Cautious First Steps in Further Development of Financial Markets

Asia's investment needs are enormous and will likely continue to grow over the coming years. Well-regulated, open and liquid capital markets therefore play an important role in investing the available capital as efficiently as possible. Individual countries will need to increase the depth of their own financial systems, as well as improve the integration of their financial markets across national borders. They are already starting to move in this direction, although the first steps will have to be taken rather carefully.

Many Asian national economies have exhibited impressive growth rates over the past twenty years. Much of this growth has been driven by increasing investment spending. This includes public and private infrastructure spending, energy supply, transport, telecommunications, supply and disposal, investment in equipment and buildings as well as capital investments by companies, and investments in private residential construction. According to the International Monetary Fund, investment made up 45 percent of the GDP in China in 2015, 35 percent in Indonesia and 32 percent in India. For Asia's developing countries, the average share of investment in GDP was 41 percent, compared to 21 percent in industrial countries. In the years to come, investment spending is expected to continue rising at a high rate, but this spending cannot and should not be financed solely by the public sector. To encourage greater involvement of the private sector in financing infrastructure in particular, however, many Asian countries need to further reform their financial sectors.

Substantial Increase in Wealth

Asian emerging markets have relatively high savings rates compared to industrial nations. According to the World Bank, the national savings rate was 28 percent in South Asia in 2014 and 45 percent in the East Asian/Pacific countries. Many Asian households saw their wealth grow enormously as a result of the combination of high savings rates and rapid economic growth. According to the 2016 Global Wealth Report published by the Credit Suisse Research Institute, wealth in Asia (excluding Japan) grew from 9 trillion US dollars in 2000 to 29 trillion US dollars in 2016. Over the same period, the share of global wealth grew from 7.7 percent to 11.5 percent. In other words, the wealth of Asian households outpaced the global average.

Representing one of the biggest challenges in this regard is the fact that, although savings rates in Asia are very high, a large share of these savings is invested for the relatively short term. The reason for this can be found in the financial sector, which is geared primarily toward banks. Banks are generally less involved in longer-term forms of financing due to their risk policies and regulatory and cost structures. Meanwhile, many Asian capital markets are relatively underdeveloped, particularly in the longer-term segments of the bond markets. This is frequently true of the markets for government bonds, where longer maturity ranges still tend to show less liquidity. In the absence of a broad range of reliable prices for government bonds over longer maturities, it is difficult to establish comparable segments for corporate bonds. This problem is even more serious when emerging markets try to establish such market segments in their local currencies. 

Highly Fragmented Market

Another compounding factor, according to figures provided by the Asian Development Bank (ADB), is that the Asian financial sector remains relatively fragmented and focused on domestic markets. Cross-border financing activities are largely handled by foreign banks, which have tended to dial back their activities in recent years as a result of regulatory changes. In this context, the ADB and other international organizations point to risks associated with inadequate financial market development in the region. For instance, there is the danger that key Asian emerging markets could stagnate at an average per capita income level and not move up to join the group of countries with high income levels.

In some ways, the experiences of many Asian countries, in particular from the era of the Asian currency crisis in 1997–98, as well as the global financial crisis of 2008–09, remain a crucial additional factor influencing reform efforts. As a result of these lessons of the past, opening the financial markets is considered to be a risk. Measures controlling the movement of capital, in particular, were and still are a useful tool for ensuring the stability of financial markets in certain situations – a view that has also been adopted in recent years by the International Monetary Fund and one that does not necessarily have to run contrary to deeper financial market integration.

What Needs to Be Done?

What can those Asian countries affected do now to develop their capital markets further while ensuring that reforms are built on both the positive and negative experiences of recent decades from a global perspective? The ADB and the Organization for Economic Cooperation and Development (OECD) mainly suggest measures aimed at fostering long-term savings.

Establishing and supporting public and/or private old age insurance systems can play a critical role in supporting this. Furthermore, it would create a new or larger pool of investors with a long investment horizon. Fundamental steps will also be needed to promote increased awareness of long-term saving, to establish a regulatory framework protecting those investors and savers, and to ensure that tax incentives are in place. Regulatory measures can also manage the supply and demand for capital in certain market sectors. And finally, further liberalization of the interest rates in some countries remains an important point in allowing market prices to rise and thus improving the allocation of capital.

It comes as no surprise, therefore, that international organizations propose more active involvement of Asian countries in formulating the global financial market regulations that impact them. This is even more important now that regulation of the financial markets is on the upswing in the US and the EU as a result of the numerous crises in recent years. When it comes to questions of financial market regulation, a more active role by the Asian emerging markets – one commensurate with their share of the global economy and global wealth – would therefore be preferable. The path to deepening integration and development of the financial markets in Asia should therefore be followed, but with care. Steps taken in individual countries in recent years are, at least, encouraging.