Information about Asia and the Pacific Asia y el Pacífico

Chapter 8. Asia’s Demographic Changes and Infrastructure Needs: How Can the Financial Sector Address These Challenges?

Ratna Sahay, Cheng Lim, Chikahisa Sumi, James Walsh, and Jerald Schiff
Published Date:
August 2015
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Information about Asia and the Pacific Asia y el Pacífico
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Ding Ding, W. Raphael Lam and Shanaka J. Peiris 

Main Points of this Chapter

  • Asia’s financial sector has a key role to play in addressing the challenges associated with the region’s changing demographics and large infrastructure investment needs.

  • Enhancing financial innovation and integration in the region could facilitate intraregional financial flows and mobilize resources from the aging savers in industrialized Asia to finance infrastructure investment in emerging Asia.

  • Strengthening financial ties within the region as well as with global financial markets, alongside appropriate prudential frameworks, could also help diversify the sources of finance and reduce the cost of funding in emerging Asia.

  • Financial deepening could help ease potential overheating from the scaling up of infrastructure investment and, hence, achieve more balanced growth in the region.


This chapter explores the potential role of Asia’s financial sector in addressing the region’s main challenges: changing demographics and large infrastructure investment needs. Diverse demographic trends across Asia are likely to affect aggregate savings and, thereby, intraregional financial flows in the long term. Population aging in the advanced Asian economies, and in several emerging Asian economies as well, could affect returns on asset classes and change the structure of the region’s financial markets. In an aging society, how to address downward pressures on savings and ensure adequate returns through diversification to high-growth emerging Asian assets remains a challenge. In some other emerging Asian economies, however, the share of the working-age population is expected to continue to rise in the coming decades and could bring higher growth and savings. However, despite their favorable demographic and growth prospects, emerging Asian economies export capital and suffer from underdeveloped infrastructure. This situation is partly related to these economies’ shallow financial systems, which constrain growth prospects. Mobilizing financial resources for infrastructure investment to harness emerging Asia’s so-called “demographic dividend” through financial deepening and innovation remains a key challenge.

Aging trends within Asia are expected to become more diverse, exacerbating the long-term challenge of downward pressure on aggregate savings. Population aging is a looming issue in China and in advanced Asia, including Japan and Korea. This trend results from a sharp drop in fertility rates and an increase in life expectancies, which can be attributed to higher incomes and medical advances (Figure 8.1). Overall, Asia is facing a demographic shift that will see a large segment of its population age significantly during the next half century. As a result, aggregate savings are likely to decline, with people running down their savings during retirement. Aggregate savings is one of the key channels through which population aging affects capital flows and financial markets (IMF 2010). Examples of these effects include reductions of external surpluses, declining asset prices, and higher risk aversion. At the same time, public saving could also come under pressure from rising pension and aging-related expenses. Access to a wider array of financial instruments with superior risk-return characteristics in emerging Asian economies could entice aging Asian savers to reduce home bias and investments in low-return, advanced economy assets.

Figure 8.1Working-Age Population Ratio in Asia


Source: The United Nations World Population Prospects 2012.

Meanwhile, several emerging Asian economies with favorable demographic transitions will face the challenge of mobilizing resources to finance infrastructure investment. Despite favorable demographic transitions that would raise growth potential, emerging Asian countries such as India, Indonesia, and the Philippines continue to suffer from underdeveloped infrastructure. Although infrastructure in these economies has improved during the past decades, investment has fallen short of the pace of rapid economic and population growth. In the World Competitiveness database published by the International Institute for Management Development (IMD 2014), emerging Asia generally scores lower in the infrastructure category than do its advanced peers in the region and remains in the higher half in the global rankings (Figure 8.2) This is particularly true for electricity generation and road networks.1 With rising public debt constraining public infrastructure investment in emerging Asia, inadequate infrastructure could be partly related to limited private sector participation and a lack of long-term capital market financing (ADB 2013). These infrastructure deficits are estimated to have impeded growth. For instance, the drop of infrastructure investment in Indonesia from 5–6 percent of GDP in the early 1990s to 2–3 percent in the past decade has limited growth by as much as 3 to 4 percentage points of GDP (Tahilyani, Tamhane, and Tan 2011). Meeting the infrastructure gap solely with fiscal spending would significantly add to the fiscal burden, eventually posing greater risks to growth.

Figure 8.2Infrastructure Ranking

Source: International Institute for Management Development, World Competitiveness Online.

Note: A lower ranking indicates a better score out of sample countries. There were 58 countries in the sample in 2010 and 60 countries in 2013.

1 Emerging Europe = Bulgaria, Croatia, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Russia, the Slovak Republic, Slovenia, Turkey, and Ukraine.

2 Latin America = Argentina, Brazil, Chile, Colombia, Mexico, Peru, and Venezuela.

Estimates of the adequacy of infrastructure usually rely on the stock of infrastructure relative to income, urbanization, population density, and the economic structure across countries. In this regard, the greatest infrastructure gap or shortfall in emerging Asia appears to be electricity generation (Figure 8.3). The median electricity generating capacity in the region is approximately 90 percent of the median for Latin America (IMF 2010). Road networks seem most in need of upgrading in Bangladesh, Myanmar, Mongolia, and the Philippines. And, despite the rapid spread of telephones and mobile phones in the region in the past decade, emerging Asia continues to lag behind Latin America in its stock of telecommunications infrastructure. How to finance this vast infrastructure investment is a key challenge for the region’s policymakers.

Figure 8.3Estimated Infrastructure Needs in Developing Asia

(Billions of U.S. dollars)

Source: Asian Development Bank (2009).

