Zeti Akhtar Aziz: Asia's new development strategy - where now?
Speech by Dr Zeti Akhtar Aziz, Governor of the Central Bank of Malaysia, at the ASEM
Conference "Asia's New Development Strategy: Where Now?", Kuala Lumpur, 19 October
2009.
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Introduction
The experience of economic development in Asia - home to more than half of the world
population and one of the most diverse regions - for more than half a century has been
remarkable. Despite being interrupted by turbulence from time to time, Asia has, in general,
attained and sustained high growth rates during this period, experienced rapid structural
economic transformation and shifted from economies based on agriculture to
capitalintensive production of modern goods and services. From a mix of poor and less developed
economies after the Second World War, Asia today features five of the twenty largest
economies in the world and several of the fastest-growing economies, contributing around
one-third of global output and world trade.
The objective of economic development is, however, not solely based on trade, finance or
even wealth. Economic development is fundamentally about the welfare of people, where
growth is but a means to achieve continued improvements in the standards of living. Viewed
within this context, Asia has achieved significant progress too. Asia's rapid development has
led to a more than four fold increase in average per capita income, lifting more than 500
million people out of poverty and destitution since the 1980s. The poverty rate in Asia has
markedly declined from 80% in 1981 to 16% of the total population in 2005. Beyond
dramatically improving basic social conditions, significant strides have also been made in the
provision and access to quality healthcare and education. Whilst Asia's urban population has
increased by more than six fold, average life expectancy has risen by 25 years to 72 years
and average literacy rate to above 90%. What makes these considerable improvements
remarkable is that they were all achieved in a relatively short span of less than two
generations.
This paper consists of two parts. The first explores the development strategies that have
contributed to Asia's successful economic transformation in the post-World War II period,
with particular emphasis on the recent decade after the Asian financial crisis. The paper then
discusses broadly how Asia's development strategies needs to be adapted going forward,
especially in light of the current global crisis which has brought significant changes to the
global economic and financial environment.
Asia's development strategy over the last 50 years
Asia in the post-World War II period
What is exceptional about the performance of Asia is the relatively high growth rates
achieved by the best performing Asian economies when compared to the champions of
earlier eras (Figure 1). The rapid transformation of Asia was led by three global growth
leaders over the past 50 years, beginning with Japan in the 1950-70s, South Korea from the
1970s and currently, China. Their average annual per capita growth rates of 6-8% are
historically unprecedented and greatly exceed those attained by the present advanced
economies at their earlier stage of economic development by at least three folds. Similarly,
ASEAN-5 experienced growth rates of more than doubled that of world average during the
past two decades. Nevertheless, Asia's growth path is no different from those of the other
economies. Asia too follows a similar industrialisation process of moving from traditional to
modern activity, from the production of low value-added goods to incrementally higher
valueadded products to eventually the services sector. What makes Asia different, however, is that
this process has been considerably accelerated.
The success of Asia has not been a result of one single factor, but instead, a confluence of
factors that has promoted, facilitated and driven economic development. Given the immense
diversity of the continent, it would not be possible to draw on exact and specific development
strategies that have contributed to the rapid economic progress and transformation.
Nevertheless, four general but salient features have been critical in the development
strategies of most of the Asian economies.
First, sustained economic growth has always been given a steadfast priority in the Asian
economies. The governments in most South-East Asian and East Asian countries have
focused on institution-building and promoting industrialisation. Institutions have been
established to plan, drive and monitor the laying of necessary economic foundations,
including enabling infrastructure, in the broader economy, while potential impediments have
been addressed. These institutions in effect aim to promote an environment that is conducive
for growth. Equally vital are the institutions to maintain macroeconomic and financial stability
stability, as well as to promote inclusion and socio-economic stability. To accelerate the
movement of resources from traditional to modern activity in the new industrialised
economies in Asia (South Korea, Chinese Taipei, Hong Kong and Singapore), industrial
policies have been targeted at enhancing efficiency, higher-productivity and competitiveness.
Incentives and some domestic protectionism had an important role at the initial stage of the
industrialisation process to advance the industrialisation process. These features are
exemplified in the experiences of Japan and the newly industrialised Asian economies
(South Korea, Chinese Taipei, Hong Kong and Singapore), as well as later, in the other
Asian economies such as ASEAN and China.
