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Why is there so little regional financial integration in Asia?

  • Economics


Why is there so little regional financial integration in Asia? 38 BIS Papers No 42 Why is there so little regional financial integration in Asia? Alicia García-Herrero, Doo-yong Yang and Philip Wooldridge1 Introduction In the 10 years that have elapsed since the Asian financial crisis, the conditions needed for financial integration have improved. Asian economies have accumulated enormous amounts of foreign assets, particularly international reserves, due to domestic savings that have exceeded investment. In addition, Asian economies have learned the lesson of balance sheet weaknesses, which has resulted in the rapid decline of the share of foreign currency denominated debt. This does not mean, however, that foreign capital has abandoned the region. In fact, it continues to pour in through foreign direct investment as well as through portfolio flows, including exchange-traded funds, private equity and hedge funds. All in all, cross-border financial transactions (both the export and the import of capital) have increased substantially in Asia in the past 10 years. Such progress in financial integration will certainly have an impact on Asian economies and therefore deserves analysis. In general terms, a country’s financial integration with the rest of the world has many benefits but also some drawbacks. The most important benefits are risk-sharing and allocative efficiency, which contribute to economic growth and integration. Portfolio diversification allows the sharing of idiosyncratic risks across countries, facilitating the insurance of income against country-specific shocks, thereby smoothing consumption over time. Financial integration, by facilitating the allocation of capital to its most productive use, should foster economic growth (Edison et al (2002); Rogoff et al (2006)). The drawbacks of financial integration are also well known: in a world with imperfect capital markets, financial integration may heighten a country’s vulnerability to macroeco

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