Globalisation has its advantages and disadvantages. Opening up to international trade has helped many countries grow far more quickly than they would otherwise have. Because of globalisation, many people in the world now have a higher living standard than before.

However, amid the increasing integration of global capital markets, the past decade has also witnessed one currency crisis after another in emerging market economies. These crises were preceded by large private capital inflows and triggered by sudden shifts in market sentiment, which reversed the trend and led to massive capital outflows, resulting in substantial macroeconomic adjustments in the post-crisis period.

Surely policy makers have a variety of options to cope with volatile capital flows. Three mainstays help economies withstand the adverse impact of capital flows. The first is sound macroeconomic policies. But what constitutes the ideal mix of policies differs from economy to economy, and is dependent on both the issues concerned and the stage of economic cycle that the economy is in.

The necessary ingredients would, I believe, include: prudent financial management policy that contributes to the stability of monetary and financial systems, investor confidence and overall economic development, as well as income and manpower policies that enhance social mobility and labour market flexibility.

HK strives for fiscal balance, low tax rate

All these add up to a tall order, but it is by no means an impossible mission, given the political will to achieve the goals. For Hong Kong, we adhere to the principle of keeping expenditure within the limits of revenues in drawing up the budget, and strive to achieve a fiscal balance, avoid deficits and keep the budget commensurate with the growth rate of the gross domestic product.

We are also committed to maintaining a low tax policy. In the face of consecutive budget deficits since 2000-01 and the economic downturn in recent years, we have adopted a three-pronged approach to restoring fiscal health through boosting economic development, cutting public expenditure and raising further revenue.

Wages and prices are flexible enough to enable the economy to absorb the movements in interest rates that may be required to balance fund flows.

Besides sound macroeconomic policies, the second pillar for coping with fund flows is a robust banking system with adequate financial oversight and supervision. In Hong Kong, in particular, a large share of bank lending goes to property and equities, which are highly interest-rate sensitive.

There is, therefore, a need to ensure that banks are not overly concentrated on lending to these sectors, or unduly exposed to interest rate risk. For instance, on property lending, the Hong Kong Monetary Authority has set a guideline to limit banks' lending to home buyers to no more than 70% of the appraised value of a property.

Bond market to reduce corporate reliance on bank loans

The third factor is the development of the domestic bond market. This will reduce the reliance of the corporate sector on the equity market and bank loans as major sources of financing. In some cases, corporates have relied on short-term foreign currency bank loans, thereby leading to maturity and currency mismatches, the factors identified as the major causes for the Asian financial crisis.

In fact, there is no shortage of savings for Asia, as Asia has much higher savings rate compared to the US and Europe. However, for a number of structural factors, the Asian bond market has not been able to function to its full potential as a financial intermediary between savings and investments.

As a result, the bulk of the Asian savings are channelled to the developed markets to fund the balance of payments deficits of those economies. While some of these savings may find their way back to Asia, these are largely in the form of foreign portfolio flows and short-term bank credits, which present risks to financial stability.

I am pleased to see that the region has made substantial progress on the development of local and regional bond markets following the Asian financial crisis. In Hong Kong, starting from 1990, the Government has been issuing Exchange Fund Bills and Notes through the HKMA. The Hong Kong Mortgage Corporation has been issuing mortgage-backed securities since 1999.

Securitisation of toll tunnels, bridges a landmark transaction

Many other public corporations have also taken the lead in launching debt issuance programmes, including local currency bonds with longer maturity periods, particularly at the retail level. In May this year, the Government has successfully launched a $6 billion (US$769 million) bond programme that securitised the revenues of Government-owned toll tunnels and bridges.

This is a landmark transaction for us, being the largest securitisation in Hong Kong, the first securitisation of tolled facilities in Asia, the first of its kind offered to retail investors. In July, the Government also successfully launched its first global bond issue of $20 billion.

Denominated in both US and Hong Kong dollars and sold to both institutional and retail investors, this was the largest-ever dual-currency and multi-tranche offering from the region. All these help channel long-term funds, such as insurance and pension funds, to meet the funding needs for government infrastructure and investment projects. They will also help enhance the depth of the capital market and maintain a reliable benchmark yield curve.

At the regional level, Asian governments have joined forces to develop the regional capital market. You are no doubt aware that there are a number of market initiatives currently going on in the region. They can be grouped under three categories, each falling under the auspices of a major regional forum.

Three initiatives help develop regional capital market

The first is the APEC's Initiative on Development of Securitisation & Credit Guarantee Markets, which is spearheaded by Hong Kong, Korea and Thailand and sponsored by the World Bank. This action-oriented initiative has received an encouraging response from APEC economies, and good progress has been made.

The second is the ASEAN+3's Asian Bond Market Initiatives. The initiatives involve a variety of studies on issues such as new securitised debt instruments, issuance of debt by international financial institutions, regional credit guarantees and enhancement facilities, and the establishment of local and regional credit rating and credit enhancement agencies.

The third is EMEAP's Asian Bond Fund. The first phase of ABF, or ABF1, was launched in 2003. The EMEAP central banks are currently working on the second phase, the ABF2, which will invest in local currency-denominated Asian bonds.

Despite all these efforts and positive developments, we obviously could not under-estimate the substantial challenges lying ahead of us. Integration of the world economy will continue to flourish, while cross-border capital flows will become more significant.

Therefore, it is timely for policy makers in the region to put their heads together on how to take forward capital and financial market reforms to reduce vulnerabilities and strengthen the resilience of the systems to external shocks.