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Kiyohiko G Nishimura: Inter-regional financial cooperation another
layer of financial cooperation towards financial stability
Remarks by Mr Kiyohiko G Nishimura, Deputy Governor of the Bank of Japan, at CEMLA's
60th Anniversary Commemorative Conference
"Central Bank Cooperation at the Beginning
of the 21st Century", Mexico City, 19 July 2012.
* * *
1. Introduction
First of all, I am grateful to the organizers for inviting me to the 60th Anniversary
Commemorative Conference of CEMLA, a symbol of financial cooperation between central
banks in Latin America. I am especially thrilled, because this is the ideal opportunity to
discuss international monetary stability and central bank cooperation from the integrated
perspective that spans Latin America and Asia. Latin America and Asia are among the most
developed regions in terms of financial cooperation.1 Today, I would like to take the concept
of financial cooperation one step further by considering the topic of inter-regional financial
cooperation. Although the theme of financial cooperation at the global, intra-regional, and
bilateral level has been discussed at a variety of international forums such as G20, I believe
inter-regional financial cooperation, especially between Latin America and Asia, represents
another important layer between the global and the intra-regional or bilateral levels.
2. Latin America and Asia in the 21st Century: from low to high correlation
Let me begin by giving a brief summary of the linkage between Latin America and Asia with
respect to real economic and financial activities, focusing particularly on the period since
2000.
Both regions have experienced several large-scale financial crises since the 1980s, namely
the Mexican Debt Crisis in 1982, followed by the so-called Tequila Crisis in 1994, the Asian
Financial Crisis in 1997 accompanied by the Russian Crisis, and the Argentine Crisis in
2000. However, roughly speaking, this period in our history also highlights the fact that, until
the collapse of Lehman Brothers in 2008, we had never faced a large-scale financial crisis
simultaneously. In fact, the cross-country correlation of real GDP growth between Latin
America and Asia shows relatively small coefficients in the early 2000s (Slide 1). The reason
could be that the regions are geographically distant, and thus relatively less influenced by
each other, particularly in terms of trade activity.
However, this relationship had already begun to change during the era of the so-called Great
Moderation, and has changed dramatically since the Lehman shock and the recent European
sovereign debt crisis. In fact, the above-mentioned cross-country correlation shows a
significant increase since 2008 in the correlation coefficients of all major Asian economies,
following a gradual increase in China and Japan a few years earlier. Although geographical
distance has not changed, our mutual dependency in trade has dramatically increased since
the mid-2000s, driven largely by China, and owing to significant improvements in
transportation technology and a decline in various trade-related costs (Slide 2).
The linkage of trade, and thus economic and financial activities, between Latin America and
Asia is expected to be strengthened further in the future. Trade volume is determined by the
size of population and the degree of complementariness of goods and services, if transaction
costs are sufficiently small. The combined populations of Latin America and Asia are forecast
to remain at more than 60 percent of the global population. As income levels increase, the
two regions combined are expected to become one of the largest consumer markets in the
world (Slide 3). Moreover, the two regions have a well-balanced supply-and-demand
relationship, ranging from agricultural goods and raw materials to capital goods. This implies
that future trade activity in a combined Latin America and Asia can be self-sustained without
having to rely substantially on advanced countries. As mutual linkage of economy is
enhanced through trade, eventually so is financial linkage between the two regions, including
an increase in foreign exchange transactions for the purpose of real demand and hedging, as
well as an increase in stock price correlation reflecting active cross-border corporate
transactions.
This heightened inter-dependency of economy and financial markets implies that a financial
crisis in one region has a direct impact on the other. Moreover, as the importance of a
combined Latin America and Asia increases, so too does the chance that they happen to
become the epicenter of a global financial crisis. In this regard, policy makers of the two
regions are mutually responsible for the stability of the global economy and financial market.
To fulfill such responsibility, financial cooperation should not be confined to one region.
Latin America and Asia have many issues in common. Addressing capital flows is one such
issue. A variety of regulations and macroprudential measures has already been introduced,
and has been to a certain extent effective in each of the jurisdictions or regions. However,
more structural issues associated with financial stability should be discussed, not only at the
intra-regional level, but also at the inter-regional level between Latin America and Asia.
These structural issues include the development of liquid and deep capital markets, and
improvements in financial infrastructure, including deregulation and harmonization of
regulations. Moreover, from a longer-term perspective, issues related to population aging,
and corresponding arrangements of social security and tax systems, also need to be
considered comprehensively with an inter-regional view in mind.
3. Asian experience on financial cooperation
Let me now turn to the Asian experience on financial cooperation, anticipating similar
discussion of the Latin American experience later from other participants.
