Choongsoo Kim: Asia's role in reviving global growth and financial
stability
Dinner speech by Mr Choongsoo Kim, Governor of the Bank of Korea, at the international
conference organized by the Asian Development Bank, the Institute of International Finance,
the KB Financial Group and the Institute for Global Economics, Seoul, 17 May 2012.
* * *
Good evening, ladies and gentlemen.
It is a privilege and a pleasure for me to speak here this evening. I am extremely grateful to
Chairman SaKong for inviting me.
As we have just enjoyed some splendid food, to boost our health and energy, I hope that my
address now may serve as substantial food for thought for everyone in this room. I may risk
ruining your appetites for dessert and coffee, but being a central bank governor, as you
know, it is my job to take away the punch bowl when the party gets going.
I would like to first briefly review recent economic and financial developments in the global
economy, before addressing the challenges and opportunities faced by Asia in repositioning
itself in the new global financial scene.
I. Where do we stand?
After four years of financial turbulence and economic uncertainty, the global economy is still
in trouble, despite some signs of recovery from the fallout of the global financial crisis. The
global economic outlook is improving only slowly, and the pace of recovery is uneven across
regions. The US economy appears to have turned the corner, with improved risk appetite
and real activities, while Asia is leading world economic growth, albeit at a level below its
potential so far.
The euro area, on the other hand, has yet to escape the specter of its twin crises and
stagnant growth. Given its sheer economic size and dominant share in global banking, the
euro area has been the major source of risk to global growth and financial stability over the
past two years or so. The recent large-scale liquidity operation by the ECB, the so-called
LTRO, has helped to calm the financial markets and stabilize sovereign debt dynamics, at
least temporarily. The LTRO's purpose, as I understand it, is to buy precious time for the
conduct of necessary fiscal reforms and bank restructuring.
Unfortunately, the positive effects of the LTRO seem to have been waning recently. The
sovereign spreads of the highly-indebted countries are on the rise again, while the abundant
liquidity is being hoarded by banks amid little signs of any increase in lending. I hope that the
time bought by the ECB through the LTRO is used wisely, to put an end to the fiscal crises
and the resultant financial instability.
A natural question at this juncture would be how to consolidate the financial gains achieved
so far, and what to do to pull the world economy out of its current troubles. I think revisiting
the dynamics of the global financial crisis, and the ensuing fiscal crises in advanced market
economies - or AMEs in short - could offer us clues to help answer these questions.
II. Reversing the direction of real-financial and cross-border linkages
Let me be more specific.
Some eighty years of macroeconomic research and policy lessons guided us to the
deployment of extraordinary monetary and fiscal stimulus measures in response to the global
financial crisis, and these policies did pay off by enabling us to avoid another Great
Depression. Success was short-lived, however, as the world economy instead fell into the
Great Recession. Adverse feedbacks through real-financial linkages triggered fiscal crises in
AMEs, particularly in the euro area, which pose threats to global financial stability even
today.
Despite their own sound fundamentals, meanwhile, emerging market economies - or EMEs
in short - have become the hostages of cross-border linkages, both real and financial, as
they have faced weak and highly uncertain external demand, sharp reversals in capital flows,
and heightened foreign exchange market pressures. As you may have noticed here, and as I
should highlight now, there have thus been two types of linkages at the heart of the
postcrisis economic and financial developments - real-financial linkages, and cross-border
linkages. And the implication is thus that a global solution is necessary if we hope to return to
a sustainable path of growth and financial stability.
We live now in an interconnected world. And in an interconnected world, stagnant growth
and fiscal crisis occurring in one region is no longer an isolated problem of that region alone.
Rather, it is a global problem, that has far-reaching implications for other regions and,
ultimately, the world economy as a whole.
I believe that our search for a global solution to the problems we now face should begin with
a focus on reversing the directions of these two types of linkages - so that in place of
negative spillovers we instead see positive feedbacks. And in fact, powerful real-financial and
cross-border linkages are a basis for positive feedbacks just as much as they are a vehicle of
negative spillovers. I also believe that the role of EMEs - and particularly of emerging Asia -
is of crucial importance in this regard.
Over the next several years at least, AMEs will find themselves constrained by limited policy
space for dealing with macroeconomic challenges. It would not be unreasonable to predict
that, to put their public finances in order, AMEs will need to undergo periods of fiscal
consolidation. Monetary policy is also unlikely to offer more stimulus, since policy interest
rates remain near zero while major central banks' balance sheets are already over-stretched.
New financial regulations are being implemented, with stronger standards applied to liquidity
and capital requirements. And while all of these developments are certainly conducive to
financial stability, they are less conducive to growth - at least in the short run. Without
growth, however, financial stability gains will likely prove elusive.
EMEs are in contrast doing better than AMEs in many respects, although their economic
growths and financial stability have been adversely affected by developments in AMEs.
Economic growth is yet to reclaim its pre-crisis level, due in part to weak external demand,
but it does nonetheless remain modest. Inflation is well under control by now. And EMEs
have in addition ample policy space, on both the fiscal and the monetary fronts, for use
should adverse shocks occur. EMEs have been cautious in their macroeconomic
management, however, in consideration of the significant tail risks stemming from the euro
area fiscal crisis, financial deleveraging, the high and very volatile price of oil, and other
factors.