Financial deepening and innovation in the region may change the way in which policies are developed to address these long-term challenges. In designing such policies, policymakers would need to consider the implications of rapid financial growth and innovation. Should further financial sector development help address these challenges, policymakers could focus on the following:

  • Financial innovation and integration in the region—Financial innovation and integration could improve the allocation of savings and strengthen domestic resilience to external shocks. With sound prudential frameworks and pricing of risks, financial innovation and a more integrated financial market across Asia would help channel large savings in the aging economies to the financing of infrastructure gaps in emerging Asia, while achieving higher yields in return. At the same time, an integrated financial sector across Asia would increase countries’ abilities to share risks. Risk sharing captures the degree to which countries succeed in insuring each other against shocks. The newly industrialized Asian economies (Hong Kong SAR, Korea, Singapore, Taiwan Province of China) share substantial risks with the United States, but much less with emerging Asian economies. Intraregional risk sharing is low, in general, within Asia (IMF 2011).

  • Improve financial deepening by improving domestic financial inclusion and capital market development—Financial deepening could help harness the increased savings from the rising working-age population in emerging Asia, which could be intermediated to finance infrastructure investment in these economies. At the same time, greater financial inclusion could raise financial savings and allow households better access to credit. Addressing the impediments to developing corporate bond markets and an institutional investor base, as highlighted in Goswami and others (2014), will be critical to channeling savings from greater financial inclusion and from advanced Asian economics to infrastructure investment in emerging Asia.

  • Greater financial integration—Financial integration can help channel savings to the most productive investment opportunities across the region. However, it also comes with the potential cost of amplifying shock propagation and synchronization in the region (IMF 2014b), as well as making portfolio flows and asset prices more sensitive to global “push” factors, and posing challenges to financial stability (IMF 2014a). In particular, if regional financial integration involves freer capital accounts and greater foreign participation in financial markets, policymakers will need to be vigilant and strengthen regional safety nets and international policy cooperation. They will also need to implement appropriate macroprudential policies.

The rest of the chapter presents stylized facts about Asia’s demographic changes and infrastructure gaps; presents empirical evidence on how demography could affect saving rates; uses a dynamic general equilibrium model to illustrate the macroeconomic impact of certain financial sector developments and discusses their potential benefits when the region is faced with demographic and infrastructure financing challenges; and discusses the role of the financial sector in addressing these challenges and the plausible policy implications; then offers conclusions.

Asia’s Main Challenges

Asia has experienced a demographic shift during the past half century, with diverse trends across countries. Advanced economies in Asia have mostly faced aging populations. The elderly dependency ratios have increased by 4–21 percentage points since 1980, most notably in Hong Kong SAR, Japan, and Korea. Population aging is modest for emerging Asian economies with the exceptions of China and Thailand (Table 8.1; Figure 8.4). The divergence in the region is likely to be more evident in the next few decades, with a few economies aging rapidly (China, Japan, and Korea), while other emerging economies continue to face demographic dividends as the youth population enters the labor force. Examples of the latter include Cambodia, India, Indonesia, Lao P.D.R., Malaysia, and the Philippines. As the working-age population increases in an economy, a notable rise in income per capita is experienced. The relationship, however, tapers off when income per capita reaches a certain threshold (Figure 8.4).

Table 8.1Age Dependency Ratios(Ranked by net change 1985–2012)
Net Change
Emerging AsiaElderlyYouthElderlyYouthElderlyYouth
Brunei Darussalam5.−0.1−29.1
Lao P.D.R.6.984.26.357.2−0.6−26.9
Advanced countries
Hong Kong SAR10.034.516.815.66.8−19.0
New Zealand15.739.819.430.93.7−8.9
Outside Asia:
United Kingdom23.130.525.026.31.9−4.1
United States17.633.219.430.11.8−3.1
Sources: United Nations World Population Prospects 2012; and IMF staff calculations.

Figure 8.4Demographic Transition in Asian Region

Note: Financial development measured by the penentration ratio of the use of public and private registries in credit market.

Demographic change could affect Asian economies in several ways. First, the demographic transition affects labor force participation, which in turn affects growth potential. Second, for rapidly aging economies, fiscal positions could come under pressure from rising pension and other aging-related spending. Third, aggregate saving could also fall with population aging, because people run down their savings during retirement. Investment could also fall as capital stock shrinks in tandem, and the interplay of investment and saving would affect capital flows and financial markets. Asset returns could be affected as risk appetite changes because an elderly population tends to favor less risky investment. Financial product structures may also change in response to age-related demand.

Aggregate saving is one of the channels through which demographic change affects capital flows and financial markets. The demographic transition in Asia is often identified as a factor contributing to high saving rates. Studies by Park and Shin (2009) and Horioka and Terada-Hagiwara (2011) show a strong relationship between demography and saving rates, in light of the life hypothesis.2 Domestic saving rates appear to have increased as dependency ratios (the population ages 65 or older and ages 14 or younger to the total population) declined during the period 1960–2012 (Figure 8.5). The negative relationship tends to hold, although with a weaker correlation, for other advanced economies outside Asia. In particular, the dependency ratio decreased until recently in most emerging Asian economies (the youth were growing up while fertility rates declined), whereas domestic saving rates increased.

Figure 8.5Correlation of Domestic Savings and Dependency Ratios, 1985–2012


Source: World Bank, World Development Indicators.

