The new financial system in Asia Pacific must ensure greater capital productivity and capital allocation efficiency in the region. The challenge is how to develop the largely underdeveloped capital markets in Asia, which has a low capital market capitalisation and a low government, corporate and household debt relative to advanced economies.
The role of financial markets for capital accumulation and the relationship between saving and investment is explored in:
- Brueckner, Kikuchi and Vachadze (2014) study how economic growth relaxes borrowing constraints and the savings rate of entrepreneurs. The inverted U relationship between level of development and the savings rate is empirically supported by the panel of more than 130 countries between 1960 and 2007.
- Kikuchi and Vachadze (2014) study how strategic complementarity in saving decisions arises due to limited pledgability in financing investment projects. Strategic complementarity is a source of self-fulfilling beliefs, which may induce dramatic changes in savings behaviour and thus economic growth.
Misallocation of capital is closely related to emergence of asset price bubbles. How the savings glut, bank loans and international capital flows give rise to asset price bubbles is explored in:
- Hillebrand, Kikuchi and Sakuragawa (2014) study how asset bubbles can trigger a savings glut, which crowds in investment when capital formation is initially depressed by a credit constraint.
- Kikuchi and Hillebrand (2014) study how small put persistent income shocks can generate booms and busts in housing prices when the revenue of selling houses can be used to repay mortgage loans.
- Kikuchi and Thepmongkol (2014) study the relationship between interest rate spreads and asset price bubbles. It shows that a deviation of the asset price from its fundamental value is caused by an expanding credit volume and a corresponding increase in interest rate spreads.
How international capital flows can destabilise economies is explored in:
- Kikuchi (2008) studies the effects of stock market integration on capital flows between countries. The optimal portfolio decisions do not necessarily induce convergence of incomes between two countries. Moreover, stock market integration may destabilise capital flows leading to cyclical reversal of capital flows between two countries.
- Kikuchi and Stachurski (2009) study the effects of credit market integration on capital flows between countries. It shows that cyclical reversal of capital flows between two countries occurs when two countries differ in their size.
- Kikuchi, Stachurski and Vachadze (2014) study how the relationship between the demand for a risk premium and income level affects international capital flows. The income rank reversals occur because of excessive capital flows from a rich to a poor country when higher income leads to lower domestic entrepreneurial investment that entails risk.
Can international financial liberalisation through foreign bank entry for instance, contribute to financial market development in the region? The impact of foreign banks on financial sector development in general has tended to focus on financial sector deepening relating to the liquidity and development of the banking sector as well as bond and equity markets (Gopalan, 2014). However, the other crucial dimension of financial sector development, especially from the perspective of emerging and developing economies in the region involves making finance more inclusive for all households and firms in an economy. One of the concerns about the relationship between foreign bank entry and financial inclusion is that the entry of foreign banks could be negatively associated with banking sector outreach owing to the tendency of foreign banks to cater to a smaller segment of the population.
This issue is empirically explored in:
- Gopalan and Rajan (2014a) advance the literature on financial inclusion by empirically testing the impact of foreign bank entry on banking sector outreach for a large sample of emerging and developing economies. The paper also specifically explores how banking concentration and foreign bank entry jointly influence financial inclusion. The paper finds that foreign banks have a significantly direct positive impact in furthering financial inclusion, although the positive impact markedly reduces when we factor in the levels of banking concentration in the economy.
How the provision of global public goods by competing powers shapes the political economy landscape is explored theoretically in:
- Kikuchi and Huynh (2014) study the relationship between public goods provision and coalition formation of countries. The framework presented in the paper is a first step to understand the interaction between global public goods provision and hegemonic structures.
While global macroeconomic imbalances are among the key issues facing policymakers, especially in the Asia-Pacific region, there appears to have been a general failure to adequately pay attention to the role of the exchange rate in allocating resources internally between tradables and non‐tradables. These sectoral changes can have both real and macroeconomic consequences.
This issue is explored in:
- Rajan and Beverinotti (2012) offer a simple analytical exposition of some of the issues relating to China’s and East Asia’s development and their impact on global imbalances using a two‐sector tradable and non‐tradables model.
The Asia-Pacific region has also seen growing monetary and financial integration both de jure and de facto. It is important to recognise that there are many gradations of monetary and financial regionalism (MFR), ranging from the weak form involving regional policy dialogue and surveillance, on the one hand, to exchange rate and monetary coordination, on the other (Rajan, 2008). While there has been active discussion of the possibility of stronger forms of MFR, effective deepening of regional monetary integration will not happen until there is a considerable strengthening of the regional surveillance mechanism with well worked out surveillance and policy conditionality. How financially integrated are the Asian economies and what are the links between real and financial integration in Asia?
This is explored in:
- Cavoli and Rajan (2009) examine some of the salient issues surrounding the degree of economic integration among Asian countries with particular attention being paid to the nexus between real and financial integration. Using a novel and simple method, the paper derives some measures of price-based real and financial integration from the relative Purchasing Power Parity and Uncovered Interest Parity relation. The paper also investigates the degree of integration between countries and groups of countries and analyse the sequence of integration – the extent to which the existence of one might cause the other.
What does the new financial system entail in terms of de facto exchange rate regimes? There is some evidence indicating a greater degree of exchange rate flexibility in the regional economies. However, there is still a high level of fixity to the US dollar regardless of the de jure exchange rate regime. What does a more flexible (and presumably stronger yuan) imply for the rest of Asia? There appears to be a prisoner’s dilemma with regard to exchange rate policies in Asia, which in turn implies that there may be potential benefits from pursuing a more coordinated approach to dealing with monetary and exchange rate policies in the region. Certainly, coordination does not imply straight-jacketing all countries in the region to a common exchange rate regime. More specifically, rather than adopting a single currency immediately, Asian economies might gradually move towards pegging to a currency basket—starting with individual currency weights and varying extents of flexibility around the pegs with a gradual convergence over time (Rajan, 2012).
Is time ripe for an Asian Currency Unit? This is explored in:
- Rajan and Pontines (2008) critically examine the rationale for the ACU proposal and offers an initial attempt at computing optimal currency composition of the ACU. The optimal basket weights computed are aimed at ensuring a regional currency basket that has minimal variance. Hence it will deliver stability in intra-regional exchange rates for alternative configurations of currency baskets in the Asian and Pacific region.