Panel I: Asia's Economic Outlook

Y.K. Choi, Barry Eichengreen, Kihwan Kim and Ted Truman set the stage for this discussion moderated by Robert Madsen. The panel addressed the current risks and challenges to the global economy and financial system. The general consensus of the panel was that although a repeat of the Asian Financial Crisis was remote there were areas of concern including the potential impact of a sharp correction in asset prices in the region could have on growth. Additional concerns were raised during the panel discussion on the misalignment of exchange rates and the impact of the rapid and large accumulation of official foreign exchange holdings on individual economies and the global economic system as a whole.

Choi started the panel discussion by recounting the sharp economic costs the 1997-98 crises had on Asia broadly, and on Hong Kong specifically. He noted that similar to that earlier period most Asian economies are still relatively small economies subject to the flows of global capital. He warned that although financial risk indicators currently suggest a benign environment—credit spreads at historic lows, equity markets at historic highs, and the U.S. economy generally stable—this was not the time for Asian economies to be complacent. Broad scanning the current global environment, Eichengreen concluded that the possibility of a repeat of the 1997 crisis was not likely; he also discounted previous concerns that economic contagion from a slowdown in China or the United States, which together account for 80 percent of global demand, was less of a concern as growth in both Japan and Europe had begun to accelerate. One question Eichengreen raised was the impact that a sharp drop in global financial asset prices could have on general economic activity.

Kim similarly saw little prospects for an imminent crisis, although he did see two potential risks: current economic growth policies in Asia which are highly-leveraged to exports were leading to an accumulation of liquidity throughout the region that in turn was fueling assets bubbles, and a slowdown in China's economic growth could trigger significant problems throughout Asia. Truman saw the main risk to the region as the failure to have learned the right lessons from the crisis. In his view, too much effort has been placed on insulating the region from global financial flows through the accumulation of substantial official foreign exchange holdings and an emphasis on regionalism. Truman indicated that more emphasis should be placed on promoting better governance, increased transparency, and greater flexibility in foreign exchange, labor markets and service sectors.

Panel II: Structural Challenges to Growth

Panelists covered a wide range of issues having an impact on long-term growth prospects, including the environment, urbanization, security, demography and inequality.

Rapid urbanization drew attention for the broad impact it was having on the environment, economic efficiency and social stability. Much of Asia's economic output now comes from mega-cities like Shanghai or Bangkok, but those cities' infrastructure are not able to handle continued fast growth. In the future, growth will need to be dispersed to mid-sized cities. Due to lower economies of scale, however, mid-sized cities generally have lower productivity levels than mega-cities. Corruption also tends to be greater in smaller cities. Therefore, although dispersal of economic activity outside the mega-cities is imperative, it carries challenges.

Environmental degradation, panelists agreed, pose additional challenges, both in and outside the mega-cities. China's environmental problems appear especially worrisome. China has 16 of the world's 20 most polluted cities, it is already the largest polluter of the Pacific Ocean and desertification is devastating farmland. Estimates place the cost of environmental damage at 8-12 percent of China's GDP. Japan and Korea are “high-capacity states” able to deal with the implications of climate change, but China and India are both highly vulnerable to global warming.

The potential for social unrest is related to the problems of urbanization and the environment. Farmers and city residents alike in China and India have become more aware of the threat to their lives and livelihoods posed by environmental degradation and are protesting to protect their interests. China recently has recently seen a 20 percent increase in cancer rates, probably due in part to pollution.

Rising inequality could further fuel social unrest. The greater rewards for skills are widening the divide between the skilled and the unskilled, and between the rural and the urban. The breakdown of Asia's old model of universal education is adding to inequality. Increasingly, Asian countries are focusing on tertiary education at the expense of primary and secondary schooling.

Security issues, panelists agreed, pose risks for Asian economies. Cross-straits relations, North Korea and the Japan-China rivalry could all add to tensions. It is worrisome that the recent agreement with North Korea potentially drives a wedge between the U.S. and Japan. The U.S. is happy to see a freeze on enrichment to advance the cause of non-proliferation, but Japan could feel more vulnerable with the agreement not leading to dismantling of existing weapons. Nonetheless, there are hopeful signs that elections in Taiwan would improve relations with the mainland, and that a new Korean president would strengthen ties with the U.S.

