Bandid Nijathaworn: Where is global finance heading?
Speech by Dr Bandid Nijathaworn, Deputy Governor of the Bank of Thailand, at the
Conference entitled, "Where is Global Finance Heading? The Stake of Emerging Economies
in the International Financial System", organised by Central Bank of Peru and Reinventing
Bretton Woods Committee, Cusco, Peru, July 13-14, 2009.
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Thank you Chair
First, let me thank the Central Bank of Peru and Reinventing Bretton Woods Committee for
the invitation. It is an honour to be speaking to you today.
The topic of this first session is "Time of upheaval: Where global finance is heading?". This is
definitely an important question given the current crisis is now almost two years old and is
still evolving. Judging from the implications that the crisis has had so far on the world
economy and financial markets, this is truly the first crisis of globalization. The crisis shows
that financial upheaval can happen in any country, regardless of whether it is large or small,
emerging or developed, and once happens, it can impart huge externalities on the rest of the
world given the globalized nature of the world's trade and payment systems. But more
importantly, the crisis points to the weakness in the configuration of policies and financial
regulation in the period leading up to the crisis that led to excessive risk-taking in the
intermediation of global savings and investment across economies.
Compared to the Asian financial crisis twelve years ago, the dynamic of macroeconomic
adjustment in this crisis also looks similar, although the trigger point this time is more
bankled than currency-led. The real surprise, however, was in the timing, the scale, and the
intensity of how the problem quickly deteriorated into a major global turbulence. According to
the IMF, compared with the previous crises, the cost of the current crisis in terms of financial
losses could be as high as 10 percent of US GDP. This implies a very substantial welfare
loss.
Is this the time of upheaval? My answer is both yes and no. The "No" part refers to the fact
that, despite the magnitude of the current crisis, aggressive policy response and the
willingness to do more by Governments have successfully contained the fallout to the extent
that collapse of the global financial system has been avoided. Financial markets, to an
appreciable extent, are stabilizing, risk appetite is returning, and signs of improvement in the
real economy are beginning to emerge on a world-wide basis. Although it is still early days,
they do point to the beginning of stabilization which is an important first step for economic
recovery to take hold.
The "Yes" part of my answer comes from what I see as a major challenge in the ideas and
policies on how best to manage the global economy going forward in this era of globalized
finance. For instance, with this crisis, we witness a breakdown in the key assumptions that
form the basis of our thinking about the efficiency and the self-correcting nature of markets
which, for a long time, underpin the rationale for globalization, liberalization, and
deregulation. These assumptions are now being challenged.
Next, in this crisis, the most damage comes from the most regulated sector of the economy,
notably the financial sector. What we saw is that, even with regulation in place, the sector
surprisingly exhibited important failure in risk management discipline across a variety of
institutions and players, including banks, institutional investors, credit-rating agencies, and
regulators. On this, a better way to manage risk to support the process of international
financial intermediation still needs to be worked out. And finally, the global economy has
never before been put in a position that it might have to deal with the consequences of the
massive policy response that have been put in place both on the fiscal and the monetary
fronts. These 4 consequences are the known unknowns, and the approach we choose to
address them will importantly influence the direction that global finance will take going
forward.
Given the focus of this conference is on the stake of emerging economies in the international
financial system, let me share with you briefly how emerging economies in Asia so far have
managed in the current crisis, and how we see the direction of global finance evolving.
This time emerging markets are not the cause of the crisis, but are affected by its global
contagion. Emerging markets in Asia, this time, were able to weather the impact of the crisis
with a relatively strong initial position. The strengths are found in the region's banking sector,
which so far has been resilient because of the limited exposure to subprime-related and
other toxic assets, the sector's strong capital base, and its low reliance on external funding.
This time external vulnerabilities of the region's economies are low. They are supported by
high levels of international reserves, continued current account surplus and low external
debt. More importantly, economic fundamentals of the region have improved markedly, and
these have helped enhance the room for policy as well as the ability of the economy to adjust
to shock. Suffice it to say that these improved qualities are no accident. They are the results
of deliberate policies to reform the domestic economy, maintain discipline in macroeconomic
management, build up a liquidity buffer for self-insurance, and strengthen supervision of the
banking system.
Notwithstanding the improved qualities, the impact of the crisis on the Asian emerging
economies have been substantial, and largely transmitted through three channels. The first is
the tightened access to international capital market as a result of the global credit crunch.
The second is the reversal of capital flows linked to the process of global deleveraging. And
the third is the impact on the real economy on account of the collapse in exports. For Asia,
the impacts have been uneven across countries, depending on the size of the initial capital
inflows and the maturity composition of external debt. Nonetheless, because of the higher
levels of reserves, the absence of significant currency mismatches, and greater flexibility in
the exchange rate regimes, emerging markets in Asia have been able to adjust better to the
shock without undermining economic and financial stability.
However, it may be noted that, so far, the impact from the trade channel has been the most
severe. This is because of the large share of exports and manufacturing in the region's GDP.
For example, exports from the five ASEAN economies fell by about 12 percent in the fourth
quarter of last year, and by 28 percent in the first quarter of this year, while GDP growth over
the same two quarters fell by 0.6 percent. This decline is large and shows that Asian
emerging markets remain closely tied to the global business cycle. Therefore, without
improvements in the world economy, a sustained recovery in Asia will be difficult in the
nearterm.