Although the Asian Governments participate directly in economic development, the emphasis
is on the private sector leading growth, particularly after industrial and infrastructure
foundations have been laid. The role of the Government has been to support the private
sector through developing an environment for the private sector to undertake higher
productivity activity, with the actual production of goods and services is ultimately driven by
the private sector. Governments, together with the established institutions, draw up industrial
plans and set targets to guide the industrialisation process for the private sector to embark to
realise these goals.
The second salient feature is Asia's high rate of savings, exceeding 30% of gross national
product (GNP) in most Asian economies, which have enabled the private and public sectors
to fund capital accumulation from domestic sources. While the private sector focuses on
investing in physical capital and adopting new technologies to raise productive efficiency,
governments across Asia place commensurate emphasis on developing infrastructure, such
as roads, ports and utilities, as well as on healthcare and education. The combination of
efficient capital and productive labour in turn generates more higher-value-added activity,
thereby accelerating economic growth.
Third, the Asian economies have adopted an outward-oriented development path, rather
than depended only on domestic demand, to expand industrial production. Just five decades
ago, Asia was amongst the world's poorest regions. Asia recognised that its development
process would be slow and marginal should low-income-driven domestic demand be relied
upon to incrementally stimulate industrial activity. It accelerated the movement of resources
from low-productivity traditional activity to high-productivity modern activity. Most of Asia,
early among the developing economies, has been very open to international trade and
foreign direct investment (FDI), resulting in Asia to be rapidly integrated with the global
economy. The trade volume of Asia as a share of total world trade increased from 14% in
1970 to 22% in 1990, and subsequently to 28% in 2008. Furthermore, Asia has also been a
major recipient of FDI, with FDI flows into Asia increasing from 7% of total global FDI to 20%
in 2007.
BIS Review 130/2009
Fourth, the immense heterogeneity and diversity of the Asian economies have not been a
restraint on progress, but have complemented and facilitated the region's economic
development. The vast differences in the stage of development of the individual economies,
such as from the advanced Japan to emerging China to developing Vietnam, together with
the rich variety of natural resources and endowments throughout the region, have enabled
Asia to capitalise on a multitude of strengths and comparative advantages. In particular,
there are the region's different development levels and consequent technological capabilities,
known commonly as the "Flying Geese Model". Such specialised division of labour is evident
in the 1970s when Japan relocated the more labour-intensive stages of production processes
to the newly industrialised Asian economies, such as South Korea and Singapore, and
subsequently in the 1980s, to emerging Asia, including Malaysia, Indonesia and Thailand.
The emergence of China in the recent decade has further provided significant impetus to this
pattern of vertical specialisation, which has effectively resulted in a globalisation of the
production chain across the network of regional economies. Whilst Asia's fragmented
industrialisation has led to a considerable strengthening of trade links within the region, the
transfer of capital, knowledge and technologies that are crucial for strengthening industrial
capabilities have also been enhanced.
Asia after the Asian financial crisis
The 1997-98 Asian financial crisis represents a significant juncture in the history of Asia. The
crisis exposed several structural weaknesses both in the domestic economies of Asia and in
the global financial architecture. Recognising the growing interlinkages and risks, a range of
new initiatives both nationally and regionally, together with the parallel development of sound
institutions and good governance, were introduced post-crisis to strengthen the resilience of
the Asian economies and minimise regional systemic risks in order to ensure a more
sustainable economic development. In retrospect, the Asian crisis marked not a halt, but the
start of an even greater presence of Asia in the global landscape.
Following the crisis, Asia has undertaken wide-ranging financial reforms, aimed at
developing more stable, resilient and efficient financial systems. This included restructuring
as well as institutional development to strengthen the resilience of the financial sector.
