This growth in intra-regional trade has been spurred, in part, by the integration of production network and supply chain in the region, especially the emergence of China and its integration into the regional economy. Also, government policies to support freer trade through bilateral and multilateral trade agreements have also had a strong supporting influence. Accompanying the growth in intra-regional trade is a deepening process of financial integration in the region, defined as cross-border investment flows within East Asia. Evidence of this can be seen from the data on cross-border flows in FDI, portfolio investment, and bank lending that point to a rising trend. Also, financial prices in the region’s financial markets show greater tendency to converge. For example, cross-border interest rate and bond yield differentials have narrowed while the volatility in money market interest rates across the region has declined. To me, a key stimulus to the current process of financial integration has to be East Asia’s rapid economic growth and the accompanying growths in intra-regional trade and cross-border investment. Government policies to develop financial markets in the region have also been important in so far as helping to provide a clear direction of policy preference towards greater regional integration. As a result, cooperative government efforts to develop regional financial markets, especially the bond and equity markets, are being carried out in many regional fora.
The slow pace of financial integration relative to trade, in my view, is a reflection of three specific factors. BIS Review 95/2006  1  First, trade integration has a much longer history in East Asia, of which the key turning point was the introduction of the ASEAN Free Trade Area in 1992. Therefore, trade integration benefits from an established policy structure and a more simplified policy framework of tariff reductions, compared to that of financial integration. Second, financial integration has essentially been a market-driven process, with the policy supports focusing on removing market impediments and developing financial infrastructure. Therefore, there has been less of a deliberate policy push while the different levels of financial market developments in the region also act as a constraint to rapid integration. And the third factor is that, compared to trade integration, financial integration is complicated by a wider set of rules and regulatory framework, especially on cross-border capital flows, that tends to be more difficult to dismantle quickly. At the same time, the policy approach on capital flows liberalization in East Asia has been more cautious following the Asian financial crisis because of the risk of capital outflows and the weakened external financial positions. This, in my view, is one reason that led to a more cautious approach in liberalizing cross-border capital outflows. Let me now come to the second part of my talk, that is, the prospect for financial integration in the region going forward, and what should be the role of policy.