(Vulnerabilities in Asia)
Although overall economic and financial stability has been improved remarkably in Asia since
the Asian Financial Crisis, there are still vulnerabilities in the region. First, there remains the
double-mismatch of currency and maturity in the banking sector. Such vulnerabilities
materialized in some Asian economies when U.S. dollar liquidity dried up after the collapse of
Lehman Brothers. We have seen similar impacts recently with the deleveraging by European
banks. Second, in Asia, including Japan to some extent, the financial intermediation function
has still been served largely by indirect financing, mostly through banks. Given this financing
structure, a large negative shock hitting financial institutions makes it difficult for non-financial
corporations to gain smooth access to debt financing from these institutions, almost
regardless of their financial soundness. Third, there is still the issue of scant investment
opportunities in Asian local currencies. Abundant savings in Asia have not been invested
sufficiently within the region, and have thus eventually been invested outside the region,
such as in bonds in the United States and developed Europe.
To put it in a different perspective, the Asian financial sector remains highly dependent on
banks, indicating the underdevelopment of regional bond and other capital markets. Owing to
such an unbalanced market structure, Asian economies are exposed to the risk that
domestic asset prices become volatile because of rapid global capital flows, resulting in a
sharp increase in the volatility of foreign exchange rates. Also, the immature local derivatives
market makes appropriate risk-taking transactions difficult, as risk-hedging instruments are
limited (Slide 4). Moreover, owing to their less-developed securitization markets, Asian
economies do not sufficiently enjoy the merits of the securitization schemes that attract a
variety of investors depending on their risk-taking capacities (Slide 5).
(Authorities' efforts to address
vulnerabilities)
How have the Asian authorities responded to these vulnerabilities? I would like to explain
their efforts in three aspects.
To develop local currency-denominated bond markets
The first is a project aimed at developing liquid bond markets to provide a bridge between
abundant local savings and local investments: the ABF of EMEAP, and the ABMI of
ASEAN+3.
The Executives' Meeting of East
Asia-Pacific Central Banks (EMEAP) established the Asian
Bond Fund (ABF) investment trust in 2003, and became the initial buyers by investing in
sovereign and quasi-sovereign bonds in the eight member jurisdictions. When it was
launched, the Fund was limited to investment only in U.S. dollar-denominated bonds.
However, since 2005, the Fund has begun to include those denominated in the local
currencies of the eight members. In addition, EMEAP launched an exchange-traded fund
(ETF) called the Pan Asian Index Fund (PAIF). The PAIF was first listed on the Hong Kong
Stock Exchange in 2005, and later cross-listed on the Tokyo Stock Exchange in 2009.2
As part of the ASEAN+3 process, the authorities have launched the Asian Bond Markets
Initiative (ABMI),3 aimed at promoting bond markets. The most notable recent achievement is
the establishment in November 2010 of a trust fund in the ADB called the Credit Guarantee
and Investment Facility (CGIF). The CGIF plans to start its credit guarantee operations for
local currency-denominated corporate bonds issued in the ASEAN+3 jurisdictions in the third
At the Finance Ministers' and Central Bank Governors'
quarter of 2012 at the earliest.
Meeting in May this year, another new roadmap for the ABMI was proposed and endorsed to
further promote resilient capital markets in the region, for example, by improving the regional
enterprises' finance and
credit rating system, developing small and medium-sized
securitization markets, and raising the level of financial education.
To establish and enhance a currency swap network
authorities to the region's vulnerabilities is a project to
The second response by Asian
establish and develop a mutual framework of U.S. dollar liquidity provision, called the Chiang
Aimed at improving the region's resilience against external shocks, the
Mai Initiative (CMI).
CMI started building a bilateral currency swap network in the region, which involves a
contingent claim on foreign currency reserves held by each ASEAN+3 authority. The CMI
has since enhanced its effectiveness by increasing its size and the number of participants. In
fact, in March 2010, the authorities evolved the CMI framework from its original bilateral
swap arrangements to the multilateral Chiang Mai Initiative Multilateralization (CMIM), which
is a collective decision-making framework signed by all member jurisdictions in a single
contract.4
To ensure the effective implementation of crisis prevention and actual U.S. dollar liquidity
support, it is essential for the authorities to monitor closely the regional economy and
financial markets, and exchange views on their respective macroeconomic policies. The
ASEAN+3 authorities thus established their own but independent surveillance unit, called the
ASEAN+3 Macroeconomic Research Office (AMRO), in Singapore in April 2011.