In addition, demographic change could also shape financial sector development, which is a key determinant of saving. Population aging in China and advanced Asian economies will reduce aggregate risk appetite given that the elderly tend to be more risk averse in their savings. Households’ financial needs in these economies will require stable returns on saving and more customized wealth management products and services. In economies enjoying the demographic dividends of higher growth and saving rates, financial sector development and innovation would help channel those savings toward higher returns and diversification. Financial frictions and borrowing constraints in these economies may encourage the need for precautionary saving. If that happens, domestic saving rates would increase for a given level of income. Financial integration and deepening would reduce such constraints and the precautionary savings motive while providing more saving options (for example, bank deposits, wealth management products, real estate through mortgages) with higher expected returns. As a result, financial development may affect economies differently, depending on the specific phase and condition of the financial markets. Empirical evidence is ambiguous (Chinn and Prasad 2003).

The impact of infrastructure on growth has been extensively studied, with most studies finding that improvement in a broad range of infrastructure categories tends to lead to faster and more balanced growth. In addition to economic returns, infrastructure investment generates large social returns in the form of stronger economic activity, improved health and education outcomes, and diminished inequality. There is also solid evidence, supported by empirical analysis, that better infrastructure improves productivity growth. For example, Canning and Pedroni (2008) use cross-country data to show that infrastructure positively contributes to long-term economic growth despite substantial variations across countries. And, using cross-country data from 1980 to 2010, Seneviratne and Sun (2013) find that better infrastructure, both in quantity and quality, could improve income distribution and reduce inequality.

Although the benefits of improving infrastructure are well understood, mobilizing financial resources for infrastructure investment has been challenging in many countries. Historically, given the public goods nature of infrastructure investment, the provision of investment has been almost entirely in the public domain in Asia and elsewhere, including in advanced economies. The large sunk costs and long construction periods often associated with infrastructure projects also make it less attractive to private investors, forcing the public sector to bear the main financing responsibility, using both on- and off-balance-sheet instruments. However, in the past, public debt levels in many emerging Asian economies, including India, Indonesia, and the Philippines, have not provided sufficient fiscal space to scale up infrastructure spending. In China, for example, local governments were one of the major drivers behind the infrastructure investment boom in recent decades (Walsh, Park, and Yu 2011). They have been actively involved in mobilizing financing for infrastructure projects through public guarantees—implicit and explicit—for bank loans, and in some cases, direct subsidies for infrastructure special purpose vehicles to boost their profits and credit ratings. In addition, the dominance of commercial banks in most emerging Asian economies also means they are the largest source of infrastructure funding. However, bank liabilities are generally short term, while infrastructure projects have long payback periods (20–30 years). This tends to exacerbate maturity mismatches and impede long-term infrastructure finance.

Government financing and provision of infrastructure alone may not be sufficient to address Asia’s infrastructure gap. ADB 2009 estimates Asia’s total infrastructure investment needs to be $8 trillion over 10 years, or about 4 percent of the region’s GDP per year. This proportion is almost equivalent to the average of the current total public investment level in industrialized Asia, and half of that in emerging Asia (Figure 8.6). The scope for sustained increases in public investment in a particular country also depends crucially on the prospects for debt sustainability and other short-term financing considerations. In recent years, although several governments across the region have stepped up their allocation to infrastructure as part of the fiscal stimulus packages developed in response to the 2008–09 global financial crisis, their ability to sustain elevated levels of infrastructure investment may be limited by other demands on budgets and on a shrinking fiscal space.

Figure 8.6Public Investment as a Percentage of GDP, 2010

Source: IMF World Economic Outlook.

The challenge of infrastructure investment financing in emerging Asia may become more pressing, given the region’s rising population and large infrastructure gap. Whether this financing gap can be met in the long term by an increase in emerging economies’ own savings remains an open question. In the meantime, changing demographics in Asia may prompt further intraregional financial integration. As advanced Asia ages further, demand will grow for access to a wider array of financial instruments with superior risk-return characteristics located in emerging Asian economies. In particular, infrastructure projects in emerging Asia could provide high yield but steady long-term returns, making them appealing to advanced Asia’s investors, such as pension funds. As discussed in the next section, further financial integration, combined with domestic financial deepening, may help emerging Asian economies address their infrastructure investment challenges.

The Macroeconomic Impact of Financial Deepening and Integration

The Impact of Demographic Changes

This section first analyzes the impact of population aging on domestic saving rates using reduced-form panel estimations. The estimation provides an analysis of the determinants of savings for 12 to 15 Asian economies. The analysis includes Australia, Bangladesh, Brunei Darussalam, Cambodia, China, Hong Kong SAR, India, Indonesia, Japan, Korea, Lao P.D.R., Malaysia, the Philippines, Singapore, Thailand, and Vietnam. These economies are further separated and grouped into different categories in the specification to test for robustness and for any differences among Asian emerging, advanced, and frontier economies. Other advanced economies outside Asia, such as Germany, the United Kingdom, and the United States, are included for reference and robustness checks. The reduced-form panel estimations features follow:

  • Sample period—Since the focus is on long-term trends, the analysis uses annual data from 1960 to 2012 where data are available. Averages over a multiyear interval (for example, 1960–65, 1965–70, 2001–07, and 2008–12) are also included to mitigate cyclical effects and account for possible structural breaks around the global financial crisis.

  • Data—Data are obtained from various sources, including the IMF’s International Finance Statistics, the World Bank’s World Development Indicators, the United Nations Population Projections, and Heston, Summers, and Aten’s Penn World Tables Version 7.1.

  • Specification—The specification is as follows:

    SGDP is the gross domestic saving rate in country i at time t in real terms; AGEEL and AGEYO refer to the dependency ratios of the elderly (ages 65 or older) and youth (ages 14 or younger) obtained from the Penn World Tables. GGDP refers to the real growth rate in the domestic economy, and LNPCGDP is the log GDP per capita in local currency units. CREDITGDP is the credit to the private nonfinancial sector as a ratio to nominal GDP. FD is an indicator of financial development, proxied by bank access and financing constraints, available from the World Development Indicators. X is a vector of control variables (such as real interest rates and inflation), and D refers to the time dummy variables for each year or for each five-year interval. Institutional or legal developments and availability of social security could also be important factors determining saving rates (Ayadi and others 2013; Chamon and Prasad 2007), which would be partly captured in the cross-sectional and annual dummy variables.