Now given this broad picture, if you agree on its accuracy, I would like to suggest the
possibility of EMEs playing a role in reviving world economic growth, and solidifying financial
stability. I believe EMEs' dynamic growth can also be a source of growth for AMEs, that is
relatively free from the vagaries of the Keynesian multiplier. And the higher and more
sustainable growth in AMEs would then help AMEs to address their fiscal and financial
challenges at lower costs than otherwise.
To put this view in perspective, let me point out some numbers. In 2011, EMEs accounted for
53 percent of world GDP, and 70 percent of world economic growth. According to a recent
study by the Bank of Korea, a one percent increase in EMEs' GDP will boost AMEs' growth
by 0.3 percentage point. The corresponding number for the contribution of AMEs to EMEs'
growth is 0.4 percentage point. This same study also shows that structural reforms can
enhance growth in both groups of countries. Therefore, stronger autonomous growth by
EMEs - driven by domestic demand - combined with structural reforms in both AMEs and
EMEs, would clearly help maximize positive feedbacks that benefit all.
III. Challenges and opportunities for Asia
That said, the next question to ask is who should take the first step, to initiate the
propagation of such positive feedbacks for growth. And I would argue that Asia - particularly
emerging Asia - is well positioned for this job. Asia is large in economic size, represents the
most vibrant economic region in the world, enjoys high rates of savings, and has strong trade
linkages with AMEs. It is also the region with the greatest potential to grow through
expansions in domestic demand. Asia, in short, has tremendous potential to lead world
economic growth going forward.
But having great potential is only a necessary condition for Asia to become a source of
positive feedbacks for growth. To realize this potential to the fullest extent, Asia needs to do
much more on the financial front. Asia is a region in which negative financial and real
spillovers from AMEs are the rule rather than exceptions. Asia has been subject to volatile
capital flows driven by global liquidity cycles. From the second quarter of 2008 to the first
quarter of 2009, for example, foreign claims of euro area and UK banks on Asian economies
fell by around 37 percent and 21 percent, respectively (IMF, REO April 2012).
Asia's international trade and finance is invoiced and settled in dollars predominantly, and
this results in currency and maturity mismatches. Risk management, however, except
through the holding of large amounts of foreign reserves, remains relatively poor. Finally,
domestic financial markets in Asia are less developed, with only limited capacity to create
high quality safe assets. And as a result the high level of savings in Asia has been invested
in foreign assets produced by AMEs. These financial weaknesses and imbalances render
Asia very vulnerable to global liquidity disruptions and market uncertainty. And it is more
likely now than ever that the global financial market will continue to face significant tail risks,
until the euro area finds its way out of the fiscal crisis.
Given this, Asia needs to be better prepared to deal with financial shocks of external origin.
This would be Asia's biggest challenge should it endeavor to lead the world economy along a
sustainable path of growth and financial stability. The challenges facing Asia are also
opportunities for Asia, however. My view is that the next decade or so will prove to be a
critical window of opportunity for Asia, to upgrade its financial system so as to make it a new
source of growth and strengthened financial stability.
Before concluding, let me briefly discuss what Asia should do to live up to such a vision.
First, Asia should push ahead with more financial liberalization and greater integration into
the global markets. If we agree that the new global financial regulations will make
crossborder capital flows less volatile, we should expect Asia to be able to reap the benefits of
financial integration at lower risk. Financial integration will bring new knowledge into our
domestic financial markets and policy circles. Financial liberalization is also consistent with
the changes in development strategy in Asia toward greater dependence on domestic
demand than on exports.
Second, Asia should upgrade its domestic prudential regulations with newly developed
macro-prudential frameworks that can address FX risk in particular. Macro-prudential policies
should be employed rather than capital controls, which could prove highly distortionary and
run counter to financial integration. And in this regard, Korea's recently implemented
macroprudential policies would be good reference for many Asian countries.
Third, Asia should implement structural reforms - which can enhance its growth potential in
the face of population aging, increase its labor productivity, and help to stimulate its domestic
demand. Pension reform, for example, could help to reduce the unduly large precautionary
savings in countries where income uncertainty is high. Increased labor market flexibility can
meanwhile contribute to job creation, and facilitate necessary economic adjustments.
IV. Concluding remarks
Now let me conclude.
We have already seen how the powerful real-financial linkages have led to output collapses
in AMEs following the global financial crisis, and how they have driven the sovereign debt
dynamics in the euro area to their critical limits. We have also seen how cross-border
linkages - both real and financial - have transmitted adverse shocks originating in AMEs to
the shores of EMEs in matters of months if not days.
But the directions of these linkages can be reversed, I believe - so that they facilitate not
negative spillovers but positive feedbacks. Exploiting the reversal of linkage effects should I
think be the first step toward finding a global solution to the current economic and financial
troubles that we all face. I also believe that Asia should be the region taking this first step, in
light of its potential for doing so.
In the next decade or so, Asia will face greater challenges, but also greater opportunities, as
it repositions itself in the new global financial scene. The primary task that remains is to seize
this opportunity with courage.
Thank you.