Naoyuki Shinohara
Naoyuki Shinohara

Remarks by Naoyuki Shinohara at World Economic Forum - Investing in East Asia

Deputy Managing Director, IMF
Manila, Philippines
May 21, 2014

I am pleased to address this gathering, which brings together members of the investment community and representatives of the business sector from across the Asian region.

In recent decades, East Asia has enjoyed high investment rates. Following a period of deleveraging after the Asian financial crisis, investment as a share of GDP recovered to levels that on average exceed those in other parts of the world. This has helped to propel growth, making the region one of the most dynamic in the world. A sizable part of this investment has taken the form of increased equity stakes by foreign firms with controlling interests—that is, foreign direct investment. Increasingly, FDI is being sourced from elsewhere within Asia, helping to develop the region’s production supply chains.

What do future prospects for investment in East Asia look like? Let me discuss the cyclical and structural considerations in turn.

In the short term, the regional investment outlook will be affected by monetary policy decisions both within and outside the region.

Normalization of monetary policy in the U.S.—initially by further winding down of the Fed’s bond purchase program, and later through increases in the Fed funds rate—is expected to lead to higher global interest rates and the rebalancing of investment portfolios. However, while global real interest rates will increase from current exceptionally low levels, analysis in the IMF’s recent World Economic Outlook concludes that long-term real rates are unlikely to revert to levels seen in the early 2000s. This reflects major persistent changes in global saving and investment behavior, including large savings in emerging markets, increased demand for safe assets, and lower investment activity in advanced economies since the global financial crisis. With real interest rates likely to remain relatively low on a sustained basis, credit conditions would continue to support investment. Moreover, if real interest rates remain below GDP growth rates, some increase in debt-financed public investment will be feasible without raising the government debt-to-GDP ratio.

To help moderate capital flow volatility during this period of U.S. monetary policy normalization, some emerging markets are striving to rebuild their fiscal space. This too can affect the region’s investment outlook if public budgets for infrastructure spending are trimmed back. On the positive, however, lower fiscal deficits would reduce crowding out and free up financing for private sector investment.

While the U.S. is tightening financial conditions, other major central banks across the world are continuing to pursue accommodative polices. By raising medium-term growth prospects, the Bank of Japan’s Quantitative and Qualitative Easing program is expected to not only foster higher investment in Japan, but also to create new investment opportunities in Asian countries that export to Japan. Already there is evidence of stepped up financial and FDI outflows from Japan into several ASEAN countries.

Domestic and international political uncertainties and tensions are once again on the radar. Elections are on the political calendar in several Asian countries, while in others, political tensions have dampened investor sentiment. Global or regional geopolitically-related disruptions could be transmitted along regional supply chains, reflecting the fact that regional business cycles have become more synchronized through greater trade integration.

Turning now to longer term, structural influences on investment, the region is characterized by considerable diversity—in per capita incomes, speed of aging, quality of infrastructure, strength of business environments, to name a few—and this diversity presents both opportunities and challenges for investors.

Emerging Asia, excluding China, faces large infrastructure needs. According to some estimates, these needs could reach as large as US$8 trillion, and is evident in the relatively low scores on infrastructure that Emerging Asia receives in international competitiveness comparisons. Inadequate infrastructure acts as a bottleneck to growth and could cause some countries to become stuck in a middle-income trap. Emerging Asia’s burgeoning middle calls also presents enormous investment potential to meet increased demands for quality housing and consumer goods. As the region becomes older, calls to strengthen social protection, including for old-age pensions, are likely to increase. To the extent these schemes represent a claim on government resources—as in the case of a defined-benefit, pay-as-you-go pension system—governments may face difficult trade-offs between investing to support future growth and responding to pressing social needs. In this context, public-private partnerships can be a viable strategy for raising infrastructure investment without unduly burdening government budgets, provided the investment climate—including quality of governance—is sufficiently attractive to the private sector and fiscal risks are clearly identified and well managed.

Asia is also facing a significant demographic divide. Population aging is looming in China and several advanced Asian economies, including Japan and Korea, while some emerging Asian economies continue to enjoy significant demographic dividends from rising working age populations. Generally speaking, countries with older populations tend to be net savers, while those with younger populations or a large proportion of elderly people tend to dissave, consistent with the life cycle model of consumption. However, a range of macroeconomic and other factors is also likely to influence saving behavior.

Demographic considerations will also impact investment demand. Countries with a shrinking workforce will tend to have a rising capital-labor ratio and hence a declining marginal return on investment. Similarly, those economies with an expanding workforce can expect investment returns to grow. This suggests that economies with relatively abundant physical capital would wish to invest in economies where labor is relatively plentiful. [On the other hand, physical capital is often considered a complement to human capital, implying that investment will be most productive where skill-augmented labor is abundant.]

Thus, East Asia faces the challenge of how to ensure the region’s savings are efficiently allocated to meet regional investment needs—both within and across borders—while also avoiding boom­bust cycles, which are a key driver of stagnation at middle income levels. Doing so would benefit both capital exporters and importers. Deeper financial integration through strengthened cross­border links, longer duration financing vehicles, and avoiding misallocation of resources would help deliver these goals. This is compatible with the ongoing process of financial integration in the context of the ASEAN economic community, and will help ensure that realizing East Asia’s vast investment opportunities continues to support dynamic and sustained economic growth.

I look forward to your discussions here today, and trust they will not only benefit those in this room, but also all the people of Asia. Thank you.


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