Federal Reserve Bank of San Francisco/Monetary Authority of Singapore Symposium
July 11, 2016
Good morning. I would like to thank the Federal Reserve Bank of San Francisco and the Monetary Authority of Singapore for their invitation to speak before this symposium on the relationship between financial reform and financial stability. I am honored to join you today.
The exchange of views on this topic is extremely important to Asia, particularly at this moment. The global economy is facing many new challenges, as we have seen in the past few weeks with the results of the Brexit referendum. So we must constantly adjust our understanding of the forces that can support, or weaken, Asian dynamism. Our exchange of views is relevant to some of the core economic issues facing policymakers, regulators, investors and corporate executives.
The Asia-Pacific region has lessons to offer the rest of the world, and there are lessons that it, in turn, can learn from others. These lessons are essential if we are to address the challenges of a world economy still seeking to achieve strong, stable, and sustainable growth eight years after the onset of the Global Financial Crisis.
Here I would like to point to one core lesson that is particularly important to a region that has experienced extraordinary success and financial instability over the past generation: neither financial stability nor economic growth cannot be achieved by standing still. It is only through a process of constant vigilance and reform that continued success can be assured.
The response of global markets to the Brexit vote underlines the ongoing need to maintain vigilance in the face of unexpected developments. Financial vulnerabilities and risks must be addressed before they can threaten stability. The Asia-Pacific has withstood recent waves of financial volatility, in part, because of policy frameworks that include more flexible exchange rate regimes and stronger reserves positions. The region is also implementing reforms that promote financial stability, such as the strengthening of bank capital and liquidity positions being phased in under Basel III.
These are the types of reforms that help financial institutions become more resilient and build the foundations for inclusive growth. And they ultimately help ensure that the global financial system works for—and not against—the benefit of the international community.
So in the time I have today I would like to address the issue of growth and financial stability with an eye to the current state of the global economy, and then the challenges of financial sector development. And I will relate that topic to the role of the IMF in the Asia-Pacific region.
The Global Outlook
Let’s begin with the global economy.
The Fund’s outlook for the world economy—which we will update next week—sees an ongoing, subdued recovery that faces many risks. The advanced economies are growing at a modest rate. But they still must address unresolved legacies from the crisis if growth is to become more robust—particularly in Europe.
The emerging and developing economies continue to provide the most important contribution to global growth. But that growth has slowed in the face of a combination of decelerating world trade, weak commodity prices, and tighter credit conditions caused by market volatility and heightened risk aversion.
Asia remains a key driver of global growth, but it is slowing, led by China’s deceleration toward 6 percent annual growth. Southeast Asia has been a bright spot, with relatively robust momentum in the ASEAN countries, as domestic demand has helped to offset slower exports. This domestic demand reflects favorable demographics and the investment needs of societies seeking higher standards of living.
The outcome of China’s economic rebalancing is one of the most important risks facing the global economy. A sharper-than-expected growth slowdown has the potential to reverberate to countries worldwide that have become closely linked to the Chinese economy. I’ll come back to this point in a moment.
A second risk is posed by global economic and financial conditions: the region’s trade and financial linkages have made it particularly sensitive to cyclical changes and shifts in sentiment. The sharp fall in commodity prices and slower exports have exacerbated corporate and sovereign vulnerabilities across the emerging markets. The situation has been building since the Global Financial Crisis as emerging market economies—including Asia’s—relied on rapid credit creation. The result was sharply higher private sector and household leverage across many countries.
At the same time, corporate profitability began to fall, stretching debt-servicing capacity and leaving corporates vulnerable. Refinancing pressures may become more acute, especially in commodity-exporting countries and commodity-related sectors. Over the past year, this situation has been exacerbated by widening spreads and rising capital outflows.
The corporate problems are most visible in China, and the potential for regional and global spillovers more acute, as we learned last year when China’s markets encountered turmoil. A rising share of debt is held by Chinese companies that do not earn enough to cover their interest payments. The most recent IMF Global Financial Stability Report estimated that “debt-at-risk” had increased to 14 percent of listed Chinese companies’ debt, up from 4 percent in 2010.
That said, we believe that the issue of Chinese corporate debt is manageable—if the government moves quickly to address the problem. That means measures that both address the current problem and ensure that there is no recurrence in the future. By doing this, the government can reduce the risks of rebalancing.
Ensuring Financial Stability
So far, Asia has shown that it is able to adapt to the unexpected. In large measure, this is a reflection of the policies and reforms put in place since the Asian Crisis. Central banks and regulators have done a good job of keeping vulnerabilities in check and strengthening their defenses. Corporates have assimilated many lessons about leverage and exchange rate exposure.
