Economic Policies and Global Prosperity: Challenges for Asia and the IMFAddress by John Lipsky
First Deputy Managing Director
International Monetary Fund
Asia Pacific Economic Cooperation (APEC) Finance Ministers Meeting
September 7, 2006
I am pleased and honored to join you on what for me is a day of "firsts"; my first overseas visit as First Deputy Managing Director of the IMF, my first opportunity to participate in an APEC meeting, and my first visit to Hanoi.
Hanoi is an appropriate setting for this meeting, as Vietnam is a notable example of an Asian economy undergoing rapid -- and productive -- change. Beginning in the mid-1980s, policymakers here embarked on an ambitious reform program aimed at liberalizing the economy, with the goal of transforming the previously centrally planned system into a modern, market-based format.
The results of these reforms are clear. Since 1998, Vietnam's GDP growth has accelerated to an annual average rate of 7 percent, or a cumulative 60 percent over that period. At the same time, the poverty rate has fallen by more than half. Among other factors, rising foreign direct investment helped to create the productive facilities needed to make this transformation possible.
In particular, Vietnam's newly-vibrant export sector has played a key role in the economy's impressive progress. As striking evidence of this success, and in keeping with the experience of Vietnam's Asian neighbors, its trade with the rest of the world has risen sharply. With real exports now more than double the 1998 level, Vietnam's share of world exports has more than tripled over the last decade or so.
Prospects for new advances reflect the Vietnamese authorities' plans for sustained sound macroeconomic management, additional market-oriented microeconomic reforms, and the opening of new opportunities through Vietnams' forthcoming WTO accession. In these circumstances, there is every reason to believe that Vietnam can achieve its goal of graduating from low-income status by 2010. My IMF colleagues and I look forward to working actively in support of this worthy objective.
I thought that it would be appropriate to share with you today some observations -- with an Asian emphasis -- about emerging markets in the global economy and in the global financial system. In addition, I would like to offer some remarks about upcoming challenges, and the IMF's plans to help meet them.
Years of achievement
The starting point for my remarks is a striking one: The past four years have been characterized by remarkably rapid and sustained growth in virtually every part of the world. The latest IMF forecast anticipates that global growth will reach about 5 per cent this year, marking the fourth consecutive year in which the pace of expansion has exceeded 4 percent. In this case, 2003-2006 will represent the fastest four-year period of global GDP gains in two decades. At the same time, underlying inflation has remained near forty-year lows, despite sharp increases in energy and commodity prices.
This performance is remarkable, not least because such a favorable outcome was so unexpected. In fact, consensus views following the 2000/2001 global growth slowdown were heavily weighted toward expectations of a mediocre recovery amidst rising volatility in both growth and inflation. Growing divergence in individual country performance was anticipated widely. Thus, a particularly encouraging aspect of the latest period has been the degree to which the improved growth performance has come to be shared across almost all economies.
Of course, this unexpected economic success has been reflected in financial markets. In particular, prices of emerging market assets in many cases have risen to record highs. Perhaps even more striking, international investors have shown unprecedented interest in holding emerging market securities denominated in the issuer's own currency. Thus, emerging market economies' good fundamental performance has justified financial advances that - if sustained - will provide a new boost to economic progress. Let me call this a prospective "virtuous circle".
It's easy to claim — and many have done so — that financial markets have fallen into the grips of "irrational exuberance", especially with regard to pricing in emerging markets. And it would be irresponsible to dismiss the risks out of hand. But the market turbulence of just a few months ago passed with only a limited impact. This has been viewed by some as a warning of more serious trouble to come. I think that the underlying message is different, however, and much more favorable.
One way of interpreting the limited nature of the most recent market gyrations is that a range of reforms, including increased domestic and international market flexibility, has enhanced economic resilience and stability. Much of this progress reflects policy changes adopted by countries — both individually and on a regional basis — in response to the difficult experiences of the late 1990s. Thus, the current favorable environment provides a justification for optimism about the potential impact of new reform efforts, while also providing specific lessons from recent experience.
Indeed, reflecting the reforms in response to the late 1990s crisis, real GDP growth in Asian emerging markets (as defined by the IMF's World Economic Outlook) recovered sharply and accelerated to over 8 percent in 2004 and 2005. Emerging Asia now includes several of the world's fastest-growing economies and three of the world's 12 largest ones, namely China, India, and Korea.
