Large capital inflows into Asia have resulted in excessive growth in money and credit in several countries, thus creating inflationary pressures and asset bubbles in the stock and housing markets. At the same time, there are concerns that Asia’s large trade surpluses are based on undervalued exchange rates which have given Asia an unfair competitive advantage. While there is little justification for such concerns, they may result in protectionist responses from the US and the EU. A related development is that more countries in Asia and the oil-rich countries are establishing sovereign wealth funds to invest their excess reserves. The US and Europe may react nationalistically over the prospect of losing their strategic assets to foreign sovereign investors. Asia therefore needs to work with G7 countries and multilateral institutions to address these policy and political challenges posed by global financial imbalances and sovereign wealth funds. Second, Asia’s rising affluence has been accompanied by increasing income disparity. By and large, this is not a case of the poor getting poorer. But because the rich gets richer faster than the poor, the widening income gap may nevertheless erode social unity and political stability which are the very pre-requisites of growth. Third, unrestrained economic growth often leads to environmental degradation. With heightened global consciousness over global warming, Asia will have to find ways to grow rapidly and sustainably. It has to address problems like inefficient energy use, carbon emissions and depletion of natural resources like water supplies and agricultural land. However, the responsibility is not Asia’s alone.

However, I believe that Asia should press on with its efforts to develop their capital markets in order to complement the banking system and improve the robustness and efficiency of its financial system. Second, as we pursue financial sector development, we will also see more sophisticated products coming to the fore. Market players and regulators alike must refine their understanding of the attendant risks; in particular, how shocks may be transmitted through such products. We must then develop tools to manage such risks. Indeed, much of the recent financial dislocation stemmed from opacity in the distribution and pricing of risks for derivative products. The key lessons include the need to monitor off-balance sheet exposures and to institute better management and supervision of liquidity risks. Addressing these issues will not be easy as we must avoid imposing excessive regulatory burden on market players or stifling financial innovation. Third, as growing inter-dependence is a reality, the central bank, the financial regulator and the guardian of the public purse must work in close coordination. They must also work with key counterparts in other jurisdictions. One key issue which requires particular attention is the establishment of crisis management and resolution frameworks to minimise systemic fallout should financial institutions run into trouble. 2  BIS Review 124/2007  Other challenges to sustained growth Looking ahead, Asia faces other challenges to sustained growth. First, global financial imbalances pose political and economic risks.