TCS Daily

Asia's New Financial Hubs

By Christopher Lingle - May 19, 2006 12:00 AM

The governments of South Korea and China have made clear their plans to promote the development of regional financial hubs in Seoul and Shanghai, respectively. While neither can hope to overtake Tokyo in terms of deep and relatively-wide financial markets, they have a better shot at displacing Hong Kong or Singapore.

Still, residents of Hong Kong and Singapore can rest easy. Neither of the announced contenders can mount a serious challenge to their positions any time soon.

Hong Kong and Singapore both have advanced financial transaction systems that were years in the making. For its part, Hong Kong has the fifth largest stock exchange with market capitalization of over $480 billion, the third largest international banking center, and fifth largest foreign exchange market.

And both Hong Kong and Singapore enjoy a good reputation for enforcing the rule of law and providing internationally-recognized standards of regulation. As such, most contracts relating to China are enforced in Hong Kong because the mainland lacks a credible way for non-arbitrary resolution of legal disputes.

Despite high-profile political commitments for Seoul to become a regional financial hub, its shortcomings include restrictive legal and regulatory systems along with weak transparency in domestic markets and corporate operations. Labor market rigidities, complicated by militant unions and weak English-language skills, make multinational banks and companies reluctant to operate there. Foreign-owned enterprises located in Korea find an underdeveloped domestic capital market with few long-term debt instruments, so capital gets raised externally.

While Seoul faces a difficult task, it is not impossible feat for it to steal a march on Shanghai, even if it cannot unseat Hong Kong or Singapore.

For example, Korea's business environment is more open and advanced than China's and there is a larger financial market than Hong Kong and Singapore. Opening a business or making acquisitions in Korea is also easier than in Japan.

Seoul's strategic geographic position makes it attractive. Increasing commercial exchanges between North Korea and South Korea reached $408 million in 2003. Data from the Korea Trade and Investment Promotion Agency indicate that over about 500 South Korean companies do business with the North.

With the sixth-largest in the global life insurance market and a population with a high propensity to save, South Korea generates a significant amount of domestic capital. And Korea's commercial base is supported by extensive domestic consumption and a democratic political system with sufficient political will to embrace meaningful economic and financial reforms.

Reforms and liberalization is the aftermath of the turmoil of 1997 led to the financial system that provides a stronger base for domestic and international capital flows. Privatization and consolidation in the financial sector and the entry of foreign investment has generated substantial international interest.

Korea's financial system is relatively open and mostly guided by market impulses with foreign investors holding up to 40 percent of listed Korean companies by market value. With more foreign players, it is harder for the Korean government to pressure financial institutions to respond to market rather than political pressures.

On balance, the basics are falling into place for Seoul in a slow if somewhat uneven manner.

The best way to move Seoul towards its goal would be to undertake a "Big Bang" approach to financial liberalization with swift and sweeping reforms.

Despite China's powerhouse economy, on many important issues Shanghai may face a much longer wait than Seoul to be a dominant regional financial hub. Shanghai boasts modern conveniences, good physical infrastructure on the ground and is better on the drawing boards. But it is one of the most costly places in the world for executives to live and for international businesses to operate. Environmental decay also makes it less attractive.

In all events, China must undergo regime change before it can provide "rule of law" structures that underpin commercial and financial success of Hong Kong and Singapore.

As it is, Beijing imposes its will and uses China's foreign-exchange reserves to control its financial sector. For example, the Agricultural Bank of China is expected to receive a fresh injection of capital to cover almost $92 billion of nonperforming loans representing over 26 percent of its total lending. The funds are to be used to clean up its balance sheet in preparation of including foreign strategic investors and public sale of shares.

All the other so-called Big Four state-owned banks have received handouts. The Bank of China received $22.5 billion with the China Construction Bank Corp. receiving about the same amount and the Industrial & Commercial Bank of China got $15 billion. Additional sums were spent on removing bad loans from those 3 banks' balance sheets to prepare them for stock-market listings.

Perhaps geography is the least important factor in deciding whether Seoul or Shanghai will rise to the task. In that sense, the concept of "regional" hubs has begun to make less sense.

In all events, the good news is not whether the rise of one trading and financial center comes at the expense of another. Just as trade creates positive-sum games, there will be room for several ports and financial centers in East Asia that will specialize in different activities.

Christopher Lingle is Senior Fellow at the Centre for Civil Society in New Delhi and Visiting Professor of Economics at Universidad Francisco Marroquin in Guatemala.


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