But ensuring financial stability means leaving no room for complacency. Now is the time for the region to reinforce its commitment to resilience and financial stability. Countries and corporates need to prepare for sudden reversals of market sentiment and capital flows.
It also means continuing the strong macroeconomic policies that have served Asia so well since the global crisis. And it calls for structural reforms that can support domestic demand and raise productivity. These reforms must address gaps in infrastructure and education, along with policy and institutional weaknesses that hamper economic progress. They also can create the fiscal space needed to generate more resources for the next stage of development.
But this progress also depends on financial sector deepening—the reforms to both government and markets that can reinforce resilience and financial stability, and facilitate the sustainable, long-term development of a modern economy.
Financial Sector Deepening
Deepening means going beyond traditional banking practices—for both consumers and corporations—to create the financial products and opportunities that can lift productivity and fuel sustainable growth. Across borders, financial sector development can create new trade linkages, enhance synergies in the service sector, and transform capital markets.
Financing is a core challenge of infrastructure development, where government funding inevitably must be accompanied by private sector investment. This means capital market development to create long-term funding channels.
It is essential that infrastructure projects are undertaken within the framework of macroeconomic policies that encourage investment support from all possible sources, domestic and international, including for public-private partnerships. This can enable the development of local currency bond markets and avoid an over-reliance on foreign currency borrowing. Projects should be given access to financial products that meet their needs without burdensome red tape.
Deeper markets also are crucial to inclusive growth. Expanding access to financial services to the millions of people in South Asia and the ASEAN countries—particularly women—who lack access to the formal financial sector is an essential goal. By giving everyone a stake in the economy, everyone will benefit. This calls for new approaches: the expansion of Islamic finance in some countries, more micro-financing in others, broader use of financial technology, including mobile banking.
So innovation is crucial. But innovation must go hand in hand with an unending commitment to vigilance, putting in place macro- and micro-prudential measures to address continued credit growth. That means monitoring excessive corporate leverage and bank exposure. It means improving asset classification practices, addressing data gaps that make monitoring more difficult, and ensuring that supervisors have the resources and authority to address emerging risks. A deterioration in outlook calls for financial institutions to strengthen provisioning where non-performing loans are on the rise. It means bringing transparency to financial markets.
The Role of the IMF
What can the IMF do to assist all of these efforts? We already serve as the family doctor: providing advice and spreading the word of best practices across the region through our Article IV reports and cross-country analytics. We use our Financial Sector Assessment Program to highlight vulnerabilities and offer concrete suggestions of ways to strengthen oversight and financial sector development.
We can foster dialogue among member governments and other stakeholders on crucial issues. For example, we are facilitating an ongoing discussion of a trend toward disintermediation in correspondent banking relationships as a result of greater international risk aversion. This appears to be having the unintended effect of limiting the development of grassroots financial institutions in under-served areas.
Finally, the Fund’s programs of technical assistance and training can help meet the concrete needs of member countries as they grapple with the challenges of evolving financial sectors.
The Fund is also working with the international community to strengthen regional and global defenses against financial crises. Asia already has the Chiang Mai Initiative, which it recently strengthened and which we see as essential protection against instability. It is an important complement to our own efforts.
The Fund can now offer a much stronger safety net because of the recent increase in our quota resources. We also have expanded our toolkit to provide more, and more flexible, financing facilities. And we are working with the international community to find new ways to strengthen defenses in the face of continued global uncertainties. That underscores the importance of a fully resourced IMF.
Taken together, we are in a good position to work in close cooperation with our Asian members—who now have a much larger say in the Fund’s governing councils thanks to the recently approved governance reforms
But like any capable doctor, we must constantly strive to improve our work, particularly in light of changing global conditions. It is also our obligation to maintain vigilance and introduce reforms.
All of these combined efforts can go a long way toward putting in place the reforms that can enable greater economic possibilities for the most dynamic region in the world. It is not possible to shield even the best-run economies from shocks in this increasingly interdependent world. But building the proper policy frameworks—and then protecting them against shocks—can go a long way to facilitate continued progress.
Asia cannot eliminate all uncertainties. But it is possible to anticipate many risks by highlighting emerging vulnerabilities. We also can insure against what cannot be avoided and be better prepared for the unexpected. The IMF has a role to play in helping this effort—both deepening and defending financial sectors. And we will work with our membership across the Asia-Pacific region to ensure the best possible outcomes.