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Financial Integration in Asia, Good Governance, and the IMF, Address by Mr. Takatoshi Kato, Deputy Managing Director of the International Monetary Fund
October 19, 2005
1. I am delighted to be here today and to have the opportunity to address this distinguished audience.
2. The topic of this symposium is timely and important. In today's globalized world, it is a fact of economic life that policymakers need to reform policies and institutions so that countries can benefit more fully from rising flows of goods, capital, and information -- or at least avoid the harsh discipline that markets impose on inconsistent policies and institutional weaknesses. Better governance has thus become a reform priority in many countries seeking a more efficient allocation of savings and less volatile capital flows.
3. There is an obvious global dimension to these gains. More predictable and better intermediated capital flows enhance the performance of the world economy. So it will not come as a surprise to you that the IMF too--as an institution concerned with the stability of the global financial system--has been involved in promoting transparency and accountability in many areas and through a variety of initiatives.
4. I would like to expand on these two themes with a regional perspective in mind. In these remarks, I will focus on institutional reform (including the promotion of good governance) to deepen financial integration in emerging Asia, and on the role that the Fund plays in supporting good governance in member countries.
Asian Financial Integration
5. Let me start with the lay of the land. The integration of Asian financial markets with the global financial system is well advanced. For example, Asia received half of the world's net private capital flows to emerging markets in 2003, and two-thirds in 2004. At the same time, the stunning accumulation of official international reserves since 2003 has turned many Asian countries into major holders of advanced economies' sovereign bonds. These facts are powerful evidence of the close ties between emerging Asia and the global capital market.
6. By contrast, intra-regional financial integration has lagged. For example, the extent to which investors in Asia have internationalized their portfolios by investing in other markets in the region remains quite limited. With a few notable exceptions, money and capital markets in this part of the world are clearly still fragmented and disjoint. The trend is evident across three broad asset classes:
· Data on cross-border banking show that the major foreign lenders in emerging Asia are generally European, Japanese, or U.S. institutions, notwithstanding growing interest in recent years of regional banks in cross-border acquisitions.
· Local stock markets also have a large international presence, but few foreign players come from the rest of Asia. And, foreign listings on Asian stock exchanges have been on a declining trend nearly everywhere.
· Finally, in spite of initiatives underway to promote cross-border holdings, regional integration of bond markets remains underdeveloped by most metrics. According to the Bank for International Settlements, the expanding issuance of foreign-currency-denominated bonds by Asian sovereigns and corporates is for the most part in U.S. dollars--and is marketed outside of Asia.
7. Against this background, the strengthening of financial ties across the region has gained prominence as a policy priority. Besides global shifts in the pattern and composition of trade and in capital flows, an important motivation has been the post-Asian crisis realization that shallow capital markets have had two undesirable consequences. First, emerging Asia has been forced to recycle its savings elsewhere. And, second, local firms have ended up depending excessively on bank intermediation. There is a shared view among Asian policymakers that deeper and interlinked financial markets in the region would go a long way toward containing capital account and balance sheet vulnerabilities.
8. The reasons for this are well-known. Stronger cross-border financial linkages and greater capital mobility hold out the promise of better risk-sharing, a more efficient allocation of capital, more productive investment and, ultimately, more resilient economic growth. Emerging Asia is of course already reaping some of these benefits through its participation in the global financial market. However, more could be gained from further intra-regional financial integration, for example, a virtuous (and growth-boosting) cycle in which larger intra-regional capital flows facilitate the expansion of intra-regional trade--and vice versa.
9. Asian policymakers are rising to the challenge to promote a more efficient allocation of funds within the region. They have launched several initiatives to deepen domestic markets and establish a pan-Asian financial system for countries that lack the minimum scale needed to support liquid national capital markets. Some of these initiatives reflect cooperative efforts, for example, the ASEAN+3 roadmap to develop a regional bond market and the Chiang Mai network of swap arrangements to support exchange rate stability in the region. Others are pursued at the national level, on the sensible premise that strengthening national institutions and policies is simply the best way to foster regional--and global--financial ties.
10. The first order of business has been to lay the groundwork for better functioning financial markets. The political economy of institutional reform suggests that the process will be lengthy, but measurable progress has been made already. In several cases, capital account restrictions no longer stand in the way of cross-border flows. Sources of supply-demand mismatches that have stunted market growth are being addressed, including by fostering the issuance of investment-grade securities, establishing benchmarks for the proper pricing of risk, and relaxing regulations that have held back the participation of institutional investors. It is telling that the capitalization of domestic bond markets in emerging Asia has nearly doubled since 1998 to about 120 percent of regional GDP at present. More remains to be done though. The unfinished agenda includes harmonizing the laws, regulations, tax treatment, and market structures that still prevent investors--from both within and outside Asia--from building pan-regional portfolios. This is difficult and painstaking work, requiring close collaboration among countries and assistance from relevant international institutions and agencies, but it has the potential to produce large payoffs.
