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ViewpointSeptember 1 2017

Zeti Akhtar Aziz: why Asia will be ready for the next crisis

The former governor of Malaysia’s central bank underlines the need to build resilience to manage future shocks to the global financial system, highlighting Asia’s comprehensive policy response after the 1997 financial crisis.
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Zeti Akhtar Aziz

Exactly 20 years on from the Asian financial crisis and 10 years on from the crisis in the advanced economies, achieving a secure and sustainable economic future for the world economy continues to be a challenge. While the global economy is beginning to show signs of stronger performance, unresolved vulnerabilities and ongoing fundamental changes to the economic environment have made the task for policy-makers even more complex.

The wide-ranging vulnerabilities have only been amplified by the low-interest-rate environment. Rising indebtedness and excessive risk taking are precipitating a misallocation of economic resources. Soaring financial asset prices that do not reflect the underlying fundamentals further reinforce this trend. Increasing income inequality is a further area of concern. Policy-makers are also confronted by changes arising from the digitalisation of the global economy with its disruptive technologies, including those associated with cybersecurity.

Because disruptive geopolitical developments, while a given, are beyond the influence of policy-makers, their potential consequences need to be taken into consideration in assessing the risks to the financial system and the economy. A further fundamental change confronting policy-makers has been the role of the media, especially social media. While reaching out to the industry, markets and communities with explanations of policy actions is important, caution is needed to avoid short-term thinking. Of importance is a clear view of the medium-term goals. Among some of the future fundamental changes are the erosion of the demographic advantage as populations age, the consequences of climate change on economies and the erosion in trust and confidence in institutions both in the private and public sector. Most economies are also confronted with massive infrastructure requirements, while fiscal debt positions of governments are significantly strained.

Be prepared

Under these highly challenging prevailing and prospective conditions, building resilience has become the greatest imperative for economies if the damage and devastation from financial crises is to be avoided. How, then, do we prepare ourselves for the future? After every major financial crisis there has generally been a rethinking of growth models, the workings of the financial system, regulatory and supervisory regimes, policy frameworks and the institutional arrangements. Following the financial crisis of 2008-09, efforts towards securing financial stability have focused on regulatory reforms, enhancing the policy toolkit and strengthening supervisory and resolution regimes, with most attention going to financial intermediaries. 

While securing financial stability is vital for supporting a functioning economy, the ultimate objective is surely to achieve sustainable economic growth. To this end, the provision of liquidity and the implementation of unconventional monetary policy measures have been relied upon. While playing a major role in averting the collapse of the financial markets and the economy at the height of the crisis, the prolonged period of these measures has had some unintended consequences for financial stability. It has also reduced the macroeconomic policy space to deal with a future financial crisis.

For most emerging economies, the repercussions of the 2008-09 financial crisis in advanced economies were felt in their financial systems and economies. Emerging economies in Asia were certainly affected by the subsequent contraction in world trade and the volatile capital flows. Supported by macroeconomic measures, growth for most resumed after a brief setback, largely driven by domestic demand. During this period, financial intermediation and credit flows were not disrupted and remained supportive of the respective economies. 

Plans in place

The resilience of emerging Asia was, however, not so much due to the policies implemented during that period but more due to the policies and reforms implemented well before the crisis erupted. In the decade preceeding it, the financial intermediaries were strengthened through restructuring, resolution and consolidation while implementing international regulatory reforms and strengthening their supervisory regimes. As a result, Asian banks during this period were better capitalised and had favourable profit conditions, and funding was mainly from retail deposits with less reliance on derivatives.

The resilience of the regional financial systems was also reinforced by the extensive financial reforms and the development of the domestic financial markets. This included deregulation of the financial system towards greater market orientation and the development of domestic financial markets, particularly the bond market. A major transformation in Asia’s financial system was the shift from being bank-centric to having a more diversified financial system, which in turn facilitated better intermediation of the more volatile capital flows. The development of the foreign exchange market was accompanied by the gradual liberalisation and transition to more flexible exchange rate regimes that allowed the market to absorb some of the external shocks. 

Mechanisms were also in place to address borrowers that were in distress for the orderly debt resolution. This involved debt restructuring for viable corporations and small and medium-sized enterprises and households, which in turn avoided widespread bankruptcies and foreclosures. This reduced the risk disruption to the intermediation process and the impact of the crisis on the economy. Subsequently these arrangements were reinforced by credit counselling and financial education for better management of the economy.

Sticking together

Oversight in the decade that followed the Asian financial crisis was also significantly strengthened to monitor the risks in the banking and non-banking sectors, the money, bond and foreign exchange markets, the levels of indebtedness of borrowers and capital flows into the financial system. Regional co-operation was taken to a higher level. The Association of South-east Asian Nations (Asean) economies decided in the early 2000s not to pursue a single currency, but instead pursue regional financial integration. The goal was to facilitate more effective intermediation of funds in the region for local investment. By the time of the 2008-09 crisis in the advanced economies, regional co-operation had already had a beneficial effect on oversight.

Financial integration in Asia has since strengthened further. Financial intermediaries are now operating increasingly in each others’ jurisdictions. The greater regional integration of financial markets also facilitates the mobilisation of funds in the region for local investments. Attention has been paid to the harmonisation of practices, rules and regulations. Based upon agreed frameworks, bilateral agreements are entered into depending on the state of readiness of respective jurisdictions. The approach has been one of co-operation rather than a set of central co-ordinating institutions. Under these arrangements, countries manage their national economies and financial systems based on their respective national objectives. In maintaining macroeconomic and financial stability in their respective jurisdictions, they would in turn not be a source of instability for others in the region. In the event of a crisis, arrangements are in place for the region to pull together.

Among the institutional arrangements established are the Asean+3 Macroeconomic Research Office (Amro); the Chiang Mai Initiative, a multilateral regional financial safety net worth $240bn; the Executives’ Meeting of East Asia and Pacific Central Banks Monetary and Financial Stability Committee, which detects and assesses risks to the region; the Integrated Crisis Management Framework, which would be triggered to collectively manage a regional financial crisis; and the South East Asian Central Banks Initiative Centre, a training and research centre for capacity building for central banks.

Smart investment

The institutional capacity of the central banks and regulatory and monetary authorities in the region is better positioned to manage future shocks to the financial system. There is now greater clarity regarding mandates and accountabilities and the required powers and policy toolkits. Governance arrangements have been put in place for the policy-making process. There has also been investment in systems, technology and talent to strengthen organisational competence and expertise. 

Cumulatively, these efforts in the region have increased its ability to manage future crises. Asia has now become one of the fastest growing regions in the world economy, sustaining growth in the region of 5% to 7%. In addition to the four large economies of China, Japan, South Korea and India, the region also comprises the 10 Asean economies which collectively have a population of 630 million people and have now become a thriving hub for consumer demand. The region’s per-capita income has more than doubled since 1995 to reach $11,167 in 2015. By 2020, it is estimated that the greater Asian region will account for more than half the world’s middle-class population. Asia has thus transitioned from being a global producer to becoming a global consumer. Foreign reserves in east Asia increased from $500bn before the Asian financial crisis to $5000bn by 2015. 

Despite these positive developments and having built a significant degree of resilience, Asian economies are still operating in choppy waters. Even on reaching the shore, we will be confronted with shifting ground and treacherous terrain. Building resilience has therefore to be an ongoing effort to sustain our readiness to manage future upheavals and crises.

Zeti Akhtar Aziz was the governor of Bank Negara Malaysia from 2000 to 2016. 

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