Amongst others, sound regulatory regimes have been established, prudential regulations
strengthened, corporate governance and financial disclosure improved, and deposit
insurance introduced. As the domestic financial systems strengthened, the environment for
the banking sector has become increasingly more competitive through gradual deregulation
and liberalisation. In addition, efforts have also been focused on developing the capital
markets, in particular the bond market, which has also reduced over-reliance on the banking
sector as a source of financing for large businesses. This has prompted the banking sector to
broaden access to credit to other economic agents. Overall, what were once bank-dominated
financial systems has become more diversified and competitive with strengthened
governance, disclosure and regulation. Asian financial deepening has been faster than in the
EU or US, while it starts from a lower base. The Asian bond market today, as a share of
GDP, is higher than the EU.
On the regional level, several initiatives have been undertaken to promote intra-regional
trade and investment since as early as the 1990s. For example, in 1992, an ASEAN Free
Trade Area (AFTA) was launched for intra-ASEAN tariffs to be lowered to 0-5% under the
Common Effective Preferential Tariff (CEPT), with a target of establishing a tariff-free free
trade area by 2015. Also, an ASEAN Framework Agreement on Services (AFAS) was signed
in 1995 to eliminate intra-ASEAN restrictions to trade in services and facilitate free flow of
services by 2015. Furthermore, in 1998, an ASEAN Investment Area (AIA) was adopted to
promote greater flows of capital, skilled labour, professional expertise and technology within
the region. These various initiatives have been further accelerated post-Asian crisis, with
various free trade agreements (FTA) rapidly emerging between ASEAN and the North East
Asian economies, namely China, Japan and South Korea. Recently in April this year, the
FTA between ASEAN and China was broadened to encompass the removal of investment
barriers from just restrictions in trade-in-goods since 2004 and in services since 2007,
thereby creating the world's largest free trade area with a population of 1.8 billion and gross
domestic product of USD2 trillion. In addition, negotiations on an FTA between ASEAN and
Japan, South Korea, as well as India, Australia and New Zealand have been initiated.
Given these regional initiatives in trade and investment, Asia's export market has become
increasingly diversified with intra-regional trade gaining a greater importance. Intra-regional
trade in South, East and South-East Asia as a share of total trade of all three regions has
risen from 25% in 1980 to 44% in 2006. More specifically, growth in intra-regional trade of
East Asia-9 (EA-9) has been higher at 17% than that of total regional trade (15%) and world
trade (12%) for the period of 1999-2008. Whilst EA-9's trade to the US as a share of the
region's total trade has declined from 17% in 1990 to 11% in 2008, intra-regional trade rose
from 28% to 39% during the same period. Overall, intra-regional trade in South-East Asia
and East Asia has about the same volume as intra-regional trade in Europe and North, which
is significantly more than either regions at the outset of their integration efforts. These
developments reflect the deeper and considerably strengthened trade and investment
linkages within the Asian region.
Of greater significance in this recent decade is that regional efforts have transcended trade
and investment areas toward an intensification of financial cooperation. The importance of
regional financial collaboration was recognised, not only to provide a platform for regional
development through channelling part of the high savings in Asia to be invested in Asia, but
also as a safeguard against the vagaries of global markets. Extensive efforts have now been
put in place in the areas of surveillance, liquidity support arrangements, crisis management
framework, the development of financial markets and other financial infrastructure, capital
account liberalisation, financial services liberalisation, development of regional payment and
settlement systems, as well as training and capacity-building.
Broadly, economic and financial surveillance, aimed at identifying regional risk sources and
vulnerabilities have been undertaken to enhance vigilance as prevention to potential financial
crises and enable prompt corrective actions. Several forums, including the Executives'
Meeting of East Asia and Pacific Central Banks (EMEAP), ASEAN and ASEAN+3, undertake
extensive discussions on these issues. An integrated regional crisis containment,
management and resolution framework has also been established, which is also
complemented with mutual support arrangements and liquidity support mechanisms, such as
the Chiang Mai Initiative (CMI) launched 2000. The CMI, comprising of the ASEAN Swap
Arrangement and a network of bilateral swap arrangements among the ASEAN+3 countries,
makes available financial resources in a timely manner to members facing temporary
balance of payments and short-term liquidity constraints. It was first agreed in 2005 that the
CMI would be multilateralised in all main components of the arrangement, and more recently
in 2009, the total size of the facility has been increased to USD120 billion.