The specification also includes an interaction term on aging and additional terms to assess the nonlinear impact on savings. Population aging may affect savings differently in advanced and emerging economies. A dummy variable equal to 1 for advanced economies is interacted with the elderly and youth dependency ratios to see if the aging impact on saving varies across the two groups of economies. At the same time, since the level of GDP per capita and the credit-to-GDP ratio may have nonlinear effects on saving rates, the specification also includes quadratic terms (LN(PCGDPSQ) and CREDITGDP_SQ) with separate coefficients.3

The empirical results of the estimation are presented in Table 8.2. A summary of the main results follows:

  • A higher dependency ratio in the population tends to be associated with lower domestic savings across most specifications. The impact of elderly and youth dependency on domestic savings tends to be negative and statistically significant. The adverse impact is also notably higher for elderly dependency than for youth dependency (about three to four times higher) in both advanced and emerging Asia. For instance, a 1 percentage point increase in the elderly dependency ratio would reduce domestic savings by 0.3–0.9 percentage point, while the same increase in the youth dependency ratio would only reduce domestic savings by 0.1–0.2 percentage point.

  • Moreover, the negative correlation between youth dependency and domestic savings tends to be higher for advanced economies. The coefficients on interacting terms (specifications 5 and 6) suggest that the negative impact of youth dependency on the saving rate appears mainly in advanced countries. This could be related to higher spending on children in advanced countries—spending that focuses more on education and human capital.

  • Per capita income and the demand for private credit tend to have nonlinear impacts on domestic savings. The nonlinear effect is similar to the findings in other studies and supported by the stylized facts shown in Figure 8.4. Higher per capita income is associated with higher savings, but the domestic savings rate begins to decline as income per capita reaches a certain threshold. The nonlinear effect also applies to credit demand. Other factors, such as real GDP growth and higher risk premiums, affect savings in an expected manner, but inflation rates do not seem to have a significant effect on savings rates.

  • Financial development, measured by openness in financial markets, tends to play a role in domestic savings, though the magnitude is small. The coefficients are, in most cases, positive and statistically significant.

Table 8.2Panel Regression Estimation Results
Dependent Variable: Domestic Saving

As a Percentage of GDP
Elderly dependency ratio−0.71−0.31−0.54−0.64−0.76−0.90
Youth dependency ratio−0.22−0.21−0.15−0.16−0.19−0.22
Elderly dependency ratio × Dummy
advanced economies0.120.59
Youth dependency ratio × Dummy
advanced Economies−0.17−0.22
Ln (real GDP per capita)32.3514.5211.900.932.53−1.03
Ln (real GDP per capita squared)−0.83−1.02−0.75−0.06−0.150.03
Ln (private sector credit to GDP)
Ln (private sector credit to GDP squared)−0.02−0.05−0.03−0.05−0.01−0.01
Real growth0.
Real interest rate−0.59−0.58−0.20−0.41−0.37−0.54
Inflation rate−0.02−0.01−0.01−0.01−0.01−0.01
Openness in financial development0.02−
Control variables:
Cross-section dummyYYYYYY
Country groupsAsiaAsiaAllAsiaAllAsia
Number of country groups5915141514
Adjusted R20.890.870.650.720.770.80
Source: Authors’ estimates.Note: Numbers in parentheses denote standard errors of estimated coefficients. Numbers in bold denote 10 percent significance level. Interactive term refers to the dummy variable for advanced countries multiplied by the respective age-dependency ratios. Country group “all” includes emerging and advanced Asia, as well as selected member countries of the Organisation for Economic Co-operation and Development. “All Asia” includes Asian emerging and advanced economies.

To complement the empirical estimations, the analysis examines the macroeconomic impact of the expected demographic transitions across countries in Asia, especially the impact on savings and capital flows, using a dynamic structural general equilibrium model. The changing demographics in the region call for a strengthening of financial integration for better risk sharing and capital allocation, as well as an increase in investment in infrastructure to meet the growing demand from the rising population in emerging Asia. In this context, the exercise illustrates that more balanced growth can be achieved through further financial development in the region. Because demographic changes and infrastructure investment would affect all agents in the economy, several examples are presented to indicate the benefits of better household financial inclusion, lower corporate riskiness, and lower sovereign risk premiums. The analysis uses the IMF’s Global Integrated Monetary and Fiscal model (GIMF) to study the macroeconomic impact of the projected demographic changes and infrastructure investment in Asia and the potential benefits of financial sector development. The GIMF is a multiregional dynamic structural general equilibrium model with optimizing behavior by households and firms and full intertemporal stock-flow accounting.4 Frictions in the form of sticky prices and wages, real adjustment costs, and liquidity-constrained households, along with finite planning horizons of households, mean monetary and fiscal policy have important roles in economic stabilization. In the exercise the model is calibrated to contain four regions: China, other emerging Asia, industrialized Asia, and the rest of the world. Because the model allows for dynamic interaction across sectors and regions, scenarios can be designed to incorporate the different demographic changes and investment needs across the region.

