Speech

"Reflections on Macroprudential Policy" By Naoyuki Shinohara, Deputy Managing Director, International Monetary Fund

January 23, 2014

As Prepared for Delivery

I am very pleased to join you today for this joint AMRO-IMF seminar and would like to express my appreciation to Mr. Yoichi Nemoto, Director of AMRO, along with colleagues participating in the just concluded ASEAN+3 working level meeting and all of the other colleagues who have worked together to foster closer collaboration between the IMF and AMRO. The topics under discussion at this seminar—the promotion of local currencies in Cambodia, Lao PDR, Myanmar and Vietnam, and macroprudential policies—are timely and important, and I am very pleased to be able to participate.

This seminar is a concrete result of the call made by ASEAN+3 ministers and governors last April in New Delhi for closer engagement between AMRO and the IMF. Their communiqué called for an “effective cooperative relationship with the International Monetary Fund and other multilateral financial institutions in the areas of surveillance, liquidity support arrangement and technical cooperation.”

We at the IMF have welcomed this call. I am very pleased at the initial progress that Fund and AMRO staff have made in recent months to expand their working relationship, including exchanging views and sharing information in surveillance, research, and other areas of common interest. I sincerely hope that today’s seminar will mark the beginning of annual events on macroeconomic and financial issues in ASEAN+3 that are of interest to both institutions. In particular, we hope to contribute to the discussion of the growing financial and economic integration within Asia and the ASEAN Economic Community, once it is launched in 2015.

Before turning to the issues that are being discussed at this seminar, I would like to take a moment to set today’s discussion in the broader context of trends in the global economy.

The Global Outlook

Last September marked the five-year mark from the collapse of Lehman Brothers, which triggered the worst financial crisis the world has seen in decades. We have made a lot of progress since then, but there is still a lot of work to do. The latest update to the Fund’s World Economic Outlook, released just two days ago, shows that global activity strengthened in the second half of 2013. This trend is expected to improve further in 2014-15, driven largely by recovery in the advanced economies. But global growth remains below potential—the level consistent with economic health and full employment.

• Despite the progress in advanced economies, labor markets are weak and unemployment remains unacceptably high. The waste of human potential and skills is a profound problem. The slack in advanced countries also raises the risk that inflation will run below levels consistent with price stability. The specter of deflation, of course, is very dangerous—something Japan understands well.
• Emerging markets are cooling off somewhat after providing the engine of global growth in the post-Lehman Brothers period. They are facing rising risks, including from the unwinding of domestic imbalances, such as credit booms and weakened fiscal and external positions.
• Low-income countries, which have been a bright spot in the global economy in recent years, face the challenge of becoming more resilient to shocks by building sufficient buffers and raising more revenue.

Asia’s Prospects

Here in Asia, the economic outlook remains robust, although risks are concentrated on the downside. The IMF estimates that Asian growth hit about 5 percent in 2013, and will rise to about 5¼ percent in 2014. Domestic demand, which has been driving growth in recent years as external rebalancing gathered steam in many countries, has been more subdued lately. This is the result of tighter financial conditions and, in some cases, policy or political uncertainty. But demand should remain healthy overall. Financial conditions remain generally supportive even after the recent tightening, and labor markets have been resilient.

Asian exports picked up in recent months, but growth prospects in the continent will be contingent on sustained recovery in the advanced economies. Inflation is expected to remain low, with the major exception of India and, to a lesser extent, Indonesia. However the region was not spared the re-pricing of financial assets and the wave of capital outflows from emerging markets in spring-summer last year. The overall impact so far has been manageable, although some countries have been subject to greater stress. On specific countries,

• Japan’s growth will remain above trend as the contractionary effects of the consumption tax hike are offset by the latest fiscal stimulus.
• China’s growth rebounded in the second half of 2013 and should remain robust this year. It likely will moderate marginally as measures to cool credit expansion dampen investment.
• India’s growth is expected to firm on policies supporting investment and a favorable monsoon, but it will remain below trend.
• In ASEAN, some countries (including Malaysia and the Philippines) registered healthy growth in 2013, and their prospects appear sound for 2014. But Indonesia is projected to slow largely as a result of recent monetary tightening.

Looking forward, tighter global liquidity––and homegrown structural impediments in some countries––will weigh on growth. But the overall impact should be partly offset by a gradual pickup in exports to advanced economies and by domestic demand. If conditions tighten further, we likely will see greater differentiation across the region. Countries with strong fundamentals and credible policies will be able to offset tighter global credit with lower policy rates and fiscal support. Those that have delayed reforms, leaving fiscal vulnerabilities untackled, or tolerating too-high inflation may be forced to respond with pro-cyclical tightening. Announcing credible medium-term reforms would rebuild confidence and ease policy trade-offs.

Turning to the topics covered in your seminar, the use of local currencies in Cambodia, Lao PDR, Myanmar and Vietnam was well covered this morning. So I would only add that the issue is important, but under-researched. I am sure the discussion has shed useful light on the factors behind the use of multiple currencies (commonly referred to as dollarization) and how to promote national currencies. History and confidence effects play a big role in dollarization’s emergence, as do expectations about the stability of national monetary standards. These, in turn, are directly linked to the emergence of credible and independent central banks.