Lessons from the 1990s
Some key lessons emerged from the crises of the mid-to-late 1990s. First was the importance of macroeconomic stability. Underlying policies need to be sound. Budgetary policies need to be fiscally prudent. Public debt burdens need to be low and sustainable. At the same time, monetary policies need to be focused on price stability: It is no coincidence that the strong global growth experienced in recent years has followed a striking reduction in inflation rates in every part of the globe. Between 1980 and 1984 world inflation averaged around 15 percent: by 2005 it was 5.4 percent. Twenty five years ago about two thirds of the IMF's membership—111 countries—had double digit inflation. Last year only 35 countries did.
The crises of the 1990s also underscored the importance of effective microeconomic reform as a complement to macroeconomic stability. The underlying theme is that enhanced economic flexibility — together with stability-oriented monetary and fiscal policies — is the most reliable way to produce well-balanced, sustainable growth. Increasing the role of market forces in both product and labor markets — and reducing overbearing bureaucratic burdens on enterprise and initiative — contribute critically to more rapid growth, given the appropriate macroeconomic framework.
Another lesson is the crucial role played by the financial sector in achieving rapid and sustained growth. Broad and deep financial markets, a well-capitalized and efficient banking system and effective regulation all contribute to strong and sustained growth.
In most cases, national policymakers took these lessons to heart, as did the IMF. Asian authorities, for example, took bold steps to shore up their financial and corporate sectors. Bad loans were written off and excessive leverage was reduced. Supervision and risk management was strengthened. In many countries, banking and financial systems were opened to foreign investment and technical expertise. At the same time, many Asian countries pared back their external debt and adopted more flexible exchange rate policies. Additional reforms boosted these economies' openness to trade and investment. Strong demand growth in key external markets — especially in the United States — also helped to produce a rapid growth recovery. Taking advantage of this favorable environment, many countries built up their international reserve holdings, in some cases to unprecedented levels.
The IMF, for its part, also re-examined many aspects of its structure and practice. For example, the Fund has become one of the most transparent multilateral institutions. Moreover, we sharpened the focus of our surveillance work, concentrating especially on macroeconomic stability and financial sector issues. And we implemented internal restructuring to ensure that the changes in our approach were followed through. Further changes are under way, of course, and I will say something about these in a moment.
The Challenges of Globalizing Finance
The global economic and financial landscape continues to evolve, and with it the policy challenges. The ongoing shifts in global finance are especially dramatic. Since the first half of the 1990s, gross foreign assets held globally have nearly tripled to over $75 trillion. International capital flows continue to surge, with emerging markets in Asia receiving a large share of the total allocated to emerging markets globally. This is partly the result of international investor diversification, reflecting among other things the growing role of new institutions such as private equity funds and hedge funds. Through accumulating large official foreign reserves, Asian economies have also played a role as investors, making them major holders of advanced countries' sovereign bonds. There is no sign that the trend toward increasing financial integration will wane anytime soon: Indeed, the history of financial markets is one of constant innovation.
Thus, financial markets will continue to create both opportunities and challenges. As markets become more efficient at financing investment and handling risk, they contribute to national and global growth. But regulatory frameworks and supervisory arrangements need constant innovation, too, if they are to keep pace with change. Otherwise, economies could miss chances for improved efficiency. At the same time, systemic stability issues need to be understood and addressed through appropriate market structures and adequate oversight.
Policy Challenges for Emerging Market Economies
At the level of individual countries, a key challenge is to harness the benefits of economic and financial globalization while minimizing the accompanying risks. In fact, the requirements are reasonably clear, and they echo the lessons learned from the 1990s. First and foremost are sound fiscal and monetary policies. This includes sustainable debt burdens. In fact, despite progress made in reducing public debt in recent years, in some economies it still exceeds 50 percent of GDP. Solid global growth — such as that anticipated in the IMF forecast — would provide the best possible environment in which to move ahead with fiscal consolidation and to reduce public sector debt burdens. The record level of international reserves in many Asian countries also provides a margin of safety for introducing new policy reforms.