The projected demographic changes in Asia would have different macroeconomic effects across the region, especially on savings and investment. According to the 2010 United Nations World Population Prospects, the working-age population in emerging Asia is projected to rise by about 25 percent by 2030, continuing its upward trend from the early 2000s, albeit at a slower rate (Table 8.3).5 In Asia’s advanced economies, the working-age population is projected to decrease by 9 percent in the next two decades. China’s working-age population is projected to peak about 2020.6 In the GIMF, the changing working-age populations in different regions are introduced as labor supply shocks. Moreover, as the empirical analysis shows, the elderly and youth dependency ratios tend to have negative impacts on domestic saving rates in Asia, after controlling for other factors. Because the GIMF does not allow for an explicit incorporation of the age of agents or their retirement decisions, the analysis imposes the impact of demographics on saving as estimated in the GIMF in addition to the labor supply shocks.7 The combination of labor supply shocks and shocks to household savings rates allows the impact of the changing demographics on both labor supply and households saving behavior to be captured.

Table 8.3Asia Demographic Changes(Cumulative growth in percentage points)
PopulationWorking-Age PopulationWorking-Age Population RatioPopulationWorking-Age PopulationWorking-Age Population RatioImplied Savings Rate ChangePopulationWorking-Age PopulationWorking-Age Population RatioImplied Savings Rate Change
Source: United Nations; IMF staff estimates

Other Emerging Asia = India, Indonesia, Malaysia, the Philippines, Thailand, and Vietnam.

Industrialized Asia = Australia, Japan, Korea, Hong Kong SAR, New Zealand, and Singapore.

GIMF model simulations suggest that demographic factors in emerging Asia are likely to be supportive of growth in the coming decades. The model simulations show that the increasing working-age population growth in emerging Asia could add 1.5 percentage points to the region’s long-term annual real output and 0.7 percentage point to its gross savings as a share of GDP (Figure 8.7) by 2020. The interplay between savings and investment would also have a significant impact on the dynamics of current accounts and, thereby, on both interregional and intraregional capital flows. In emerging Asia, the increase in savings tends to outweigh the increase in investment, leading to a rise in annual current account surpluses. In advanced Asia, the decline in savings tends to outweigh the decline in investment, which would lead to an increase in the real interest rate and capital inflows. (However, in practice, emerging markets are likely to continue to receive net capital inflows given their relatively high growth rates and real interest rates).

Figure 8.7The Impact of Demographic Changes

Source: Authors’ estimates based on the simulations of the Global Integrated Monetary and Fiscal model.

Although gross savings in emerging Asia would increase because of the rising working-age population, such savings would probably be insufficient to finance the region’s immediate infrastructure investment needs, given the estimated size of the infrastructure gap. The decrease in the interest rate spread between emerging Asia and advanced Asia, owing to the demographic changes, is unlikely to have a material impact on intraregional financial flows. More needs to be done to enhance regional financial integration to facilitate a more efficient allocation of resources across countries.

The Benefits of Financial Deepening and Integration

The baseline scenario considers the expected demographic changes and rising investment in Asia during the next decade. The simulation assumes an increase in investment of 2 percent of GDP per year for the next 10 years in emerging Asia, with public and private investment each contributing half.8 Different policy instruments are available to increase public infrastructure investment. The domestic options—financed by domestic debt or the sale of state assets—include reallocating public expenditure, implementing tax policy measures, and relaxing fiscal targets. The external options consist mostly of external borrowing. In the GIMF, because fiscal policy is governed by specific rules that allow it to respond flexibly to the business cycle while containing the government debt-to-GDP ratio, the augmented public investment spending would be financed by a combination of revenue measures and domestic and external borrowing.

Long-term output would increase under the baseline scenario but would crowd out private demand and widen trade deficits. The model simulation suggests that emerging Asia’s long-term annual output would increase by 3–4 percentage points, but private demand would be replaced by public demand and the region’s trade deficit would widen. The persistent positive output gaps and inflationary pressure would also lead to tighter monetary policy.9 In this regard, the question of how to mobilize domestic and external financing resources to ease the impact of the expansionary shock is a key policy challenge. The analysis uses the GIMF to illustrate that enhancing financial deepening and integration in emerging Asia could help mobilize savings in the region and potentially lower infrastructure financing costs. In particular, the analysis illustrates the benefits of financial development in three scenarios representing the three important agents in the economy: households, firms, and the sovereign. The three scenarios, explained in more detail below, are (1) household financial inclusion, that is, improving household access to financial markets in emerging Asia; (2) lowering the sensitivity of the external finance premium to corporate leverage (or net worth); and (3) reducing emerging Asia’s external borrowing premium, possibly through financial integration.

Household financial inclusion scenario—This scenario assumes that the share of liquidity-constrained households in emerging Asia declines from 50 percent in the baseline scenario to 25 percent, the level that is applicable in advanced Asia. If more households have access to financial instruments, and thus the ability to smooth consumption intertemporally, the private sector will have a greater ability to offset the expansionary fiscal shock, and the private sector will be less subject to crowding out. A larger domestic saving pool would also improve the economy’s ability to mobilize savings to finance large investment needs and reduce pressure on public finance. Model simulations suggest that, with improved financial inclusion, a more sustainable and balanced growth path can be achieved. The positive output gap resulting from the increase in labor supply and public investment is slightly less than in the baseline scenario, but there is much less inflationary pressure and the need for monetary tightening is less. The region also imports less compared with the baseline scenario.

Corporate riskiness scenario—This scenario shows the effects of a persistent decrease in the riskiness of emerging Asia’s corporate borrowers that reduces the corporate finance premium by 1 percentage point. The decrease in the corporate finance premium originates from the lower sensitivity of “external” spreads to corporate leverage, which effectively reduces the borrowing cost faced by firms. Thus, there is an immediate decrease in the cost of capital. Therefore, business investment, such as in private infrastructure, increases. A lower cost of capital also raises profitability, leading to higher dividends and an increase in household wealth. This effect is particularly important if there is private sector involvement in infrastructure investment. Lower costs also lead firms to increase production and demand more labor, which pushes up wages.