Recent efforts to enhance financial stability
In addition to the above-mentioned two projects, momentum is building among Asian central
banks to make cross-border collateral arrangements (CBCAs), aimed at further enhancing
financial stability in the region. CBCAs are arrangements whereby a central bank provides
local currency liquidity by accepting foreign currency assets, such as sovereign bonds in
foreign countries, as eligible collateral. Such arrangements already exist in some advanced
countries. CBCAs are thought to be an effective framework particularly in times of short-term
Foreign financial institutions' branches and subsidiaries often lack
money market stress.
stable local funding sources, such as retail deposits. However, under a CBCA, they can still
continue to provide credit to their customers, who are in most cases branches and
subsidiaries of non-financial corporations domiciled in their home countries.
In fact, a CBCA was established in November last year between the Bank of Japan and the
Bank of Thailand, as there are many Japanese non-financial corporations operating in
Thailand. At almost the same time, a CBCA was announced between Bank Negara Malaysia
and the Monetary Authority of Singapore, and early this year between Bank Negara Malaysia
and the Bank of Thailand. Meanwhile, EMEAP has formed an action group and made a
CBCA reference template for their future expansion in the region. So far, they are bilateral
negotiations between two jurisdictions, depending on their necessity.
Moreover, Japan and China are making efforts to enhance mutual cooperation towards the
development of financial markets in the two largest Asian economies. Owing to cooperation
between the authorities and private market participants, many tangible outcomes have
of Chinese government bonds by the Japan's
already been achieved, including the purchase
Foreign Exchange Fund Special Account and the start of direct exchange between Japanese
yen and Chinese renminbi on the Tokyo and Shanghai markets.
4. Towards inter-regional financial cooperation
As economic and financial linkages deepen, I believe that the above-mentioned efforts and
issues addressed in Asia can be shared more or less with Latin America. Both regions also
have common structural problems. I believe that it is fruitful for regions bearing similar
problems to resolve them collaboratively.
First, let me raise the issue of demographic change and economic potential. Slides 6, 7, 8,
and 9 show the ratio of working-age population to the rest, that is, how many people of
working age have to provide for one dependent person, for Japan, the United States, Asia,
and Latin America, respectively. Low fertility rates and population aging have been the main
cause of prolonged low economic growth in Japan since 1990. This is also likely to become a
big issue even for Korea and China in the not-so-distant future. Some Latin American
countries may also have similar concerns, although the degree varies across jurisdictions.
Having this future vision well in mind, we have to be prepared even now to implement the
necessary social reforms, including the restructuring of social security systems, tax reforms,
and revision of employment systems.
Second, let us consider the development of asset prices and credit expansion. In Slides 10,
11, 12, and 13, the development of property prices and loans in real terms is added to the
chart of the working-age population ratio (inverse dependency ratio) in the previous Slides 6,
7, 8, and 9, respectively. In Japan and the United States, we see a significant relationship
between population dynamics and real asset prices. A similar tendency is also observed in
China, as representative of Asia, and Brazil, as representative of Latin America. Whether this
development leads to the generation and bursting of asset bubble depends largely on future
policy implementation in the respective regions.
To address these structural problems, it might be more effective for both regions to
collaborate, rather than to deal with them individually and independently. The following three
points are also issues to be considered cooperatively.
First, as an economy develops and a middle-income class emerges, we need to implement
measures to realize a more balanced growth between domestic and external demands. At
the same time, the population eventually ages as the economy matures, and thus the key to
success will be the promotion of domestic demand appropriately in line with the
developmental stage of the economy.
Second, from the viewpoint of reducing asset price volatility, it is also important to further
develop regional capital markets with the aim of enhancing resilience against external
shocks. In this regard, we need to take into account market differences within the region.
Third, it is essential for each jurisdiction to harmonize its market regulations and practices
with the global standards in promoting cross-border transactions. However, unilateral effort
by a single jurisdiction has its limitations, and thus collective effort is desirable to improve
market infrastructures effectively in both regions. While respecting diversity across
jurisdictions, we should not introduce arbitrary regulations or ignore global contractual
practices.
Needless to say, even if we are successful in dealing with these issues, we cannot
completely prevent financial crises. However, we can improve our resiliency in times of crisis
by preparing multi-layered safety nets as backstops in the financial system. Such safety nets
include the development of deep and liquid capital markets, the establishment of currency
swap networks, and cross-border collateral arrangements. Moreover, it is also important to
establish solid foundations for individual and regional economies by addressing at an early
stage long-term social structural problems such as declining fertility rates and population
aging. A resilient real economy is an indispensable factor in financial stability.
Last but not least, as you already know, the IMF-World Bank Annual Meetings will be held in
Tokyo this coming October. The Bank of Japan plans to take advantage of this opportunity to
co-host a seminar with CEMLA. I will participate in this wonderful event, representing the
Bank of Japan, and I look forward to the enthusiastic proposals and discussions regarding
financial stability in Latin America and Asia, and thus global financial stability, among a
variety of participants, including senior officials of central banks in the two regions.
I will stop here. Thank you for your kind attention.
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