Putting Asia’s Savings to Work in Asia Region

For more than three decades, Asia has experienced faster economic growth than any other region in the world. As it has developed, Asia has been exporting its savings, through a trade surplus with the United States, and re-importing them, in the form of direct and portfolio investment via New York and London–a process that has created severe, though largely overlooked, financial tensions.

At the end of 2015, the combined net asset position of China, Hong Kong, Japan, Korea, Singapore, and Taiwan amounted to $7.3 trillion–almost exactly equivalent to the net international investment liability of the US. And this imbalance is not likely to go away any time soon. In fact, the US has seen its net liabilities grow lately–to $7.8 trillion at the end of September 2016–owing largely to its continuing current-account deficit and stronger exchange-rate effects, EJInsight reported.

Why don’t Asian countries invest their savings within their own region? An obvious reason is that the US dominates global finance, particularly in the capital and currency markets. The US, once the world’s banker, had become its venture capitalist, investing internationally, especially in Asia, instead of just borrowing and lending.

But that doesn’t mean that Asian countries are better off investing in the West–not least because of the carry trade that took root after the 2008 financial crisis. As Hyun Shin and other economists at the Bank for International Settlements have argued, low developed-country interest rates and a weak dollar drove financial markets, led by the New York and London hubs, to borrow money in low-interest-rate currencies and invest in higher-interest-rate currencies.

Financial Game

This financial game has had a far-reaching impact. While the conventional view is that trade imbalances drive exchange rates and capital flows, financial accounting in Japan, for example, tells a different story.

From 2010 to 2015, the cumulative external surplus accounted for just 44% of the net change in Japan’s investment position. Financial-account transactions caused 32% of that change, while valuation changes relating to exchange and interest rates accounted for the rest.

Japan’s persistent current-account surpluses should have strengthened its net international asset positions. But, thanks to the appreciation of foreign holdings of Japanese equities, the country’s net international asset position actually deteriorated, from a peak of $3.8 trillion at the end of 2012 to $2.8 trillion at the end of 2015. As Bank of Japan economists point out, Japanese holdings of foreign assets are less profitable than foreign holdings of Japanese assets.

What Japan should be doing is investing more in high-growth Asia. At the end of 2015, only 10.1% of 574.8 trillion yen ($5.08 trillion) in gross outward investment remained in Asia, with 70% going to North America, Europe and Oceania.

Channeling Funds 

This preference for investing outside Asia is shared by the region’s other major savers–namely, China, Hong Kong, South Korea, Taiwan, and Singapore–even though returns within Asia are generally higher than elsewhere. As a result, the region has been made hostage to volatility in capital flows, exchange rates, and interest rates.

The problem is that, two decades after the Asian financial crisis, there has been little progress in institutionalizing Asian financial intermediaries that will channel savings to high-return projects within the region. In India, for example, the top ten investment banks are from the US and Europe. The situation is not much different in Hong Kong and Singapore. Even in China, where local investment institutions are growing rapidly, the ability to channel funds to the high-return real sector remains limited.

Meanwhile, the central banks of leading Asian surplus economies (particularly China and Japan) need to work with other major central banks (especially the European Central Bank and the Bank of England) to change how excess savings in high-growth regions are used. The goal should be to ensure that savings in surplus countries–including, say, Germany, which has a larger current-account surplus than China and Japan–are used wisely, to help sustain growth throughout the world economy.