhance the global framework being developed through the WTO.

Second, the challenges in the financial area. At the domestic policy level, there is no substitute for stable macroeconomic policies—policies that give confidence to financial markets and attract private savings. Likewise, transparent and predictable regulatory policies, and a reliable legal framework are essential ingredients in creating a favorable investment climate. Certainly, Hong Kong’s record shows the value of such policies.

But the quickening pace of financial innovation and integration raises other challenges, as well. To begin with, the presence of large capital inflows reduces the room for policy maneuver and limits the scope for policy mistakes. Moreover, financial sector reforms and increased access to international markets expose domestic financial systems to new risks. In many countries, in Asia and elsewhere, prudential regulation and supervision have not kept pace with the new complexities of thebanking business. If left unaddressed, this gap could pose dangers for domestic and external stability. Indeed, all countries must be vigilant about the strength of their banking systems, so that the monetary authorities can tighten policy when needed, without fear of aggravating banking sector problems.

Beyond this, Asia needs a stronger, more dynamic financial infrastructure that can handle the increasingly complex intermediation requirements of the region. As Mr. Yam has observed on several occasions, Asia still relies significantly on European and North American financial markets to intermediate its huge savings pool. I have no doubt that Asia’s major financial markets—Tokyo, Hong Kong and Singapore—will continue to grow. This, and the development of other financial centers, such as Shanghai, Bangkok, Kuala Lumpur, and Seoul, will eventually create a network of modern financial centers in Asia that will help meet the region’s immense financial intermediation needs.

Third, the challenges for regional policy coordination. With countries becoming more closely integrated, each country has an increasing stake in the sound policies of the others. Accordingly, countries of the region can play a constructive role in encouraging each other to maintain sound policies. The swap arrangements among a number of Asian central banks are a good example of constructive cooperation to maintain regional stability. Certainly, it would be worthwhile exploring how such initiatives can be further developed. Moreover, the effectiveness of bank supervision will be enhanced by greater cooperation between national supervisors in the region, as part of the development of a more global approach to such issues. In this regard, I also welcome the membership of several newly emerging market economies in Asia in the Bank for International Settlements, as well as their full support for the strengthening of the surveillance role of the IMF, strongly endorsed by the Interim Committee.

Clearly, there is a broader need to reduce risks in the global economy and strengthen financial safety nets. Of course, whenever a country faces a difficult situation, whether the problem is of a short-term nature or a more fundamental disequilibrium, the Fund is ready to help with policy advice—and with financial assistance, if warranted. Toward this end, our strengthened surveillance leads us to give greater attention to capital account developments, the soundness of domestic banking systems, the quality and timeliness of data countries released to the public, and other issues of particular relevance to emerging market economies, including those in Asia.

We are also taking steps to ensure that the Fund has the necessary resources to fulfill its mandate. In this regard, I welcome the participation of several Asian economies in the New Arrangements to Borrow, which will double the credit lines available to the IMF to deal with exceptional situations that may threaten theinternational monetary system. These resources could become a key supplement to the Fund’s own resources in a time of systemic crisis. But they cannot support the Fund’s normal operations—nor should they. The Fund is a cooperative institution based on quotas, and its strength and credibility depend on maintaining its quota strength. To this end, the membership will soon be deciding on a quota increase, which I believe will need to be substantial.

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I have outlined what I believe globalization means for the emerging market economies of Asia. You will have noted that globalization makes imperative not only the maintenance, but also the continued expansion, of a network of well-equipped, first-class regional financial centers. This is why the IMF sees as essential the contribution Hong Kong will have to continue to provide in the future to the prosperity of Asia. Let me conclude with a some more specific remarks on Hong Kong.

Hong Kong is a prime example of an economy that has managed rapid structural transformation in an increasingly integrated world economy in a most successful way. And indeed, its history, geographic location, openness to trade and importance as a financial center all point to its critical interest in continued global integration—an interest that is shared in China, in the region, and in the rest of the world. Let me mention briefly the ingredients of its success and explain why I have confidence—not only in Hong Kong’s future—but also in its increasing contribution to global integration and prosperity.

First, its long record of sound policies. Hong Kong’s prudent monetary policy built around the exchange rate link to the dollar and supported by a tight, rule based fiscal policy has created an environment of macroeconomic stability and investor confidence. The Joint Declaration and the Basic Law, which together enshrine the principle of "one country, two systems" provide confidence that this policy framework will continue. And the arrangements for the Hong Kong Monetary Authority and the People’s Bank of China to operate as two mutually independent, but cooperating, monetary authorities have been wisely and clearly established.

As you know, the IMF generally visits each of its member countries at least once a year to review its economic policies, performance, and prospects. In the IMF’s annual review of Hong Kong’s situation and prospects, completed only two weeks ago, the IMF Executive Board strongly endorsed this policy framework; I am also pleased to confirm that these consultations will continue on a regular basis after the transfer of sovereignty.

Second, its flexible product and labor markets. The lack of flexibility, especially in labor markets, is the "Achilles heel" of many advanced economies. This has not been the case in Hong Kong. Indeed, the entrepreneurial and management skills of the people of Hong Kong are second to none.

Third, the openness of its economy. With a free port and no capital controls, Hong Kong is one of the most open economies in the world. China is also moving toward greater openness: the renminbi now trades on a market basis in China, and exchange controls on current transactions have been eliminated. But I do not believe that China will want to stop there; of course, prudence is in order in view of the complexity of the issues still to be resolved, but the Chinese authorities know quite well that the sooner China moves to fuller trade liberalization and creates the conditions allowing for the progressive liberalization of all capital transactions, the more it, too, will benefit further from globalization. One can easily see how promising these converging trends in China and Hong Kong are.

Fourth, the steps being taken to ensure that Hong Kong continues to develop as a world financial center. Hong Kong’s prudential supervision is already of the highest standard; banks are highly capitalized; and official foreign exchange reserves are large by any standard. Thus, Hong Kong is well placed to deal with any pressures that may arise.

Fifth, Hong Kong’s sound legal and administrative framework, the neutrality of its civil service, the impartiality of its judicial system and its freedom of information. All have been critical to Hong Kong’s economic success to date and will remain so in the future. Here, I salute the wisdom of the Chinese, British, and Hong Kong authorities for incorporating these principles into the Joint Declaration and the Basic Law.

And sixth, the continued economic development of the mainland. This vast market provides excellent trade and investment opportunities for Hong Kong, just as Hong Kong’s own dynamism will provide further impetus for China’s growth and development.

Let me conclude by noting that transitions always present some degree of uncertainty; that is their nature. But the remarkable wisdom of the Chinese, Hong Kong and British authorities in devising the "one country, two systems" approach will help ensure that the transition runs smoothly and the uncertainty is short-lived. IMF and World Bank members will have the opportunity to see the "one country, two systems" approach in action in September, when they come to Hong Kong for the 1997 Annual Meetings.

You can be sure of our continuous interest, which will manifest itself in the future, as in the past, in the framework of our yearly consultations. I would be delighted if my remarks were to make you share my confidence that in the future Hong Kong will continue to play a leading role—in the framework of the new, faithfully implemented arrangements—in promoting Asian prosperity and integration into the world economy.