Another challenge is to develop and deepen local capital markets and to integrate them better within the region. Meeting this challenge will allow Asia to make more efficient use of its huge pools of domestic savings. Asia's infrastructure investment needs also are enormous. Nonetheless, Asia's corporate sector — especially small and medium-sized enterprises — still has limited access to financing. Consider that bank assets often exceed 100 percent of GDP in Asian countries, compared with 70 percent of GDP in the United States. By contrast, corporate debt is only 1-5 percent of GDP in many countries, compared with 22 percent of GDP in the United States, 16 percent of GDP in Japan, and 12 percent in the Euro area. Further financial sector reforms could help to lay a sounder foundation for future growth. In particular, Asia's financial system needs to become less bank-dominated, through the development of deeper and broader financial markets. Bond markets remain small compared with those in more developed economies. Derivatives markets are also underdeveloped, making it harder for financial intermediaries and corporations to manage risks flexibly.
A Regional Focus
Asian policymakers have launched several initiatives to advance regional financial integration. For example, the Asian Bond Market initiatives already are starting to spur market development. The introduction of Asian Bond Funds has spurred the creation of local-currency bond indexes. At the same time, steps are being taken to extend benchmark yield curves and improve trading infrastructures. Such moves will boost market liquidity, helping to attract offshore investors.
Moreover, better harmonization of laws, regulations, tax treatment, and market infrastructure could reduce impediments to cross-border bond investment and issuance. Other steps to contribute to the depth and stability of capital markets in the region include strengthening corporate governance, improving transparency, developing institutional investor bases, as well as enhancing supervision and regulation. The agenda is large, but so are the payoffs to well-managed financial development and integration.
Another important initiative for regional financial cooperation is the Chiang Mai Initiative. I welcome this move to enhance policy dialogue and expand regional safety nets because they can assist in strengthening regional surveillance, reduce the risk and severity of liquidity crises, and complement the role of the IMF in promoting global financial stability.
Policy Challenges for the IMF
In this dynamic environment, the IMF also is adopting to new challenges. The Fund's Medium-Term Strategy is being implemented in order to improve the institution's effectiveness. For example, we are responding to the rapidly expanding size and complexity of international financial markets by strengthening our work in this area. We are consolidating our efforts on domestic and international markets in the newly-created Monetary and Capital Markets Department. By this effort, we hope to advance understanding of how financial market development can enhance economic growth and stability.
At the same time, we will be extending our critical work on crisis prevention and crisis resolution. We recently held a dialogue with senior officials of several APEC economies in Korea regarding our Medium Term Strategy. There was enthusiasm for strengthening contacts with the IMF, especially in view of the continuing challenges of improving domestic financial markets and growing cross-border financial flows. I firmly believe that both the IMF and the APEC countries can benefit in many ways from a stronger partnership.
You will recall that when the IMF's Managing Director addressed last year's APEC meeting, he emphasized the need to make voice and representation in the IMF reflect the increasing role of emerging markets in the region. He called such actions essential to the IMF's credibility, legitimacy, and relevance
Substantial progress has been made in the ensuing year to forge a consensus for governance reforms in the IMF, with the cooperation and support of many of those present today. As you are probably aware, the Fund's Executive Board has approved a concrete proposal to be submitted to the Fund's Governors for their approval. The proposal calls for a two-stage approach, including immediate action on quota increases for a small group of countries whose quotas are most clearly out of line with their weight in the global economy. This will be followed up in a two-year timetable for achieving the main objectives of governance reform. These objectives include agreement on a new quota formula, a second round of general quota increases and further quota rebalancing. The voice and participation of low-income countries will be addressed at the same time.
As I noted at the outset, Asia's role in the world economy has increased significantly in the past few years. Emerging Asia's rapid reemergence as the world's fastest growing region following the severe testing of 1997/98 has contributed greatly to the recent strength in global growth.
Despite recent successes, large challenges remain to be addressed in order to maintain Asia's "virtuous circle" of progress. An overarching task is rebalancing the sources of global growth while preserving macroeconomic stability. Sustaining the momentum for reform at global, regional and national levels also will be critical to success. Another essential task is that of reinforcing the multilateral framework of cooperation and coordination that has represented an essential element of the global economy's unprecedented expansion, and from which Asia has benefited so impressively. This includes making sure that the Doha round of trade negotiations reaches a successful conclusion.
The IMF also has a critical role to play in sustaining Asia's progress and reform. As described in the Medium Term Strategy, this will involve actions at the global, regional and national level. With your support, we will make new advances toward our mutual goals when we gather in Singapore in just a few days.