Macroprudential Policy in Asia

Turning to macroprudential policies, the financial crisis of the past half decade has underscored the costs of systemic instability at both the national and the global levels. It has also highlighted the need for dedicated macroprudential policies to safeguard financial stability.

As the fastest-growing region of the world, Asia is likely to remain a key destination for capital flows over the medium term. Nevertheless, as I already said, the region faces challenges, and many have direct implications for macroprudential policies.

Among the key issues, the implications of financial liberalization in China will be significant and difficult to predict. Increased volatility of cross-border capital flows will continue to preoccupy policymakers, especially as the advanced economies undertake future changes in unconventional monetary policies. Along with the need for deeper financial markets in Asia, further development of macroprudential policies and enhanced analysis of their use would be important to reduce vulnerabilities. They would enhance the resilience of financial systems in the face of volatile capital flows.

As you know, the macroprudential approach to financial regulation is not new to Asia. Since the Asian Crisis, many countries have devoted greater attention to financial regulation and supervision to avoid threats to financial stability. This approach enabled Asia’s bank-dominated financial systems to have come through the global financial crisis generally unscathed.

Asian policymakers have proactively used macroprudential instruments to address emerging vulnerabilities in such areas as housing and foreign liquidity related measures.

In particular, many ASEAN+3 countries have deployed targeted and escalating macroprudential policies to stem vulnerabilities related to rising home prices and other asset market exuberance. This has taken place in an environment of low global interest rates, surging capital flows to emerging markets, and rapid domestic credit growth. These measures targeted such areas as mortgage loans, car loans or credit card loans deemed at risk. Overall, as I said earlier, these measures have helped address vulnerabilities.

Enhancing the Effectiveness of Policy Tools

A key question now confronting Asia is how to enhance the effectiveness of macroprudential policy tools without damaging the free flow of capital or efficient allocation of capital and to limit their other potential side effects. The challenges can usefully be broken down into several key steps that include:

• Developing the capacity to assess systemic risk;
• Assembling and calibrating the macroprudential toolkit;
• Communicating clearly with the public and markets;
• Monitoring and closing regulatory and data gaps; and
• Setting up appropriate institutional frameworks.

In the Asian context, key deficiencies appear to include closing existing data gaps, assessing systemic risks, and enhancing regional and international cooperation.

• Assuring access to the appropriate data and information is critical for policymakers to properly perform the other tasks required to make macroprudential policy operational.
• Closer analysis of the build-up of vulnerabilities is essential, especially in the context of financial sector interconnectedness. For this to happen, further progress is needed in establishing early warning systems, and developing the technical capacity to analyze systemic risk.
• Regional and international cooperation in the area of macroprudential policy has become all the more important as Asia becomes more integrated with the global system through finance and trade. Even when each country’s macroprudential policy is optimal at the national level, policies may be suboptimal when financial cycles are not synchronized across countries, or systemic intermediaries can evade policy actions taken by national authorities.

While effective macroprudential policies are essential to limit systemic risk and reduce the likelihood of future crises, they cannot be expected to prevent all future crises. Alone, they are unlikely to contain risks driven by real imbalances. Macroprudential policies must be supported by strong supervision and enforcement, and complemented by appropriate monetary, fiscal, and other financial sector and structural policies.

Authorities also should take into account potential unintended policy consequences; for example, the impact on trade finance and financial deepening. Here, appropriate macroeconomic policy could reduce overburdening macroprudential policy, and promote better understanding and monitoring of the transmission mechanism through which macroprudential policy influences the economy.

Addressing Spillover Effects

Finally, Asian countries should consider how macroprudential policy could help address potential spillover effects from exiting unconventional monetary policies. Just as they may have helped offset the risks associated with capital inflows, it is worth exploring whether macroprudential policy may help limit the adverse consequences of a reversal of inflows.

Developing macroprudential policy will remain a work in progress. So I hope today’s seminar will contribute to better understanding of how macroprudential measures have been used in Asia, how to improve these policies, and how other regions can learn from Asia’s experiences.

The IMF, in cooperation with international partners and national authorities, is ready to help advise on the development and implementation of effective macroprudential policies in Asia in light of experience here and elsewhere.

Conclusion

Let me close by reiterating that policymakers should be mindful that macroprudential policy, like any public policy, is not free of costs. There inevitably may be trade-offs between the stability and the efficiency of financial systems. For instance, by requiring financial institutions to maintain a high level of capital and liquidity, policymakers may enhance systemic stability. But they also can make credit more expensive and lower economic growth. Balancing these benefits and costs require difficult judgments.

With all this in mind, I would underscore the importance of increasing collaboration between the IMF and the AMRO. This will make the two institutions stronger and serve Asia more effectively. I am pleased that we are off to a very good start. With this, I wish you good luck in your endeavors and will eagerly await to hear your views during the course of the seminar.

Thank you.