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Speeches & Transcripts November 13, 2017

Opening Remarks at 2017 Asia Forum on Reserves Asset Management

On behalf of the World Bank, it is my pleasure and honor to welcome you to our 2017 Asia Forum on Reserves Management.  I am grateful to you, our distinguished speakers and participants for joining us.   My profound gratitude to the Bank of Thailand for co-sponsoring this forum, as well as for your warmth and hospitality.  Hearty congratulations on your upcoming 75th anniversary and as you celebrate your numerous achievements over the last 75 years. 

Our goal is for the Asia Forum to serve as a convening and discussion platform – a place to exchange views on global financial markets, and the prospects and challenges facing public sector asset managers in Asia.  Fostering knowledge sharing opportunities among peer institutions is an important part of the capacity building mission of the Reserves Advisory and Management Program(RAMP).  For the past 16 years, the program has helped clients execute best practice in reserves management and achieve risk-adjusted returns that meet their policy objectives by sharing the World Bank Treasury’s knowledge and expertise.

Since, its founding in 2001, the program has grown from 3 to 65 clients, including many institutions represented here today.  RAMP’s assets under management has grown from US$650 million to US$21 billion.   I am grateful for your confidence and assure you that my colleagues and I will continue to do our utmost best to sustain your trust in our ability to support your laudable mission as public sector asset managers.

In keeping with our goals for the Asia Forum, we have selected the following areas of focus – spillover effects of monetary policy of major central banks, the status of China’s reform agenda and economic growth, implications of innovative technologies and cyber threats, as well as new trends in investment and risk management.

I would like to kick off the discussion by sharing my thoughts on the challenges facing public sector asset managers in Asia today. They are the global operating environment, impact of the normalization of monetary policy of major central banks, the impact of low interest rates for longer periods than previously anticipated and the implications of innovative technologies.

First, notwithstanding synchronized global economic growth, geopolitical and climate change risks coupled with anti-globalization, populist sentiments and protectionist threats together present a challenging operating environment.  

Second, there may be spillover effects from major central banks unwinding their post-global financial crisis unconventional monetary policies. The US Federal Reserve, the European Central Bank and the Bank of Japan have all recently signaled or taken steps to start to normalize monetary policy.  Nonetheless, normalization is expected to be gradual. Jerome Powell, who President Trump recently nominated to succeed Janet Yellen as Chair of the US Federal Reserve, has said that “US monetary policy normalization has been and should continue to be gradual as long as the US economy evolves roughly as expected.” If his view holds, the likelihood of a sell-off in the tail-end of the yield curve is lower.  Such a moderate and predictable normalization pace should give emerging market economies time to adjust to the expected policy changes.

Third, since normalization will be gradual, interest rates will be lower for longer. Confronting this reality, while at the same time preparing for potential spillovers from a change in policy will be challenging for public sector asset managers.  Already, low interest rates have resulted in many central banks generating lower than expected returns on fixed income portfolios.  This is especially true for holders of securities exposed to negative policy rates in Europe. Meanwhile, the search for yield may have already exposed public sector asset managers to more vulnerable financial markets as asset prices have reached unprecedented levels. Today, long-term real interest rates are at historic lows, as are levels of volatility in global bond and equity markets.  Therefore, lower or negative term-premia have boosted the prices of a variety of asset classes, including bonds, equities, and real estate.  If these circumstances persist, we may see further foray into riskier asset classes in the search for yield. 

This is especially true if, in the face of continued policy normalization, long term yields begin to rise. A pick-up in wage inflation in advanced countries could also cause the Federal Reserve to accelerate its gradual tightening, paving the way for a market sell-off and possible “snapback” in global bond yields.  We could also experience an unexpected event such as the 2013 ‘taper tantrum’ which followed the announcement by the then US Federal Reserve Chair, Ben Bernanke, of a tapering of the US asset purchase program, and led to rapid interest rate rises across global financial markets. We must therefore always be prepared for uncertainty and unexpected market movements.