Considerable efforts have also been placed in regional financial market development,
especially for a deeper and more liquid secondary bond market. On the supply side, the
Asian Bond Market Initiatives (ABMI) seeks to develop deeper and more liquid capital
markets that facilitate the channelling of the large pool of savings in the region to fund
productive investments, thereby enabling further regional economic development. Recently,
the establishment of a Credit Guarantee and Investment Mechanism by ASEAN+3 to support
the issuance of local currency-denominated corporate bonds, with an initial capital of
USD500 million, was announced. Meanwhile, the Asian Bond Fund (ABF) Initiative focuses
on addressing demand-side issues by broadening and deepening domestic and regional
bond markets through pooling reserves for investments into regional bond markets. Two
funds, totalling USD3 billion, have been established to catalyse market development.
Regional financial integration has accelerated in this decade. A more diversified financial
system, together with strengthened financial infrastructure and capital account liberalisation,
have seen the share of intra-regional portfolio investment, in both debt and equity, as a share
of total portfolio investment has increased to 24% in 2007 from 15% in 2001. Mergers and
acquisitions (M&A) have also been growing, with intra-regional M&A as a share of total M&A
in the region rising to 47% in 2006 from 32% in 2004. Most of the investments were into the
services sector, such as financial services and real estate. However, despite the
considerable progress in financial integration in Asia, it is still low compared to the European
Union-16 (2007: 56% as a share of total portfolio investment).
Asia going forward
The current global crisis, considered to be the most severe in the post-World War II period,
has revealed weaknesses to the current global system. In the aftermath of the crisis, the
global economic and financial landscapes are expected to change significantly. While signs
of stabilisation are now emerging, prospects for recovery in the advanced economies are
expected to be gradual. The general consensus is that the emerging economies in Asia, in
particular China and India, will lead the global recovery moving forward. Several structural
factors will support growth in Asia, including the growth-enhancing reforms and greater
regional integration that have been undertaken in the recent decade. In addition, Asia's
relatively strong and resilient financial systems, which have remained relatively unaffected in
this current global financial crisis, are in a sound position to provide financing to support
domestic economic activity. Indeed, this trend will accelerate the formation of more
multipolar global landscape in the future.
For continued progress and development, the strategies for Asia are adapting to the
changing landscape; leveraging on regional strengths and addressing current weaknesses
and future risks. Two key principles have contributed to Asia's earlier success, namely the
regional and global integration of the economy and inclusive development. Asia has always
embraced openness. While greater integration beyond national borders will likely continue,
the pattern of integration will change. It will become increasingly diversified among emerging
economies, in particular within Asia. Similarly, to ensure sustainability of economic growth, it
requires consideration of inclusion.
Three key strategies for Asia
Going forward, three areas are critical for Asia. The current crisis demonstrated the effects of
Asia's reliance on trade and final demand from the advanced economies. While domestic
demand and intra-regional trade has started to increased, it still shows the region's continued
close trade connections with the global community. Exports performance in the Asian
economies was dramatically adversely affected, causing the more open economies in the
region to slip into recession, while other Asian economies experienced slowing economic
growth. The decline in world trade followed the reduced final demand from the advanced
economies. The outward-oriented policy across Asia and the internationalisation and vertical
integration of manufacturing supply chains amplified the magnitude and speed of trade
contraction in the Asian economies. An important strategy for Asia going forward is,
therefore, to intensify the balance of the outward-oriented development strategy with
efforts to promote the greater role of domestic demand. This economic diversification will
provide increased resilience in the face of external shocks and will enhance the overall
growth prospects for Asia.
Several preconditions are already in place to support domestic demand in Asia going
forward. The first is the favourable demographic structures, fast-rising income levels,
broadening affluence and the growing middle income class across most of the Asian
economies. Estimates suggest that both China and India have large and growing domestic
middle-class markets - estimated to be about USD1 trillion per year in China and USD250
billion annually in India. This trend is expected to continue given an increasing young
population in Asia with new spending patterns, threreby leading to the rise of a modern retail
sector across the region. In China, organised retail trade as a share of total retail trade has
increased from 5% a decade ago to an estimated 17%, while in India, the retail market is
growing by 7% per annum. The second factor is the relatively sound financial position of
households in Asia, with high saving rates that exceed 30% of GNP in most countries and
relatively low debt levels, thus providing the potential for rising consumption to be sustained.
