Challenges of the Asian Economy and Financial Markets

Challenges of
the Asian Economy and Financial Markets

Interim Summarization

August 8, 2001

Expert group on the challenges
of the Asian Economy and Financial Markets
Subcouncil on Foreign Exchange and Other Transactions
Council on Customs, Tariff, Foreign Exchange
and Other Transations

The Expert Group on the Challenges of the Asian Economy and Financial Markets (hereinafter referred as "Expert Group") was founded in the Subcouncil on Foreign Exchange and Other Transactions in the Council on Customs, Tariff, Foreign Exchange and Other Transactions on January 23, 2001. The Expert Group has held ten meetings in which members actively discussed views expressed by experts from Asian countries.
The main arguments of the Expert Group have been compiled in this Interim Summarization.

August 8, 2001

Council on Customs, Tariff, Foreign Exchange andOther Transactions
Subcouncil on Foreign Exchange and Other Transactions

Expert Group on the Challenges of
the Asian Economy and Financial Markets
Members' List

Members Etsuko Katsu	Associate Professor, School of Political Science and Economics, Meiji University
Megumi Suto	Professor, Faculty of Economics, Chuo University
Shunji Nanjo	Deputy Chief, Editorial Board, Yomiuri Shimbun
Naoyuki Yoshino (Group Chairman)	Professor, Faculty of Economics, Keio University
Expert Members
Eiji Ogawa	Professor, Graduate School of Commerce and Management Hitotsubashi University
Hidenobu Okuda (Deputy Group Chairman)	Professor, Graduate School of Economics, Hitotsubashi University
Hajime Kaneko	Chief Manager, International Marketing Promotion Division, NEC Corporation
Ke Long	Research Fellow, Fujitsu Research Institute
Yoko Kitazawa	International Affairs Expert
Masaaki Komatsu	Professor, Graduate School for International Development and Cooperation, Hiroshima University
Daisuke Takeuchi	Head, Asia Oceania Headquarters, The Nomura Securities Co., Ltd.
Tomikazu Hiraga	Director, Asia and Oceania Department, Japan Center for International Finance
Eiji Hirano	Director, International Department, Bank of Japan
Yukiko Fukagawa	Associate Professor, Faculty of Economics, Aoyama Gakuin University
Takayoshi Fujimura	Professor, Faculty of International Development, Takushoku University
Fumio Hoshi	Director, Project Finance Department, Japan Bank for International Cooperation
Osamu Mori	Director and General Manager, Finance Division, Mitsui & Co., Ltd.
Hidefumi Yamagami	General Manager, Research Office, The Bank of Tokyo-Mitsubishi, Ltd.

Challenges of the AsianEconomy and Financial Markets
(Interim Summarization)

Contents

Foreword

< The Construction of Efficient and Stable Financial Systemsin Asian countries>

1. Characteristics of Asian Financial Systems
(1) High Savings Ratios
(2) Financial Systems Centered on Bank Lending
(3) Development of Capital Markets Remains Limited

2. Each Country's Measures Aimed atRevitalizing the Banking Sector
(1) Measures Taken after the Currency and Financial Crises
(2) Situation of Banks' Financial Intermediation Function

3. Issues for the Future: Toward theConstruction of Efficient and Stable Financial Systems
(1) Foreign Banks and Local Banks
(2) Strengthening of Bank Monitoring Functions
(3) Expansion of Financing for Small and Medium-sized Businesses
(4) Provision of Long-term Credit
(5) Development of Capital Markets

4. The Role of Japan
(1) Financial Institutions
(2) Institutional Investors
(3) Role of the Government

5. Summary and Other Points to Consider
(1) Summary
(2) Other Points to Consider

<	Current Status and Discussion Points Concerning Foreign Exchange Regime, and Controls on Currency Trading and Capital Flows in Asian Countries>
(Appendix)

1. Foreign Exchange Regime
(1) Current Status
(2) Discussion Points

2. Management and Control of Currency Trading and Capital Flows
(1) Current Status
(2) Discussion Point

Meeting Report

(Provisional Translation)

Interim Summarization by The Expert Group on theChallenges of the Asian Economy and Financial Markets

Foreword

The economies of Asian countries were severely damaged by the currency and financial crises of 1997, which hit the banking sector hardest. Early in 1999, most countries recovered rapidly, mainly spurred by the expansion of exports. However, since the end of 2000, economic slowdowns have become evident in an increasing number of countries, due to such factors as slackened expansion of exports accompanying circumstances like the slowdown of the U.S. economy. In foreign exchange markets, currency values have depreciated in many countries, due to factors such as political instability, in addition to economic slowdown.

On the other hand, Asian countries have been continuing efforts at structural reform such as restructuring of finance and corporate sectors after the currency and financial crises. Given the current economic slowdown, the implementation of structural reform and other appropriate economic measures to maintain stable growth, has become more important than ever for Asian countries.