Sovereign risk premium scenario—This scenario assumes a 1 percentage point decrease in emerging Asia’s sovereign risk premium. A sustained fiscal expansion (as assumed in the baseline scenario) tends to increase the cost of capital and crowd out private investment. If financial integration could lower external borrowing premiums for the region (discussed in the next section), public investment would rely more on foreign funding, thereby reducing pressure on the domestic economy. Similar to the financial deepening scenario, inflation and the real interest rate would not increase as much as in the baseline scenario, and there would be less monetary tightening.

The simulation results suggest that better access to finance and lower financing costs would allow emerging Asia to scale up infrastructure investment with lower macroeconomic and fiscal risks. As shown in Figure 8.8, interest rate and inflation increases (indicators of aggregate demand pressures) would be less than in the baseline scenario, while long-term growth benefits would remain largely unaffected. Moreover, a deeper domestic investor base and lower financing costs also would create fiscal space and enhance fiscal sustainability. The next section discusses the possible ways to bring about these benefits and the policy implications of doing so.10

Figure 8.8Simulation Impact of Financial Sector Development in Emerging Asia


Source: Authors’ estimates.

How to Enhance Financial Deepening and Integration in Asia

Financial sector development can play an important role in addressing the challenges of demographic change and infrastructure investment needs in Asia. Financial sector development broadly consists of financial integration and financial deepening, through which economies across Asia develop closer financial linkages and firms and households have greater inclusion in and better access to financial markets.

Relative to its trade integration, Asia’s degree of financial integration, both with the world and the region, is low. Asia’s financial integration could be more effective, particularly its intraregional integration. Asian economies currently benefit less from risk sharing than do advanced economies. Controlling for a broad set of structural and cyclical factors, including trade integration, relative GDP growth, interest and exchange rate movements, and exchange rate volatility, the degree of financial integration of many Asian economies is below the level predicted by the model for all economies. The exceptions are the financial centers of Hong Kong SAR and Singapore. In several cases, financial integration falls below the norm for Latin America and emerging Europe (IMF 2011). Risk sharing captures the degree to which countries succeed in insuring each other against shocks—perfect risk sharing implies no further potential gain from redistributing risk.11 Greater risk sharing in Asia could help reduce its susceptibility to external shocks and lower sovereign risk premiums.

One way to enhance risk sharing is to strengthen the quality of financial integration by further developing financial markets and increasing harmonization and coordination.12 Indeed, policies can amplify the benefits from risk sharing at minimal risk of financial contagion and excessive volatility. Such policies include developing harmonized market standards and rules, building common trading rules and platforms, and harmonizing accounting standards and securities regulation. These policies, in turn, will deepen regional markets, increase participation of institutional investors, and encourage Asia-wide portfolio investment. Recent capital market reforms and the Asian Bond Market Initiative, for example, have already led to a notable diversification of sources of financing and an expansion of the investor base (Goswami and others 2014). Combining these initiatives with ongoing efforts to promote convergence in macroeconomic policy objectives can help ensure that the benefits of financial integration are maximized for Asia. Examples of efforts to promote convergence include regional surveillance, peer review, policy discussions, and, ultimately, greater regional policy coordination and safety nets.

As noted previously, a component of financial deepening is greater financial inclusion. Financial inclusion could help harness the increased saving from population growth in Asia, which, in turn, could be used to finance the region’s infrastructure investment. Increasing households’ and small and medium-sized enterprises’ access to finance in Asia could be facilitated by diverse savings products, credit bureaus, and better collateral and contract enforcement (Table 8.4). The impediments to developing the corporate bond markets and institutional investor base highlighted by Goswami and others (2014) and discussed earlier in this chapter will be critical to channeling financial savings realized from greater inclusion in the region into infrastructure.

Table 8.4Selected Indicators of Financial Inclusion
Households with Access to BanksAdult Population Not Using Formal Financial ServicesSMEs Lacking Access to Loans from Financial Institutions
East Asia and Pacific42876 / 51–75140–170 / >59
South Asia22612 / 51–7560–70 / >59
Middle East and North Africa42136 / 26–5012–15 / >59
Sub-Saharan Africa12326 / 75–10026–30 / >59
Latin America and the Caribbean40250 / 51–7511–12 / 40–59
Central Asia and Eastern Europe50193 / 26–505–7 / 20–39
High-income countries9060 / 0–2510–12 / <20
Source: Consultative Group to Assist the Poor and World Bank, Financial Access 2010.

Financial integration and deepening could potentially reduce the external borrowing premium and its sensitivity to domestic balance sheet considerations. The degree of financial integration within Asia is low, in part reflecting capital account restrictions in a number of countries in the region (Pongsaparn and Unteroberdoerster 2011). However, Asia as a whole is a net capital exporter. A large amount of Asia’s capital outflows go to the government debt market in the United States and Europe and, in turn, Asia receives foreign direct investment and portfolio inflows that typically have a higher rate of return than do the sovereign bonds. Foreign portfolio inflows tend to significantly reduce sovereign bond yields as shown in Goswami and others 2014. Thus, greater regional portfolio flows (or integration) would be expected to reduce sovereign risk premiums, particularly in emerging Asia. However, deepening the debt market by encouraging greater participation by regional investors might increase asset price sensitivity to global and regional financial conditions. At the same time, a broader domestic investor base can prevent asset prices from overshooting or undershooting in response to sales or purchases by foreigners that are driven by external factors (IMF 2014a). Therefore, the size of direct participation of foreign investors in local-currency bond markets warrants close monitoring and needs to be balanced with broad financial system development policies. Mizen and Tsoukas (2012) also find that the external finance premium measured by corporate bond spreads of Asian firms was more sensitive to leverage and risk of bankruptcy during the Asian crisis of 1997–98 than it was during the global financial crisis. This suggests that bond market deepening in the region, partly in response to the Asian crisis (Goswami and others 2014), may have played a role. Lower sovereign and corporate spreads would be an important channel through which financial integration and deepening could help finance infrastructure in emerging Asia. This includes aging Asia, where the returns would still be greater than they would be through investing domestically or in other advanced economies.