This is further supported by the ability of the financial sector to provide financing to support
consumption. In this regard, Malaysia is an example, with household debt at 66.8% of GDP
as at end-July 2009, while the growth of credit to the household sector has continued to
increase in this recent decade. Of significance is the quality of these assets, measured by
the level of non-performing loans, remains low.
The second strategy is the further diversification of the external markets, in particular,
to accelerate the efforts to foster greater regional trade ties, for Asia. It would also shift
the composition of intra-regional trade from intermediate inputs for the production of goods
for final demand to the traditional markets, to a more balanced composition with increased
share to meet final demand within Asia. First, as the emerging economies, in particular Asia,
gain importance as growth centres, the cumulative markets of Asia as export destinations will
expand over time. The rapidly rising Asian middle income class will increase final demand for
goods and services. Second, Asia can leverage on its immense diversity as a source of
economic complementarities. The "Flying Geese Model" illustrates how Asia had, in the past,
harness the diversity of the. Going forward, similar emphasis can be adapted beyond merely
for the production of goods for final demand outside Asia, and draw on the different
comparative advantages of the Asian economies.
Financial integration as a third strategy
The third strategy is the This is important for
promotion of deeper financial integration.
further advancing the economic development of the region. Financial integration is generally
associated with capital mobility and refers to the extent to which an economy's financial
system is interconnected with other financial markets. A fully integrated financial system will
be one in which potential market participants, both in the banking sector and financial
markets, adopt a single set of rules, have equal access and are treated equally. This would
in turn be reflected in an international convergence in the prices of financial products and
assets, with low transaction costs that encourage the institutions, issuers and investors to
venture beyond the domestic markets into foreign markets. Essentially, the end goal of
financial integration is to establish a free flow of finance and capital, akin to trade integration
which aims for the unrestricted mobility of goods and services. Deeper financial integration
would further enhance the competitiveness and dynamism of Asia.
Broadly, greater financial integration would bring about three key benefits. First, financial
integration fosters greater competition and economies of scale in the financial system,
thereby improving the efficiency in the allocation of capital within the region and thus
increase the capacity of the financial system to meet the differentiated and growing demands
of investors. While the individual Asian financial markets, on their own, are small in size and
fragmented, an integrated market would raise Asia's attractiveness to both regional and
global investors. Second, financial integration would facilitate a more efficient transfer of
surplus funds for investments within the region, with lower intermediation costs and thus
more optimal returns. Through the greater opportunity for risk-sharing and diversification
across a wider geographical area, country-specific shocks and financial vulnerabilities would
be reduced, thus contributing towards enhanced regional financial stability. Third, financial
integration enables countries to build on the complementarities between countries.
Individually, different financial systems can leverage on the comparative advantages of the
different markets that exist in the region. Thus, with greater integration, countries in the Asian
region can expand on financial products and services.
Regional financial integration is particularly important at this stage of Asia's economic
development. Indeed, a more integrated financial market within the region would lead Asia to
a higher stage of economic development. First, while many of the Asian economies have
large surplus funds, there also exists many development needs across the Asian economies,
including more advanced infrastructure development including transportation, healthcare and
education, which require substantial financing. However, cases of mismatched funding needs
are not uncommon. In this regard, a more integrated regional financial system would enable
for a better matching of saving and investment in the region, thus effectively
that
channelling Asia's large pool of savings into productive uses within the region
would support growth and development in the region.
Second, the large and growing trade sector in Asia provides an expanding market for
financial services. The ease of obtaining access to credit through financial integration,
specialisation and exploitation of economies of scale would support the increasing trade and
investment activities. Furthermore, the regional development of capital markets, both in
bonds and equities, provides greater opportunity for firms to raise capital needed for future
industrial expansion. More importantly, higher value-added goods and services tend to
require more credit for more advanced production equipment and technology. As a result, the
role of external finance becomes increasingly more important to facilitate regional trade and
investment as economies move towards higher stages of development. Thus, deeper
regional financial integration would facilitate Asia's growing intra-regional trade and
investment trends. Third, Asia is home to more than half of the world population, with a
growing middle income and young population in the region. This represents a massive
potential market for financial products and services. The high rate of savings also
provides a large local investor base.