Since February 2001, the Expert Group on the Challenges of the Asian Economy and Financial Markets has been discussing the issues that Asian countries face mainly on financial and capital markets as they strive to maintain stable economic growth in the existing Asian economic climate, along with related topics, such as efforts made to resolve those issues and Japan's involvement. During this discussion, the Group has listened to the views of experts from six Asian countries (China, South Korea, Singapore, Malaysia, Thailand, and Indonesia).
The main economic and financial issues that Asian countries should address to prevent the reoccurrence of currency or financial crises are the creation of efficient and stable financial systems, and issues of the foreign exchange regime, and management and control of currency trading and capital flows.

(1)		To secure continuous economic growth, it is essential to achieve efficient resource allocation by building efficient and stable financial systems. In particular, savings ratios in Asian countries are extremely high. The construction of financial systems that efficiently allocate these ample domestic savings for various investment purposes is an important issue from the standpoint of preventing the recurrence of currency and financial crises by not being overly dependent on foreign funds to secure the economic growth. Considering factors such as the characteristics of business styles in Asian countries, it seems that, banks and other financial institutions (hereafter referred to as "banks") will continue to play a main role in financial intermediation function in the financial systems of the various countries. Since the previous currency and financial crises, Asian countries have taken measures such as restructuring their financial sectors, boosting equity capital, reorganizing and disposing of non-performing loans at their banks, and strengthening the supervision of banks and prudential regulations. Nevertheless, although there are differences from country to country, lending by banks remains slow overall and there has been no conspicuous improvement in the profitability of banks themselves, so it cannot be said that the financial intermediation function of the banks has recovered sufficiently. In addition, improvement in the securities market, such as stocks and bonds, remains an important issue for Asian countries from the standpoint of supplementing the financial activities of banks and also for the provision of long-term credits.
(2)		Because the previous currency and financial crises were caused by a sudden outflow of short-term funds under what was effectively a dollar-pegged system, the consideration of appropriate foreign exchange regime and appropriate ways to manage and regulate currency trading and capital flows is an important issue for Asian countries in order to prevent future currency or financial crises and to maintain stable growth. Since the crises, most Asian countries have been moving toward more flexible exchange rate systems based on their reflections that effectively dollar-pegged exchange rate systems were a key factor that undermined the stability of their currency. Recently, however, as exports have declined due to the slowdown of the U.S. economy, achieving currency stability has become more important than ever for authorities in Asian countries. In addition, the fact that Asian countries have handled currency trading and capital flows (especially short-term flows) in a variety of ways even after the crises, with, for example, countries such as Malaysia adopting a fixed exchange rate system, it is still necessary to discuss ways of managing and regulating currency trading and capital flows in light of the current situation. Furthermore, based on examples from the past, currency and financial crises (credit crises) do not necessarily occur simultaneously. Nevertheless, based on Asian recent experience, because one factor behind the crises was the fragility of the financial systems, it appears that building efficient, stable financial systems and preventing recurrence of financial crisis is also important to prevent recurrence of currency crisis.

Based on an awareness of the above issues, so far this Expert Group has thus far mainly discussed which issues Asian countries should address to build efficient and stable financial systems. Regarding Japan's involvement in each country's efforts, the Expert Group has especially focused on Thailand, Indonesia, Malaysia and South Korea, which were particularly influenced by the currency and financial crises. (However, this has been limited to the consideration of trends that all the countries have in common, and has not extended to the consideration of the details of individual countries.) In the future, the Expert Group plans to continue its discussion of the issues mentioned above. The Expert Group has compiled the main arguments that have emerged from its discussions so far as a reference for future deliberation.

(Although the Expert Group heard opinions from experts from various Asian countries about foreign exchange regime and ways to manage and control currency trading and capital flows, these issues have not yet been discussed among the members of the Expert Group. Therefore, discussion points and other items related to those issues have simply been briefly summarized in the appendix.)

1. Characteristics of Asian Financial Systems

(1)

High Savings Ratios

Except for some countries such as the Philippines, the savings ratios are high in Asian countries, the fact is evaluated as a positive fundamental of Asian economies that supports strong growth. In order to efficiently allocate these ample domestic savings to various investments, domestic financial systems must function efficiently at financial intermediation.

During the early and mid-1990s, Asian countries recorded strong economic growth, but at the same time, the current balances of most of the countries were negative and investment ratios exceeded savings ratios. This trend was welcomed because Asia was able to achieve stronger economic growth than other developing regions thanks not only to domestic savings but also to vigorous foreign investment (which, especially in the case of direct investment tends to invite technical transfers). On the other hand, excessive short-term borrowing from foreign banks, caused the Asian currency crisis. For this and other reasons, some members of the Expert Group indicated that since Asian countries have ample domestic savings, they might be able to maintain sufficient growth without being overly dependent on foreign capital (especially short-term funds).

