bandid nijathaworn : regional financial integration and development of local markets speech by mr bandid nijathaworn, deputy governor of the bank of thailand, at the jp morgan investor seminar during the imf / wb annual meetings, singapore, 17 september 2006. * * * first, let me start by thanking jp morgan for inviting me to speak this morning. the topic today is “ regional financial integration and development of local markets ”. given the limitations of time, i want to focus my talk this morning on just two issues. the first is on what has been achieved so far in east asia in regional financial integration. and the second is the prospect for regional financial integration as we move forward, and what role should policy play. to begin, i think one important defining phenomenon that has been a key driver of east asia ’ s recent rapid growth is the increased interdependency amongst economies in the region, especially in trade, and especially in the trade between china and the rest of the region. intra - regional trade is now the largest component of total trade in most east asian economies. for example, total trade share of asia10 with asia - 10 has risen to 41 percent this year, compared to a share of about 21 percent fifteen years ago. and asia - 10 now trade among themselves more than with the g3 economies. this growth in intra - regional trade has been spurred, in part, by the integration of production network and supply chain in the region, especially the emergence of china and its integration into the regional economy. also, government policies to support freer trade through bilateral and multilateral trade agreements have also had a strong supporting influence. accompanying the growth in intra - regional trade is a deepening process of financial integration in the region, defined as cross - border investment flows within east asia. evidence of this can be seen from the data on cross - border flows in fdi, portfolio investment, and bank lending that point to a rising trend. also, financial prices in the region ’ s financial markets show greater tendency to converge. for example, cross - border interest rate and bond yield differentials have narrowed while the volatility in money market interest rates across the region has declined. to me, a key stimulus to the current process of financial integration has to be east asia ’ s rapid economic growth and the accompanying growths in intra - regional trade and cross - border investment. government policies to develop financial markets in the region have also been important in so

a wider set of rules and regulatory framework, especially on cross - border capital flows, that tends to be more difficult to dismantle quickly. at the same time, the policy approach on capital flows liberalization in east asia has been more cautious following the asian financial crisis because of the risk of capital outflows and the weakened external financial positions. this, in my view, is one reason that led to a more cautious approach in liberalizing cross - border capital outflows. let me now come to the second part of my talk, that is, the prospect for financial integration in the region going forward, and what should be the role of policy. on this, i see substantial scope for the pace of financial integration in east asia to be gaining more momentum going forward as the constraints that used to limit the pace of integration begin to unwind. first, the external positions of the economies in east asia have now become much stronger, with current account surpluses, substantially lower external debt, and larger international reserves. second, asian savers themselves increasingly want to diversify their savings abroad in search for better yields while asian firms also look for better opportunities to lower their costs of fund by tapping funds from external sources. reflecting these two factors, we are seeing a reorientation of policy in the region to make cross - border capital outflows more liberal without compromising the risk on macroeconomic stability. and the third factor is that asian financial institutions are now back in good health after a period of restructuring and consolidation. so, we are likely to see asian financial institutions becoming more active in intermediating cross - border capital flows within the region, as they explore new business opportunities based on their expertise and knowledge of the region. all these factors, i think, will set in train a stronger momentum of cross - border capital flows within the region in the period ahead. and under such circumstances, what then should be the role of policy? government policies, in my view, have played an important role in the development of east asian financial markets. the key policy has been the implementation of financial sector reform which has resulted in a much improved financial system, especially the banking sector. policies have also been directed at developing the region ’ s capital markets, especially the bond market. and as i noted, policy cooperation has also been strengthened to support regional financial integration. but while policies have been important, financial integration in east asia has essentially been left to the market, in the sense that the process is basically