Financial product structures will also need to adapt to demographic change and infrastructure financing. Aging societies will demand financial products that provide inflation protection and allow the drawdown of savings, such as annuities. Markets in such products remain underdeveloped in Asia, partly because of limited diversification of systemic risks. Government policy can help these markets develop by addressing the duration and inflation risks. Building on the deepening of sovereign bond markets in emerging Asia as outlined in Goswami and others 2014—including the introduction of Treasury Inflation-Protected Securities and Separate Trading of Registered Interest and Principal of Securities—could facilitate public infrastructure investment, while also helping develop a benchmark to price financial innovations in the provision of private infrastructure finance.

Public-private partnerships (PPPs) offer an alternative provision mechanism to public investment, provided they are properly structured. PPPs have become a popular vehicle for providing infrastructure given that sound infrastructure projects that address clear bottlenecks are likely to have relatively high economic rates of return. Also, the private sector can be made responsible for constructing the infrastructure, providing the principal services related to it, and tailoring asset design specifically to this purpose. To the extent that these infrastructure services are supplied directly to final users, charging is both feasible and, from an efficiency standpoint, desirable. However, experience suggests that effective implementation of PPP projects and, more generally, increasing private sector involvement in the provision of infrastructure, requires coordinated action on many fronts, including strong legal and institutional frameworks and a well-informed decision-making process.

PPPs have specific characteristics such as long duration, varied risk-return characteristics, and complex structures that make capital markets better able to finance infrastructure—especially the corporate bond market. As to project financing through banks in Asia, new Basel III capital requirements mandate that banks hold more capital against long-term finance typical in PPPs. Moreover, the large size of investments would run up against banks’ single borrower limits, even with syndication, given the infancy of takeout financing and securitization.13 Although raising adequate equity finance tends to be one of the most challenging aspects of infrastructure project financing and PPPs, Asia’s relatively deep stock markets,14 as well as growing private equity firms, make it less of a binding constraint (ADB 2013). However, once the construction phase is over and an infrastructure project is generating a steady stream of revenue over a long horizon, it might be suitable to package the financing as long-term bonds that are sold to investors.15 In some Asian markets, bonds issued by infrastructure-related companies already constitute a substantial share of total bonds outstanding. For example, in Malaysia, 40 percent of bonds outstanding are issued by infrastructure-related firms. Developing the infrastructure bond market in the region can help draw nontraditional investors into the financing of infrastructure projects.

However, several obstacles must be overcome before investors can be encouraged to purchase infrastructure bonds:

  • Shortage of regional infrastructure asset class—Although a substantial pool of funds in the region is ready to be invested in infrastructure projects, a regional infrastructure asset class that meets the requirements of investors is absent, particularly in advanced Asia. Assisting emerging Asian economies in structuring bond financing for the brown-field phase in infrastructure projects could create additional supply.

  • Low credit ratings—Another hurdle is that infrastructure projects tend to be given credit rating that are too low to be of interest to institutional investors, particularly the pension funds in aging advanced Asia. Traditionally, governments have provided guarantees to ameliorate the situation, but doing so carries a fiscal risk. Another way to improve the credit rating of infrastructure bonds is to make subordinated debt tranches available to raise the credit rating of the senior tranches of the debt to investment grade. The securitization of infrastructure assets can allow banks to offload some of their long-term risk in infrastructure loans and help promote the development of a bond market. This would also allow banks to conserve their capital under the Basel III rules. However, securitization would require well-developed bond and derivatives markets, which usually go hand in hand, as outlined in Goswami and others 2014, to provide liquidity and minimize risk. It would also involve having a regulatory framework that allows for the securitization of revenue streams while ensuring some “skin in the game,” as well as functioning markets for distressed assets including well-functioning bankruptcy laws and resolution frameworks.

Promoting a long-term investor base would help build up a stable source of finance for infrastructure projects. The role of long-term institutional investors (for example, pension funds, mutual funds, and life insurance) has increased (Table 8.5, IMF 2014a), offering a natural financier for infrastructure projects. Also, infrastructure assets offer pension funds some measure of protection against inflation, while pension funds offer financing in domestic currencies. However, the main drawback of pension funds as a source of infrastructure project financing is that they tend to lack the expertise to evaluate and invest in complex and heterogeneous infrastructure assets. A more common way for institutional investors to gain exposure is by participating directly in an unlisted fund. Unlisted funds are set up by management companies on behalf of institutional investors to provide these investors with exposure to infrastructure projects without having to develop in-house expertise. Data from ADB 2013 show that, as of 2013, there were 88 unlisted infrastructure funds investing in Asia, with a total of $22 billion committed. That total is growing. Institutional investors can also buy debt linked to infrastructure projects through bond funds that invest in such projects. This investment is done mostly through mezzanine debt. Another option is to purchase debt that is issued by project operators and securitized by the revenue stream from infrastructure projects.

Table 8.5Amount of Institutional Investor Assets(Millions of U.S. dollars)
InsurancePension FundsMutual Funds
Hong Kong SAR13,93379,6401,237,624
Source: Standard Chartered Research.


