By Arup Kumar Chatterjee
Insurance companies, pension funds, and other institutional investors in Asia and the Pacific can pave the way to a resilient and sustainable future.
The recent global public health crisis has revealed that economies can no longer afford to return to old ways of doing things. But there could be a silver lining in a coming “age of sustainability” in Asia and the Pacific that can get countries growing strongly again.
Reaching this new age, however, will require greater use of insurance companies, pension funds, and other institutional investors to tap the region’s well-known and huge pool of savings. Asia’s savings rate is very high, at about 27.11% of gross domestic product, ranging from 40.24% in Singapore, 30.20% in India, and 24.86% in the Philippines, to 14.23% in Georgia.
It calls for a more diverse range of infrastructure investments that meet environmental, social, and governance goals. And it needs measures that can allow corporations and households to invest more widely.
For now, high public debt, rising domestic spending, and adverse exchange and interest rates are constraining fiscal space. In addition, governments’ inability to implement countercyclical fiscal policy to respond and mitigate the adverse effects of external shocks by increasing expenditure or reducing taxes to create a demand, worsens these constraints.
Several factors contribute to high, untapped savings in the region, both among households and corporates.
Social insurance schemes such as unemployment and health insurance or sovereign insurance schemes for natural catastrophes are absent or underdeveloped. In the absence of these automatic stabilisers to offset fluctuations in economic activity after an economic shock, many developing countries cannot borrow, or can do so only at very high interest rates. Since they cannot run deficits, they resort to procyclical fiscal policy by imposing cuts in public spending, and this is potentially damaging for economic welfare.
Moreover, as economies in transition become market-oriented, reducing the state’s role, more people are working in their homes and uncertain about their future income. Especially, the increasing prominence of the gig economy poses a challenge to the paradigm of standard employment. Existing social insurance, like unemployment coverage, offers little support, as it is not designed to cushion short-term income fluctuations.
Households resort to precautionary savings to maintain income during shocks as a sort of self-insurance against shocks such as fluctuating prices and wages, borrowing constraints, or a lack of formal insurance. In addition, the lack of diversification opportunities for financial assets restricts borrowing against future income to finance current purchases of durables, including houses.
The share of corporate savings, primarily reflected in retained earnings, also influences overall saving patterns. Corporate savings mitigate uncertainties due to cyclical and transitory factors such as money supply, interest rates, and inflation, cost of investment goods and real estate prices, and internally financed investment projects. In addition, an incentive to reduce debt and the underfunding of company pensions encourage more significant cash holdings, which in turn add to savings.
Yet, by tapping household and corporate savings, a significant share of investments for sustainable and resilient growth could come from the private sector.
Clearly then, this will require better social safety nets and high-quality savings run by diversified contractual savings institutions – insurance companies, pension funds, and investment trusts – encouraging greater financialisation of household savings away from gold and property and other precautionary investments. In addition, these institutions can increase options for financial protection against contingencies and improve risk management.
The design of insurance and pensions systems is rarely guided just by market development considerations. Instead, they primarily reflect important social choices and differing perspectives on the appropriate role of the state – particularly the role of funded versus unfunded pay-as-you-go schemes in the case of pensions.
Nevertheless, insurance, funded pensions, and collective investment schemes can help add to a savings pool denominated in local currency through complementary arrangements. This pool of savings can contribute vitally to deep, liquid, and stable domestic capital markets for financing private sector innovation, investment, and growth if grown over time. It can also lower dependence on foreign debt.
These institutions can also ease fiscal constraints. Since insurance companies and pension funds have long investment horizons and low leverage, they can effectively provide long-term funds in local currency and are less likely to exacerbate volatility by selling into short-term corrections. They typically purchase bonds to back steady cash flows for their subscribers. Governments can thus finance their fiscal deficits by borrowing from the local markets without exchange rate risk by issuing such bonds.
The participation of these institutions can also help create a more steady demand for local currency debt assets and stabilise long-term government bond yields, thus enhancing signals from market interest rates for better monetary policy implementation.
And to tie this back in with sustainability goals, infrastructure debt can provide long-term, resilient, and visible cash flows, underpinned by attractive yield potential that supports environmental, social, and governance issues.
Change is coming to Asia and the Pacific. We need to look to insurance companies, pension funds, and other institutional investors to access the region’s huge pool of savings for a resilient and sustainable future.
(Asian Development Bank Blog)