ISLAMABAD: The pace of economic expansion in Asia and the Pacific has slowed considerably in recent years, with the outlook clouded by uncertainty, growth is expected to plateau at about 5 per cent for 2017.

The financial sector in Asia-Pacific region is currently not in a good shape to achieve the twin goals of inclusive growth and financial stability, a report released by the United Nations Economic and Social Commission for Asia and the Pacific (ESCAP) points out as it looks at the challenges facing the region from a governance and fiscal policy perspective.

The ‘State of Finance in Asia Pacific Region’ states that by taking into account demographic shifts, rapid urbanisation, large infrastructure needs, and the evolving structure of economic activity in Asia, the twin goals and financial stability can be met.

In this context, the financial sector should take on a bigger role than it has in the past and should, itself, become an engine of growth, emphasised the report. Although the region has an abundance of domestic savings, paradoxically, it relies too much on foreign savings (inward Foreign Direct Investment). This paradox can be explained by the under-developed financial markets and institutional investor base in the region.

The Asian financial sector is dominated by short-term bank lending. This dominance has come at the cost of under-developed equity and bond markets in most countries, these also prevent institutional investors from supporting equity and bond market depending.

The report says that the demand for funds by companies and individuals through financial markets (equity and bond markets) and bank credits is larger than the supply of funds through domestic institutional investors and bank deposits in many Asian countries.

This leads to the region depending on foreign investment to finance local funding needs and leads to a rise in the cost of capital. In this respect, countries should adopt policies that develop both financial markets and institutional investors to narrow the gap between demand and supply of funds.

Asia increased its share of global GDP from 23.2 per cent to 38.8pc between 1990 and 2014, much larger than the shares of the United States and European Union.

However since 2012, a sluggish global economy has led to a slowdown of exports, which shows the limits of such an export-driven growth model. This situation forces countries in the region to shift from their current export-driven growth model towards a new model that is focused on domestic consumption.

A healthy and dynamic financial sector therefore will be needed to smooth this transformation and to mobilise large savings to finance big infrastructure needs. A well-developed financial sector reduces volatility of the economy by providing a variety of instruments and information to help households and firms cope with adverse shocks through consumption and investment smoothing.

However, the financial sectors in the region are ill-suited to facilitate this transformation and to mobilise large savings.

The Asian financial sector is dominated by short-term bank lending. The short duration of banks’ liabilities limits their capacity to finance long-term investments such as home loans and infrastructure investments.

The bank-centered financial systems also lead to a supply-demand gap in lending of small and medium-sized enterprises’ (SMEs), which are a backbone of a resilient national economy in every country due to their nature of stimulating domestic demand through job creation, innovation, and competition.

The region therefore suffers from a supply-demand gap between funding (bank, equity and corporate bond funding) and investment (financial deposits, mutual, pension and insurance funds), which leads to a rise in the cost of capital and depending on foreign investment to finance local funding needs. Therefore, the diversification of financing modalities beyond conventional bank lending is better to serve the various financing needs of the region.

The report stressed that economies must continue their efforts to develop financial markets. These efforts must be expended along multiple dimensions, including depth, access and efficiency.

Published in Dawn, April 30th, 2017