11. What is the role of better governance in all this? The short answer is that strengthening governance in private and public institutions is an essential element of the reform strategy. In a closely interconnected global economy, investors are ever more demanding and discriminating. Better corporate governance is essential to promote the development of deep and liquid--and hence more stable--financial markets and create a favorable investment climate. While some Asian jurisdictions already employ standards and practices in line with international norms, full compliance will require, in many cases, more changes to national legal and regulatory frameworks.
12. The unfinished agenda is long. Priorities include enhancing information disclosure and accounting standards, strengthening the role of minority shareholders, supporting effective creditor rights, tightening the prudential supervision of financial firms, and strengthening court processes and the judicial systems. Advances already made in corporate-governance rules and financial regulation need, of course, to be supported by more vigorous implementation and enforcement. With better governance structures in place, investors will have greater confidence in the rules of the game and markets will hopefully be better insulated from government interference. In short, financial stability and efficiency will be boosted--locally and globally.
The Role of the IMF
13. Let me turn now to the role of the IMF in this process. Consistent with our mandate for promoting macroeconomic and financial stability, and in light of the critical nexus between financial and corporate sector health and macroeconomic stability, we at the Fund have been paying increasing attention to the promotion of transparency, accountability, and good governance in our member countries since the Asian crisis. Accordingly, concerns about governance issues influence significantly the Fund's policy advice in many areas -- such as strengthening revenue administration, enhancing the financial accountability of state-owned enterprises, consolidating extra-budgetary funds into the budget, reinforcing central bank independence, and improving bank supervision.
14. The promotion of good governance in public and private institutions is at the heart of two initiatives conducted jointly by the Fund and the World Bank--the Financial Sector Assessment Program (or FSAP) and the Reports on the Observance of Standard and Codes (or ROSCs). Participation in either initiative is voluntary.
· The FSAP provides a comprehensive review of a country financial sector by a team typically from the Fund, the World Bank, and national central banks and supervisory authorities. 72 out of 184 IMF members have participated in the exercise as of June 2005 and many have posted the results on the IMF external website [see http://www.imf.org/external/np/fsap/]. Important weaknesses have been identified in some countries and the supervisory authorities are using these diagnoses to strengthen their systems. Since April 2001, the Fund has also assessed efforts to counter money laundering and terrorism financing. Technical assistance in these areas is being provided to bring national frameworks up to best practices.
· In addition, together with other relevant bodies, the Fund has developed international standards and codes of conduct. These now cover a wide variety of policy areas including statistical dissemination, monetary and fiscal policy transparency, and banking supervision, as well as accounting, creditor rights, and corporate governance. Information about the implementation of these codes and standards is being published, on a voluntary basis, in ROSCs for individual countries [see http://www.imf.org/external/np/rosc/rosc.asp]. About two-thirds of the IMF's membership has participated in the initiative by having at least one standard assessed. The further development and monitoring of these codes and standards provides a potentially important mechanism through which countries can calibrate and develop their financial and economic infrastructures to international benchmarks.
15. Admittedly, the record of Asia's participation in the FSAP and ROSC initiatives has to date been disappointing.
· Only seven countries (India, Korea, the Philippines, Sri Lanka, Singapore, Bangladesh, and Japan) have had FSAPs to date. The overall take-up rate of less than 25 percent for countries in region has been about half the average across all IMF members.
· As regards the ROSCs, at 50 percent, the participation rate in the Asia and Pacific region (which in the IMF taxonomy includes Australia and New Zealand as well as a number of island economies) trails that of nearly all the other regions of the world.
On balance, this uneven performance suggests that there is still some way to go before the benefits in terms of an improved investment climate are fully recognized across the region. And it also suggests the importance for cooperative fora like this one to turn up the peer pressure on members that have not stepped up yet to the challenge of embracing greater transparency in their institutions and policies.
Concluding Remarks
16. The promotion of good governance is a common element of both Asia's strategy to achieve deeper financial integration and the IMF's mandate to foster global financial stability. This is to be expected. From both a regional and a global perspective, a sound governance framework for private and public institutions is indeed a critical building bloc of sounder and more resilient financial systems.
17. I see the issue of improving the workings of financial systems in Asia as being a key area for IMF engagement with the region in the coming years. An important initiative in this regard has been a recent high-level seminar on Asian financial integration, jointly sponsored by the IMF and the Monetary Authority of Singapore, which brought together senior policy-makers from across the region to discuss the challenges of Asian financial integration. I expect that the issues flagged in that seminar -- and touched upon in my earlier remarks -- will provide a focus for the IMF's future analytical work and technical assistance in the region. And I hope that countries in the region will make full use of existing IMF-World Bank initiatives -- notably the FSAP and ROSC instruments -- to benchmark themselves against best practices and identify reform priorities for their financial sectors.
18. Thank you for your attention.
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