In conclusion, we find that further financial integration and market deepening in Asia would allow the region to mobilize financial resources for greater benefit. As discussed in Obstfeld 2009, financial opening could benefit the emerging economies that pursue it through better risk sharing with the rest of the world and the alleviation of capital scarcity. Because the share of the working-age population appears to be at a stark transition point in many Asian countries, there is a greater need to enhance financial integration and deepening to cope with the higher dependency ratio that will reduce domestic savings and growth. Well-executed and well-structured infrastructure projects—particularly PPPs in emerging Asia—could provide pensioners in advanced Asia with high-yielding, long-term returns. In addition, demographic transitions are likely to intensify incentives for capital flows to emerging Asia, where labor resources remain abundant. Financial innovation and integration could provide individuals and pension funds with access to a broader array of financial products tailored to the needs of an aging society. This, alongside greater financial inclusion and financial market deepening, could reduce the cost of capital in emerging Asia. Together, these changes could help spread the benefits of financial integration across the region. The simulations suggest that raising the infrastructure investment-to-GDP ratio by 1 percentage point in emerging Asia will raise annual output by 2 to 3 percentage points in the long term.

At the moment, the degree of financial integration, both within Asia and between Asia and the rest of the world, is relatively low, especially when compared with Asia’s high degree of trade integration. Several barriers may have limited financial integration and the channeling of savings to the most productive investment opportunities across the region. For instance, financial inclusion is relatively low in emerging Asia, capital account and investment restrictions remain in place in many countries, and the development of debt capital markets that would be an ideal vehicle for private infrastructure finance has been uneven (Goswami and others 2014). However, deepening debt markets by encouraging greater regional flows might increase asset price sensitivity to global and regional financial conditions (IMF 2014a). That said, a broader long-term domestic investor base can reduce the susceptibility to external factors and finance infrastructure at lower costs if it is supported by appropriate financial instruments, macroprudential policies, and regional cooperation.

Asia’s financial sector has a key role to play in the transformation of the region’s real economy by helping address the key challenges of demographic change and infrastructure needs. As its population becomes increasingly urban and middle class, Asia needs to shift from its current manufacturing- and export-driven growth model to more vibrant and diverse markets. A healthy and dynamic financial sector can serve the social and economic needs for this transformation, and support a successful and sustainable new growth model.


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The authors are grateful to Fei Han, Yitae Kim, Jerry Schiff, Alison Stuart, Chikahisa Sumi, and participants at the IMF Asia and Pacific Department seminar and the joint IMF/Hong Kong Monetary Authority seminar for helpful comments. This chapter is partially based on IMF Working Paper 14/126 (Ding, Lam, and Peiris 2014).

A higher ranking indicates a lower score out of the sample countries.

Previous empirical analyses find an important role for demographic variables on saving rates based on the life-cycle hypothesis, such as Modigliani (1970), Feldstein and Horioka (1980), Chinn and Prasad (2003), Park and Shin (2009), Hung and Qian (2010), and Chinn and Ito (2008). A higher proportion of elderly in the population is often associated with lower saving rates given that the elderly typically finance their living expenses by drawing down savings. Similarly, higher youth dependency in the population will typically be associated with greater consumption given limited earning income, posing a negative impact on the overall domestic saving rates. The elderly also see less need for precautionary saving, because they assume that younger relatives will provide them with care and financial assistance. This suggests that higher elderly and youth dependency in the population would generally be associated with lower saving rates.

The regression uses lagged terms on the explanatory variables to mitigate potential endogeneity problems. An alternative would be to use the non-overlapping periods for the saving rate and the explanatory variables as in Chinn and Ito (2008) and Ayadi and others (2013).

For the theoretical structure of the GIMF model, see Kumhof and others 2010.

In our analysis, the working-age population is defined as ages 20–64. Data can be downloaded from

Although the elderly dependency ratio in China is projected to more than double by 2030, the youth dependency ratio is expected to decline sharply. As a result, China’s working-age population ratio will only decline from 65 percent in 2010 to 63 percent in 2030.

We assume that a 1 percent increase in the working-age population ratio will increase the savings rate by 0.3 percent in emerging Asia and by 0.5 percent in advanced Asia.

The scenario of a 2 percent increase in investment as a share of GDP is for illustrative purposes. Although the need to increase infrastructure investment in emerging Asia, partly through public investment, is widely recognized, there is no consensus on the optimal level of infrastructure investment, the financing scheme, or the efficiency of the investment.

In the GIMF, the central bank uses an inflation-forecast-based interest rate rule. The central bank varies the gap between the actual policy rate and the long-term equilibrium rate to achieve a stable target rate of inflation over time. Under this framework, the monetary policy stance tends to tighten when there is a positive output gap or inflation gap and vice versa.

Results show the peak level impact on the real interest rate and inflation and the average impact on real output over the next decade after the initial shocks. The households scenario assumes the share of liquidity-constrained households in emerging Asia declines from 50 percent to 25 percent; the corporate scenario assumes the corporate borrowing premium declines by 1 percentage point; and the sovereign scenario assumes the sovereign risk premium declines by 1 percentage point.

Typically, risk sharing compares how growth in the marginal utility of consumption differs across countries, which is indicative of how much risk is shared.

However, risk sharing should not be expected to contain the most extreme of shocks.

Long-term syndicated bank lending to Asia from outside the region has also been affected by the global financial crisis and continued deleveraging of European banks, although a number of Asian banks have stepped up cross-border lending, particularly Australian, Singaporean, and Japanese banks.

The share of stock market capitalization as a percentage of GDP in most Asian countries is comparable to the countries’ total banking sector assets, with debt securities markets coming in a distant third. This contrasts with many advanced economies, where the banking sector continues to dominate financial intermediation

The revenue stream from infrastructure tends to be less sensitive to the economic cycle and is generally inflation protected, too.

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