Also important is the potential threat to performance as normalization could lead to balance sheet deficits.  Depending on the severity of these deficits, the operational independence of some institutions could be at risk.

I therefore recommend a renewed emphasis on prudent risk management and a focus on longer investment horizons.  It may also be an appropriate time for you to review your strategic asset allocation and governance processes to ensure they align with the objectives and risk tolerance of your institution.

Finally, another challenge that we must give due attention to is the pervasive impact of technological innovation especially disruptive technologies such as robotics, blockchain, crypto-currency and artificial intelligence. 

Since robotics technology is designed to mimic the same manual paths taken by a human at higher speeds and at lower costs, its application enhances efficiencies. Blockchain or distributed ledger enables true and immutable records to be kept on a trusted ledger that is secure and resilient and could redefine central banking since it cuts out the middleman in many circumstances.  The ledger can hold all kinds of transactions, assets, or executable ‘code’.  While the reception by the public sector of crypto-currency and Bitcoin was not initially enthusiastic, a number of central banks are studying the possibility of issuing digital currencies.  For example, while Tunisia was the first country in the world to have its own government issued digital currency, the Swedish Central Bank, Riksbank, is actively working on an eKrona project to determine whether it should supply crypto-currency to the general public.  The impact of bitcoin has been compared to how paper money replaced gold and silver as instruments of exchange. Since Bitcoin more than 800 cryptocurrencies have blossomed in this unregulated market. If adopted, crypto-currency could change the character of money supply and change the efficacy of monetary policies.

We must keep abreast of these technologies, not only to leverage the opportunities they offer but to also protect our institutions from potential vulnerabilities.

Equally, public sector asset managers should invest in cyber security as digitalization while providing far reaching benefits, has increased the risks to the global financial system

Overall, I am optimistic that with prudent investment and risk management as well as due attention to technological innovation that Asian central banks are well positioned to address any future challenges. This is more so given the resilience that most Asian countries have built up since the Asian Financial Crisis, 20 years ago. The elements of the resilient frameworks include well managed flexible currency arrangements, more robust capital markets, efficient public debt management, strengthened governance, increased capital buffers in the financial sector and prudent financial regulatory frameworks that are also applicable to non-banking institutions. 

To enhance resilience to future crises many Asian countries have also built up huge sums of reserves, and in many cases, to levels well above those warranted by traditional precautionary metrics.  Some central banks have taken further steps to prudently diversify into non-traditional asset classes such as corporate bonds and equities, to enhance yield.  Your track record of learning and prudent adaptation gives me confidence that you will be able to tackle any future challenges

We face a multiple equilibria global economy where you have extremely flat or negative risk premium on the one hand and rising risk premium on the other. In this environment, we must ask ourselves the following question. What policy options do public sector asset managers have in terms of reserves management?

The answer depends on what your risk tolerance is. Certainly, policy choices will differ depending on the economic situation and exogenous factors that you face. If a macroeconomic circumstance of a country is weak, safekeeping of foreign reserves and building national wealth should be the priority. On the other hand, robust macroeconomic indicators and ample reserves give some leeway to cautiously expand the investment universe.

I believe that reserves managers should not only revisit the basic principles of sound investment management – a holistic approach, diversification and focus on risk management – but must also extend their understanding of macroeconomics, investment strategies, and technology innovation beyond current horizons.  Indeed, policy makers should always remember Chairman William Martin wise words - “The job of the central bank is to take away the punch bowl just as the party gets going.”

We, at the World Bank, stand with you. We are committed to sharing our knowledge and building a constructive strategic partnership with you not only in reserve management, but also in development finance, infrastructure investment and debt management especially as you seek to broaden the tools available to you for promoting financial stability.  

I very much look forward to informative and useful sessions given the distinguished experts that are with us over the next two days.  Thank you.