Reflecting this, the focus of the policy response, at least in Thailand, has been to help the
economy adjust to the impact of the crisis through a supportive stance of monetary and fiscal
policies while maintaining the overall policy discipline. As for banks, the supervisory
approach has been to ensure that the banking system remains healthy, and continues to
operate fully to support the economy with good risk management and adequate capital.
At this time, consistent with developments elsewhere, more positive signs in the real
economy are also beginning to emerge in Asia, and this has led to a view that conditions for
recovery look more promising in Asia, given the lesser impact on the region's economic
fundamentals and the banking sector. I find this view quite plausible. This is because, in the
case of Asian financial crisis, it was also the countries that did not have a serious financial
sector problem or external vulnerabilities that were able to recover relatively more quickly.
On this note, let me digress to the issue of decoupling. If we divide the dynamic of financial
crisis into three phases, namely, first the shock of the news phase when everything is on a
downturn, to the second phase of market stabilization, and the third phase of economic
recovery, it is clear from what has happened so far that, on the downturn, it is a recoupling
story both for the real economy and for finance. The downturn has been quite synchronized
because of the globalized nature of the world's production, trade, and financial investment.
Nonetheless, for the market stabilization and the economic recovery phases, I see
decoupling in the timing and in the pace of recovery being a strong possibility. This is based
on significant differences that exist, between the core-crisis countries and the countries
affected by contagion, in the relative strength of the economic fundamentals, the state of the
banking sector, and the perception of risk by investors. However, beyond the initial recovery,
sustained economic decoupling will be difficult without a major restructuring in the sources of
growth which, in the case of Asia, calls for a reorientation of the growth driver from exports to
domestic demand.
Making this transition safely in this era of globalized finance will be the next important
challenge for emerging markets in Asia. In the past ten years, the share of domestic demand
in the region's GDP fell by 6.3 percentage point, and the share is now 12.3 percentage point
below its peak in 1994. Moving the ratio back will require major restructuring in both the
demand and the supply sides of the economy, which needs to be supported by policies that
redirect economic incentives from savings to domestic consumption and investment. Such
task is gigantic. Chief amongst the polices needed to support this transition will be the
development of the region's financial system, to ensure an efficient intermediation of savings
into productive investment. This is really the key issue where the challenge and the
constraint to economic decoupling lies. One of the prime reasons underlying the current
global imbalance is the limited capacity of the financial systems in emerging markets to
generate investment from their local savings. As a result, the intermediation was taken up
instead by financial systems in the advanced economies which, as we know, led to
risktaking and a major asset price bubble.
In closing, I want to end my remark by making a few observations on the direction of global
finance going forward.
As a matter of fact, the current crisis is also a crisis of globalized finance, considering the
damage that has been done to the global banks and financial markets. Lessons learnt from
this crisis will definitely bring about important changes in the global financial landscape, as
well as in the regulatory approach to bank regulation and supervision. On this, key trends we
can expect to see in the emerging financial landscape will include, on the demand side,
consumers becoming more risk averse and having preference for local institutions and for
simplicity of transactions and instruments, while demanding greater accountability and
transparency. On the banking side, business models of banks will become more
conservative, relying less on wholesale funding and on the use of leverage, while giving
greater importance to risk management and higher liquidity buffer. And on the regulatory
front, more emphasis will definitely be on public surveillance and the use of macroprudential
oversight, with focus on system-wide stability, closer supervision of the systemically
important financial institutions including non-banks, and establishing an international
procedure for an orderly unwinding of a troubled systemically important global player. These
changes will help reduce the likelihood of crisis and contain the impact of a systemic failure
to the level that can be managed by conventional policies. In parallel with this, on the
economic front, adjustment to the financial crisis will continue and, in the process, the global
economy will likely move into a world of two halves. The first half is the corecrisis countries
whose immediate policy concern will be to rebuild financial fundamentals and resume
growth. The second half is the less-affected economies, including emerging markets in Asia,
whose policy focus will be to sustain growth and avoid financial instability. This latter point is
important because, given abundant liquidity, the shift in the pattern of global growth towards
the less-affected economies will spark a new financial cycle driven by a resumption of large
capital flows to emerging markets. The challenge for emerging markets, therefore, is to grow
safely by managing all the attendant risk associated with the strong capital flows. In this
context, it is important that the experience of the last ten years, when the fall in Asian
demand after the Asian financial crisis was offset by a boom in US residential investment,
must not be repeated. Otherwise, the crisis risk will remain high, and globalized finance will
be seen only as a threat to long-term economic stability.
Managing this risk and growing safely will be the stake of emerging market economies going
forward. To achieve this, policymakers will need to acknowledge the risk and come up with
the appropriate safeguards. First and foremost for emerging markets is the continued
strengthening of the domestic financial sector as I have noted, which is the key pre-requisite
for raising the ability of the financial system and the economy to manage risk. Next, regional
financial mechanism will also need to be strengthened to provide additional safeguards in the
context of market surveillance and coordination of crisis prevention and resolution efforts.
One lesson we have learnt dearly from the current crisis, as well as from the Asian financial
crisis, is that globalized finance can be a source of serious risk to global economic and
financial stability. Policymakers at the global level must accept this fact and be prepared to
respond to it in a forward-looking way.
I probably have used up the allocated time. Again, I want to thank the Central Bank of Peru
and Reinventing Bretton Woods Committee for the invitation. It has been a pleasure, and
thank you for your attention.