Table: Savings Ratios (S) and Investment Ratios(I) in Asia

(as % of GDP)

	1980		1990		1995		1999
	S	I	S	I	S	I	S	I
Thailand	23	29	34	41	36	43	33	21
Indonesia	38	24	32	31	36	38	32	24
Malaysia	33	30	34	32	37	41	47	22
South Korea	24	32	37	38	36	37	34	27
The Philippines	24	29	18	24	15	23	20	19
Singapore	38	46	44	37	51	33	52	33
China	35	35	38	35	42	40	40	37
Hong Kong	34	35	36	27	33	35	31	25
Taiwan	33	34	29	23	27	25	26	23
Japan	31	32	33	32	31	29	28	26

World	24	25	24	24	21	23	25	23

Sources:

World Bank, "World Development Indicators" and "World Development Report".
Figures for Taiwan taken from "Industry of Republic of China".

(2) Financial Systems Centered on Bank Lending

-1-

Businesses in Asian countries procure a relatively high proportion of their fund through bank loans. This trend seems to have remained basically even after the currency and financial crises. (Since the 1980s, efforts have been made to develop securities markets, but generally most are still immature.)

Malaysia got a relatively early start, in the mid 1980s, on constructing a corporate bond market and promoting the issue of corporate bonds through government policy, and its bond market has expanded well. However, most issues are privately placed bonds or bonds by small or medium-sized businesses. Since the fact is that these bonds are guaranteed by banks and allocated to financial institutions, their liquidity is low, and it does not seem that they appropriately distribute credit risks through a market mechanism.

Table: Bank Loans, Corporate Bonds, and StockMarkets as % of GDP

	Bank Loan Balance		Corporate Bond Balance		Stock Market Value
	End of `97	End of `00	End of `97	End of `00	End of `97	End of `00
Thailand	120.9	86.1	11.5	10.2	23.9	26.2
Indonesia	61.1	20.9	3.6	1.7	25.4	20.0
Malaysia	98.1	91.6	47.7	41.3	122.2	124.9
South Korea	64.8	88.4	19.9	25.8	15.7	36.4
The Philippines	56.5	39.6	N/A	N/A	51.6	77.6
Japan	110.9	109.3	10.5	12.9	52.5	70.9
U.S.A	45.1	48.6	38.1	45.2	113.2	124.2

Note: The balance of bonds in the Philippines is reportedly negligible because CPs are issued instead of corporate bonds.
Source: IMF, "International Financial Statistics".

-2-

Generally, it is said that in situations where there are large discrepancies in the quality and quantity of information about corporate behavior between investors (parties that provide funds) and businesses (parties that receive funds) bank loans are a more advantageous form of corporate fund procurement than the capital markets, and they play a larger role if there are few businesses with credibility, or if systemic and legal frameworks are inadequate, etc.,.
In shareholding patterns of businesses in Asian countries, shares tend to be concentrated extremely heavily in the hands of a very few top shareholders. Moreover, the ratio of cross-shareholding among businesses is high. Also, it is said that there is a high proportion of small and medium-sized businesses and conspicuous asymmetry of information, and besides, the governments sometimes provide tacit guarantees for loans. It seems that these circumstances limit the development of securities markets in Asian countries and that they have resulted in bank-dependent fund-procurement structures.

Table: Concentration of Corporate Ownership

	Concentration (%)		Year-end	Corporate Sample
	Top Shareholder	Top 5 Shareholders	Year-end	Corporate Sample
Thailand	28.5	56.6	1997	All listed companies
Indonesia	48.2	67.5	1998	All listed companies
Malaysia	30.3	58.8	1998	All listed companies
South Korea	20.4	38.5	1998	81 listed non-finance companies

Source: ADB (2000), "Corporate Governance and Finance in East Asia".
(Extracted from "Prudential Regulations in Asia," submitted by Ms. Katsu, at the 9th Meeting of Expert Group)

(3)

Development of Capital Markets Remains Limited

At the time of the currency and financial crises, banks and businesses faced difficulties in procuring funds as Asian currency values depreciated causing debts denominated in foreign currencies to balloon and they plunged into excess debt. Credit shrinkage occurred and the macro-economy suffered a major shock. This experience has led to a strong awareness of the need for Asian countries to develop capital markets, especially domestic bond markets offering liquid, corporate bonds denominated in the local currency, as part of the overall diversification of fund procurement methods aimed at complementing bank loans. In fact, major Asian corporations that faced a credit crunch due to the financial crisis obtained fund by issuing corporate bonds. However, in addition to the inadequate market infrastructure, there were other factors such as government involvement and bank guarantees of corporate bonds that make it appear that market mechanisms are not yet functioning adequately in Asian corporate bond markets compared to their counterparts in the U.S. or other developed countries.

In 1999-2000, the South Korea corporate bond market was temporarily paralyzed because some chaebol conglomerates faced problems in acquiring funds. The government came to their rescue through such measures as injecting public funds into investment trust firms that took on corporate bonds and instructing government-affiliated banks to help redeem the bonds.

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