Whilst extensive regional cooperation have been initiated and undertaken in the liberalisation
of the Asian financial systems and in the development of financial infrastructure, there still
exist several areas where efforts needs to be further strengthened to deepen financial
integration in Asia. The important four areas include financial sector liberalisation, capital
account liberalisation, regional payments and settlements systems, and cooperation among
regulators and central banks. These priorities would, however, need to take into account the
diversity of the various economies within the Asian region, in terms of the level of
development both the financial system and broader economy. Therefore, reforms need to be
sequenced and aligned to the heterogeneities of the various economies.
First is the further liberalisation of financial services undertaken to allow for the greater
presence of regional institutions in the individual domestic markets, which would further
facilitate trade and investment flows within the region. Beyond the General Agreement on
Trade in Services (GATS) commitments, limits on licenses, branch networks, ownership
share and voting rights still remain in most Asian financial sectors today. Gradually removing
these restrictions to facilitate a greater presence of Asian financial institutions and investors
in each other's economies would facilitate the integration process.
Second, the policies of gradually liberalising the capital account of the balance of payments
would facilitate greater cross-border investment and capital flows. This would enable firms
and investors to better tap the regional financial markets to find the lowest cost of funding
and highest risk-adjusted return. Equally important is the appropriate prudential safeguards
to manage short-term flows and for the liberalisation process to be appropriately sequenced
and based on a well-functioning, well-regulated and adequately developed domestic financial
systems.
Third, as payment and settlement systems are relatively well-developed in most of the Asian
markets, the increased linkages of the national payments systems would enhance the
efficiency and reduce the cost of financial transactions within the region. Several efforts have
been initiated in this area. The Executive' Meeting of the East Asia and Pacific Central Banks
(EMEAP) Working Group on Payment and Settlement Systems (WGPSS) - Working Group
on Financial Markets (WGFM) Joint Taskforce has embarked on a cross-border collateral
arrangement initiative to support and improve the liquidity management of internationally
active financial institutions in the region. Second, the AseanPay Initiative of 2004 has led to a
link-up of ATM networks across the region, allowing for convenient cash withdrawal to
support Asia's increasing tourism activity. With wide participation by banking institutions in
Malaysia, Indonesia, Thailand and Singapore, such infrastructure can be extended to
enhance the efficiency and cost-effectiveness of intra-region card electronic payments and
remittances. The Real Time Gross Settlement (RTGS) systems of Bank Negara Malaysia
(RENTAS) and the Hong Kong Monetary Authority, have been linked to facilitate faster and
more efficient forms of payments. Further linkages could be pursued among the broader
Asian community to link more RTGS systems, thereby facilitating faster and more efficient
form of payments.
Fourth, while greater financial integration brings about many benefits, its associated risks
have to be anticipated and managed. In relation to this, cooperation among the region's
financial regulators and central banks need to be further strengthened. There is already
extensive cooperation and collaborative mechanisms in place. More specifically, there is
improved regional surveillance that facilitates early detection of emerging risks and potential
contagion at the regional level. In addition, institutional arrangements and a framework for
financial crisis containment, management and resolution is now being put in place. These
infrastructure have been reinforced by infrastructure development in the areas of financial
markets, payments systems, and regulatory framework. With significant strides already
accomplished, a key challenge for Asia will be in intensifying this positive momentum for
cooperation and collaboration. Over the next few years, the focus will be on the
implementation of the next set of recommendations that are embodied in the region's road
map produced in 2006 , which outlines the strategic direction of regional cooperation. These
include the development of a vibrant and efficient foreign exchange market, a deeper and
more liquid secondary bond market, the further strengthening of the mutual support
arrangements and liquidity support mechanisms to deal with crises, as well as the
intensification of capacity and capability in reserve management and the overall capacity
building. The institutional arrangements that are now established to deal with financial
stresses and crises must be complemented with collaborative arrangements and frameworks
to deal with an economic crisis within a