Peter Pang: Managing capital flows - the search for a framework
Welcoming address by Mr Peter Pang, Deputy Chief Executive of the Hong Kong Monetary
Authority, at the Asian Development Bank Institute and Bank for International Settlements
Joint Seminar for the book launch on "Managing Capital Flows: the Search for a Framework",
Hong Kong, 21 April 2011.
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Good morning, Ladies and Gentlemen.
1. Let me thank Mr Kawai for inviting me to this event. It's my honour to welcome you
to this joint seminar by the Asian Development Bank Institute (ADBI) and the Bank for
International Settlements (BIS) to mark the launch of the new book, "Managing Capital
Flows: the Search for a Framework". This is a topical issue right at the centre of attention of
policymakers in this region. And as the title suggests, it is also a subject that we are still in
search for an answer.
2. There is an old Chinese proverb saying that "water can keep a boat afloat but it can
also capsize the vessel". This suitably characterises the nature of international capital flows
- it brings both benefits and risks to the development process in Asia. Capital inflows have
been playing a key role in the economic development of the region - funding investments
and bringing along technology and skill transfers. These were conducive to the emergence of
the "four Asian Tigers" in the 1980s, and the rapid modernisation process of China, India and
other Asian economies. On the other hand, the pro-cyclicality and highly volatile nature of
capital flows poses significant macroeconomic management challenges to policymakers. If
not properly managed, the build-up of excesses amid strong capital inflows and the
subsequent bursting of the bubbles could be detrimental to financial stability, wreaking havoc
on economic growth.
3. Managing capital flows has been a dynamic learning process for policymakers in
developing economies. Prior to the Asian financial crisis, Asian economies embraced capital
flows with little wariness of the downside risks. The dominant flow pattern at that time was for
Asian governments to invest their savings in high-grade government papers of the advanced
economies. The funds were then recycled back to Asia in the form of highly volatile
shortterm capital flows. These resulted in serious imbalances in the balance of payments
accounts, and mismatches in currency and maturity in the balance sheets of banks. The
subsequent shifts in market sentiment and expectations led to abrupt reversals of capital
flows out of Asia. Currency crashes amplified the adverse effects as capital fled the region in
a drove. The Asian Miracle went bust. The capital flows that had once fertilised the
impressive growth eventually caused a capsize when the Asian financial crisis hit us in 1997
- a lesson that we all still vividly remember.
4. The Asian financial crisis gave us a much-needed wakeup call at a dear price. Yet,
looking back, the crisis also has its silver linings: the painful adjustments that followed
prompted governments to strengthen economic fundamentals, enhance banking systems,
deepen local bond markets, and build up foreign reserves to cope with potential external
shocks. Because of these developments, the region has been able to emerge from the
recent global financial crisis relatively unscathed and is now one of the key driving forces
supporting the global economic recovery.
5. But we cannot afford to be complacent, as we are now confronted with a new round
of challenges in uncharted waters. The unprecedented monetary easing in the advanced
economies has led to global excess liquidity. And with the robust recovery of the emerging
markets, there are powerful push and pull factors driving investors to search for yields in
developing economies including Asia. From Q3 2009 to Q4 2010, the net capital inflows to
emerging Asia1 amounted to US$541 bn, the largest inflows in recent years.
6. The strong capital inflows and resultant abundant liquidity have led to exchange rate
appreciation, fuelled credit growth and driven up asset prices in the region. With output gaps
closing, inflationary pressures are accelerating in a number of Asian economies. Capital
flows also complicate the macroeconomic policy responses. While exchange rate
appreciation and monetary tightening could theoretically cool down the economy, in practice,
they may attract even more speculative inflows to profit from interest rate arbitrage and
currency appreciation.
7. So how should we cope with these challenges presented by the unprecedented
scale of global excess liquidity? Given the global nature of fund flows and the increasing
interconnectedness of the global financial system, it is obvious that national policies alone
are insufficient to tackle the challenges. We need greater international and regional
cooperation to manage risks posed by volatile capital flows to global financial stability. I
believe there are three main areas for cooperation.
8. First is enhancing the resilience of the global and regional financial systems through
financial regulatory reforms. A large amount of work in this area is under way at the G20, the
Financial Stability Board (FSB) and various standard setting bodies - including but not
limited to strengthening banks' capital and liquidity requirements, reducing moral hazard
posed by systemically important financial institutions, and reforming the OTC derivatives
markets. Recently, the FSB decided to set up regional consultative groups, including one for
Asia, to bring together central banks, finance ministries and regulators in different regions.
These groups are expected to serve as a platform for us to discuss and cooperate on issues
of interest to regional financial stability, and to reflect the region's collective views to the FSB
in the international standard setting process.
9. The second area is enhancing the global and regional financial safety nets. We
welcome the recent significant augmentation of IMF's resources and lending facilities. These
enhancements will allow the IMF to respond more effectively and speedily to member
countries in need. Regionally, the establishment of the Chiang Mai Initiative
Multilateralisation (CMIM) further enhances the regional capacity to cope with capital flows
and safeguard financial stability of the region. The HKMA fully supports this important
regional initiative, and indeed we have played an active role in its development and
participated directly in the arrangement.
10. The third area is enhancing the capacity of regional capital markets to absorb capital
inflows and channel them to productive uses. In this regard, the HKMA took the lead in
developing the Asian Bond Funds (ABF) under the aegis of the Executives' Meeting of East
Asia Pacific Central Banks (EMEAP). The ABF, as a pioneer product, aimed to provide a
convenient low-cost local-currency instrument for investment, and at the same time help
identify and remove the impediments to bond market development. In parallel, with the
strong support from the ADB, ASEAN+3 members have undertaken a range of projects
under the Asian Bond Markets Initiative to promote the development of the local currency
bond markets. Notwithstanding these regional efforts, we still have a long way to go in
developing a regional bond market that is broad and deep enough to channel the region's
abundant savings to meet its huge investment needs. Continued national and regional efforts
in this regard are much needed.
11. At the domestic level, there has been growing recognition that there is no
one-sizefits-all approach to capital flows management. While conventional macroeconomic policies
are useful in containing overheating in the overall economy, their deployment is often
constrained by their broad-brush nature and the concern about attracting even more
speculative inflows. Therefore, many developing economies have also adopted other
prudential and capital account measures to manage capital inflows and to contain the
buildup of excesses in specific sectors of the economy and the banking system. For example,
some regional economies have recently tightened the mortgage underwriting standards of
their banks, and limited banks' foreign currency borrowing and derivatives positions.
12. To effectively manage capital flows, policymakers would need to improvise with the
apparatuses in their policy toolkit and apply a policy mix tailored to their domestic
circumstances. It is like the use of "Chinese herbal medicine" - we feel the pulse, carefully
calibrate a combination of remedial herbs (i.e. policies), and follow through with continuous
fine-tuning in the light of market reactions. The process is pragmatic and, to a large extent,
interactive.
13. Given the need for customised solution at the national level, the sharing of
experience is therefore very important. We welcome the timely publication of this book, which
provides a good basis for studying the different approaches to managing capital inflows by
different economies. Individual countries' experiences would, collectively, help shed light on
the formulation of an effective policy framework.
14. Ladies and gentlemen, let me end my remarks by quoting a line from the book: "Risk
of crisis as financial integration increases will never disappear, and countries must pursue
protection from risks of volatility and sudden stops"2. We should always be vigilant, even in
peace time. To Mr Kawai and other authors, congratulations yet again on the launch of this
new and important book.
15. Thank you.