Frameworks to Support Financial Market Development And Integration in Asia

In addition to specific programs that promote infrastructure finance, efforts should also be made to enhance and harmonize the legal, institutional, and governance frameworks in ways that support cross-border investment and contribute to the general stability and effectiveness of financial markets. The experience of Europe highlights the very important roles, albeit indirect, that building harmonized frameworks had on the effectiveness of financial markets. Similar steps in Asia can contribute to making effective use of Asia's savings to support its own infrastructure investment and development.

5.1 Harmonization of Financial Practice and Infrastructure

The experience in Europe strongly emphasizes the importance of creating an overarching framework of comparable practices, infrastructure, and codes affecting the financial sector. The ability of an economy to attract investment is seen as depending on creating a stable environment in which investments are secure, macroeconomic risks are minimized, and competitive conditions result in unbiased market signals that attract investments. Financial market distortions can arise from many sources, and the Europeans have methodically attempted to increase harmonization between countries as a necessary part of creating a unified financial system for Europe. Areas of potential harmonization include bankruptcy codes, licensing, financial accounting, dispute resolution, provisioning and recognition of impairment, taxation, capital adequacy and other supervisory requirements, disclosures, and income repatriation, among others. Asia should systematically review where infrastructure, standards, and practices hinder equal treatment of cross-border investments or create frictions in cross-border flows. Coordinated efforts in Asia should be taken to introduce harmonized practices and in some ways this process is already underway as countries implement international standards and best practices. These efforts should be strengthened and accelerated (including providing significant technical assistance to poorer economies), because they offer—in addition to their other benefits—ways to strengthen the effectiveness of financial markets. The improvements will enhance the general investment atmosphere in Asia, and help in infrastructure financing.

As mentioned, the impediments to regional integration are both non-financial and financial in nature. In Asia, work on dismantling non-financial barriers seems to be progressing steadily, as can be seen from Soesastro's (2007) discussion on how the ASEAN Economic Community (AEC) Blueprint focuses on integration of trade and infrastructure and supporting institutions and policies. Progress is also being made on the financial side, especially by ASEAN working groups, but it appears that this effort could be intensified.

5.2 Regional Mechanisms for Macroeconomic Oversight

Macroeconomic stability is important in reducing risk that can hinder infrastructure investment. Poorly designed macroeconomic policies can make investments in specific countries unattractive and can result in recessions, high inflation, volatile exchange rates, etc. Good macroeconomic policy making is thus a precondition for infrastructure investment. Also, cross-border investment would benefit from coordinated macroeconomic oversight to promote macroeconomic stability in all affected countries, and to coordinate in areas such as defending a configuration of exchange rates. A strong macroeconomic oversight and policy development apparatus is needed—the Chiang Mai Initiative (CMI) was a movement in the right direction, but it has faltered in this regard—and the type of structured oversight and consultation offered by an institution such as an AMF should be seriously considered.

The Chiang Mai framework includes a provision for “Economic Review and Policy Dialogue” at regular intervals at the minister and deputy levels to work towards prevention of financial crises and swift taking of remedial actions. Recently, there has been increased discussion about strengthening the CMI, including raising the size of potential rescue packages and strengthening the oversight function to build a credible system in ASEAN+3 to monitor the economic and financial situation of member countries. Such a strengthening of CMI would further its functions for effective Asian macroeconomic oversight. ASEAN+3 countries have agreed to set up an ASEAN+3 Surveillance Unit in Singapore (ASEAN 2009). This is a strong step towards building an AMF.

Bolstering macroeconomic stability will require dealing with the cluster of related issues associated with the large accumulation of reserves, exchange rates (external and between Asian countries), inflation control, monetary sterilization, stability of inward and outward capital flows, and sovereign wealth funds. These have become regional issues and a regional oversight and policy development entity should be created to handle them. Such a regional entity or institute could also function to determine how the large accumulation of reserves and SWF assets could be channeled into investment in Asia.

5.3 Regional Mechanisms for Financial Stability Oversight

A similar line of argument applies to financial stability. A strong banking system, well-functioning securities markets, reliable payments systems, etc., all supervised by effective regulators, are needed to maintain financial stability. A coordinated effort by financial sector regulators is called for to create stable financial conditions that can bolster infrastructure investment flows. Creating an Asian equivalent to the Financial Stability Board now embodied in the proposal for an Asian Financial Stability Dialogue (AFSD) by ADB President Kuroda is recommended to facilitate this coordinated effort. Among tasks for the AFSD would be to identify and promote high quality standards and practices throughout Asia, support development of mechanisms for cooperation between national supervisors (in all financial subsectors), and address issues related to crisis management and lender of last resort situations (ADB 2008c). The AFSD should also take steps to ensure that rapid changes in financial markets associated with the globalization of finance or integration of regional markets do not introduce new risks to financial soundness. Finally, the current turmoil in international financial markets provides a sharp warning to all Asian countries that preventive steps to avoid financial distress in Asia are an extremely high priority, and that there is an urgent need for an institution such as the AFSD to address threats to Asian financial systems.

5.4 Final Thoughts: Global Financial Crisis as a spur to Asian Integration

The financing of national and regional infrastructure in Asia for increased connectivity and integration should be viewed in the context of the ongoing global financial and economic crisis and the rebalancing of the global financial system, including its governance and the building of a sustainable, integrated, resilient, and balanced Asia. The severity and global nature of the crisis has forced many changes—among them is a new view that the macroeconomic policies being followed in Asia were components of global imbalances that need to be redressed. One piece of the rebalancing is that Asia must become more inward oriented so that more of its savings shift from short-term investment in external markets toward regional long-term productive investments, of which infrastructure investment is ideal. Providing appropriate market infrastructure (investment tools, integrated markets, innovative and cost effective financing options, clearing operations, good cooperation and coordination frameworks, sound rules and regulations, stable internal and external macroeconomic and macroprudential conditions, and business environments conducive to private sector participation, among others) would bolster the development of efficient and secure markets in which long-term, cross-border infrastructure investment could thrive. All this simultaneously would help create rebalanced, resilient markets that could be part of the solution to the crisis. This would facilitate Asia's move toward rebalanced growth, with less dependence on exports to advanced economies, increased intraregional trade, and increased regional demand and consumption.

The development and integration of Asian financial markets could serve twin goals. It could enhance Asian integration through enhanced regional connectivity—financing the development and implementation regional infrastructure projects—which would have high pay-offs for all participating countries. At the same time, Asian financial and technical resources could be effectively mobilized and allocated to meet the large investment needs in productive sectors like infrastructure

Both the prevention and management of crises and the building of regional infrastructure require a high degree of cooperation and partnership between countries so that increasingly common solutions can be offered and policy and technical friction between countries can be minimized. Regional efforts, such as the CMI or the renewed commitment to the ABMI, are pointing a way, as are various calls to create regional macroprudential or financial cooperation entities. Efforts are becoming more cooperative—at this point most are multi-country in nature, but over time some elements may become more supranational—and a process of integration of aims and methods is underway, spurred both by technical advantages and by the financial crisis. Regional infrastructure investment and development for seamless Asian connectivity is both a beneficiary of, and contributor to, this evolution.

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