Panel III – Financial Infrastructure

This panel addressed the issue of Asia's financial infrastructure by highlighting several critical areas underpinning the infrastructure. The discussions began with an examination of Taiwan's experience during and since the 1997-98 Asian Financial Crisis, by FCS Commissioner Susan Chang, who noted that continuous reforms went a long way to insulate Taiwanese banks from the crisis. This was followed by a discussion of Asian corporate governance practices by Former Philippine Finance Minister Jesus Estanislao, who observed the need for Central Banks to take a leading role in ensuring the adoption of strong corporate governance practices at banks given the persistent bank-centric nature of Asian economies.

Jonathan Fiechter, IMF Deputy Director, elaborated further on the banking theme to note the strengths and weaknesses of financial supervisors in the region, who are often constrained by cultural and traditional tendencies to favor borrowers over creditors and to provide banks with a high degree of forebearance. He questioned the prudence of such policies given the reality of the global market place in which Asian banks must compete. Deborah Schuler, Moody's Asia Director, addressed the conditions of Asian banks directly, noting some worthwhile improvements although much room for improvement remains. In particular, she voiced her concerns about the persistent notion of banks as public institutions, government's reluctance to relinquish state control over banks, and a weak legal system especially with regards to the enforcement of contracts and adherence to bankruptcy laws.

Panel IV: Financial markets

This panel saw lively discussion of equities, bonds, private equity and banks. Panelists at times disagreed on the speed and effectiveness of reforms in Asian capital markets.

Much discussion focused on China's booming stock market. On the positive side, it was noted that an equity culture was taking hold of Chinese retail investors and that the stock market was becoming an important alternative source of external financing for corporations alongside bank loans. On the negative side, valuations are unsustainably high, and the market is driven by less sophisticated retail investors rather than professional fund managers.

One panelist criticized the continued and occasionally increasing restrictions on banking sectors in the crisis-economies. Banks there still rely on interest income rather than less volatile fee income, and government policy at times inhibits the industry's development. A recent regulation seeking to limit the number of expatriate bankers in Indonesia came in for criticism.

Another panelist, however, argued that most of Asia is highly open to foreign investment. Private equity is finding ample opportunities to invest in China and India. Japan, however, is not reaching its potential as a destination for private equity, despite its unusually low interest rates and large number of cash-rich firms.

Bond markets remain undeveloped. Some governments recognize the need to offer corporations more alternatives to bank financing, but the supply of corporate debt securities is limited in Asia, and markets are generally illiquid. Markets need more private issuers and fewer state-owned enterprise securities. China's market, however, could see rapid growth now that regulators are loosening restrictions on issuance.

Panel V: Regional Integration

This panel, moderated by Henny Sender, explored recent trends in economic, financial and monetary integration in Asia, delving into the pros and cons of regional integration. Overall, the discussants appeared to support regional integration, although several expressed skepticism over some of the government-led initiatives to achieve it. Framing the discussion, the panel generally agreed that regional integration made sense given the small size of many of the ASEAN economies and their growing interdependence through trade and production networks. Some panelists believed that regional integration to date has been a natural outgrowth of market developments, but worried that recent bilateral trade agreements were not wholly WTO compliant.

Also of note, were comments made by Masahiro Kawai indicating a need for the development and enhancement of the infrastructure for delivery of social services. Citing Indonesia as an example, he spoke about the difficulty the international community had in trying to provide assistance to the most disadvantaged during the crisis due to the lack of established channels to fund those who were most in need of assistance. Other areas touched upon by the panelists included, regional bond initiatives in Asia, currency blocks, the role of exchange rates in the region, policy coordination and how to better manage capital markets.

In addition to the information shared, the discussants raised a number of questions for consideration. An example of this was the point raised by Nick Hope that it is hard to have two leaders in the region and therefore are we going to see a smooth transition as China outgrows Japan or will competition between the two impede the progress of regional integration. In response to earlier comments during the conference calling for greater formalization of the bilateral currency swap arrangements between countries, Hope asked whether it made sense to create a regional set of rules which differed from the global ones.

In one of the more poignant moments of the discussion, an audience member responded to a panelist’s assertion that corruption had not necessarily hindered the economic development of the region. The speaker contradicted the panelist and stated that corruption had held back the region and greater transparency and governance were essential for progress in integration and development in Asia.