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The rise of regional markets

By Andrew Sheng (chinadaily.com.cn)
Updated: 2008-11-17 10:21

Special Coverage Exclusive: An Asian view of the global financial crisis

Contents:  Preface  A historical inflexion point  The macro question  The micro origins  Lessons for China and Asia  Back to basics  One world, three paths  Status quo  The rise of regional markets  Romance of the three regions  Conclusion

The second scenario is that the global imbalance will shrink quite dramatically as the US adjusts, so that the surplus of the emerging markets will also shrink, possibly faster than conventional wisdom would suggest.

There are several reasons for this. The first is that as real interest rates increase to reflect higher risks, world growth will slow down despite attempts to reflate growth.

The second is that the current phase of deleveraging will continue as banks have to recapitalize and therefore the level of capital flows, market turnover and general volatility will decline in the medium term. The third is that the post-crisis shocks will lead to greater inward looking policies, a higher level of regulation and risk-aversion in terms of investments. All this suggests that the emerging markets will adjust back to basic balance more quickly than anticipated.

In this scenario, those emerging markets that take the opportunity to strengthen their domestic financial systems, improve domestic corporate governance, develop their social infrastructure and maintain social stability will be the major winners.

Advanced country pension and mutual funds and surplus emerging markets will still have to park their savings in markets with high growth potential that offer stability in property rights.

But building strong domestic financial markets is easier said than done and it will take time. This is because emerging markets can no longer simply replicate the wholesale banking model that has proven to be fragile.

One of the side effects of the current crisis is that it has forced a complete re-think of how emerging market financial structure should be deepened to build in high levels of efficiency, robustness and transparency, without incurring excessive levels of government intervention. In other words, it requires a complete overhaul of the current forms of domestic governance.

Here, strengthening of domestic markets is still key and pre-condition to stronger global markets. But national strengthening is really a building block to regional strengthening, as economic geography still counts. South-South dialogue between emerging markets will increase because of lack of willingness of the present powers to change the status quo. Within Asia, there will be greater monetary and financial cooperation, not ruling out a regional currency arrangement.

I see that one basis for development of regional financial cooperation is the creation of regional Financial Stability Forum (FSF) arrangements, whereby ministries of finance, central banks and financial regulators meet regularly within each region, so as to support deliberations of the FSF at the global level. These regional discussions will form the basis for future regional cooperation.

It is possible that the G-7 may concede to some power sharing in the Bretton Wood institutions in order to coordinate policies to address the global imbalance. This will certainly come in the form of greater pressure on exchange rate revaluation for the emerging markets, particularly China.

My own personal view is that exchange rates matter less than real total factor productivity growth. As long as a country's total factor productivity is growing, changes in the nominal exchange rate should stably adjust to reflect such changes. For example, global imbalance will be adjusted partly through a gradual increase in Asian exchange rates as a bloc against the US dollar and the Euro.

This second scenario will take at least 10 years to unfold.

To be continued...

The author is chief advisor at the China Banking Regulatory Commission and former chairman of the Hong Kong Securities and Futures Commission.