By Chris Wright and Taimur Ahmad
Ten years on from the Asian financial crisis, how vulnerable is the region to shocks in the global economy? It may have weathered the sub-prime turbulence – but a US slowdown is another matter
Asia, it seems, has largely bounced back since its devastating financial crisis 10 years ago: its economies are richer and have a bigger share of the world economy than in 1997, when the crisis – sparked by a plunge in the Thai baht – dragged the region into recession.
Asian governments today have far more balanced accounts, higher foreign exchange reserves and less debt, while the region’s corporations are, by and large, better financed. Last year, developing Asian economies generally grew at an astonishing 8.3%.
“The region as a whole has been focusing on improving its fundamentals,” says Margarito Teves, secretary of finance for the Philippines. “It has learned from its own experiences after the 1997 and ’98 currency and financial crises. The region has come up with a lot of reforms since then and continues to [implement them], including in the Philippines.”
On the macro level, the capacity for countries across the region to withstand sudden domestic and external shocks has vastly improved; the large build-up of foreign exchange reserves also acts as a cushion against such events. “I think the world today is very different from a decade ago,” Thailand’s central bank governor Tarisa Watanagase tells Emerging Markets.
Back then, banks and companies across the region took on large amounts of short-term foreign currency external debt, partly because of exchange rates that had been effectively pegged to the dollar – a fact that encouraged widespread external borrowing, which led to excessive exposure to foreign exchange risk. Tarisa says that financial sector improvements since have helped to change the picture dramatically.
“Risk management has taken root in the mindset of bankers. The way central banks approach commercial banks has been overhauled,” adds Tarisa, whose country was at the epicentre of the turmoil that slammed the region a decade ago.
Risks
But the picture is not as rosy as it may first appear. In its recent regional outlook, the Asian Development Bank (ADB) devoted a whole chapter to a single question: Is Asia decoupling? Is Asia’s economy now so independent of the rest of the world – as a result of booming intra-regional trade - that it can withstand the shocks in the US and elsewhere?
“The answer,” says ADB chief economist Ifzal Ali, “is a resounding no.”
Though an unfashionable view, it’s one Ali holds strongly. “Pre-crisis, there were signs that Asia was decoupling,” he says. “But if you look at post-crisis Asia, the correlations have become much, much stronger. Anything that happens in the G3, within a one- to three-year lag, there is an effect in Asia, and the effect is much more pronounced than it was.”He’s not alone in his view. The debate about the extent to which the world has decoupled from the US economy rages on. Ken Rogoff,
a Harvard professor and former IMF chief economist, believes Asia is not immune to a US slowdown. “I don’t buy the decoupling story at all,” he says. “Asia is clearly vulnerable. If we see a more serious US slowdown, it would be very tough on Asia.”
Crisis? What crisis?
This summer’s global credit crisis brought home the fact that risk has not gone away. But Teves’s reaction to today’s global turmoil is typical of many in the region: sub-prime’s no problem, but a US slowdown is a different story.
“The impact on the Philippines [from problems in global credit markets] is minimal because we don’t have too many of this type of collateralized debt obligation,” he says.
“Our central bank is rather strict in issuing licences to financial institutions to engage in business of this nature. Fortunately, we have had some good assets to work on, instead of having to get involved in sub-prime assets. I don’t think we will be affected directly on this particular issue.”
Asia has been rewarded for its lack of sophistication in leveraged finance and sub-prime lending: there’s been so much less to unwind. This is part of the reason that Asian markets, both debt and equity, have outperformed the rest of the world since sub-prime really emerged as an issue earlier in the year.
Tarisa too admits that the return of volatility presents new challenges for the region. “The world today is a lot more volatile than previously, even though you have a risk system in place,” Tarisa warns. “Even with good policies in place today, we need to be very vigilant, very observant.”
Regional strength
The real worry is not financial market volatility but the impact of a severe US slowdown on the region. “What might be of concern is if something happens to the US,” says Teves. “If it leads to recession, to the extent that the US is a large market for the Philippines in terms of exports, there will be some effect. So we will have to make adjustments by enlarging exports to other countries. In Asia, that will be China, Japan and India.” The US accounts for around 18% of Philippine exports.
ADB’s Ali points to the weakness of intra-regional trade – the common argument for the region’s supposed resilience. “It has been very fashionable to talk about this,” says Ali. “But what is happening is that the explosive growth in intra-regional trade is all in one category: components and parts.”
Ali’s argument is that most of these are then exported to China, where they are assembled into something else, before being exported again – to the west. He says that when this is considered, 79% of exports from Asia end up in G3 countries. In those circumstances, “there is going to be a ripple effect on Asia. It’s just that, given the growth dynamics we have in Asia today, the effects are not going to be as catastrophic as they would have been 10 years ago.”
Strong links
In Indonesia, there is more of an acceptance of this idea: that the world remains linked no matter how much Asia grows. “The trend of trade within the Asian region has improved. This phenomenon could mean that the dependency of Asian economies on the US is reducing,” Sri Mulyani Indrawati, Indonesia’s finance minister, tells Emerging Markets. “Yet we should remember that the countries playing an important role in intra-Asian trade, such as China, Japan and South Korea, have a close relationship with the US. Therefore intra-Asian trade is not strong enough to counter the impact of a US economic slowdown.”
Indonesia sees about 13% of its total exports go to the USA (and Mulyani expects it to “continuously decline” because of the increase in intra-Asian volume); in terms of FDI, the US is barely even a player in Indonesia, at just 1.5% on average since 2000. That would suggest that US problems should not spill over to Indonesia, but Mulyani is not so sure. “The impact of the US’s economic slowdown on Indonesia might be relatively small,” she says. “Yet the indirect impact still needs to be considered because of the important role of the US economy in the global economy.”
She takes a similar view on sub-prime: “Indonesia cannot avoid the impact of the sub-prime mortgage issue, as in the globalization era, the interdependency among economies has become stronger, especially in the financial sector,” she says. “The sub-prime issue has brought a negative impact on Indonesia’s financial market,” but she says well coordinated fiscal and monetary policies reduced that impact, and that “this experience re-emphasized the importance of cooperation and coordination among countries in the world in addressing global financial issues.”
She adds that sub-prime has caused a headache for government debt management – a big issue for many Asian nations – and that Indonesia has had to juggle the sources of fiscal financing as the costs of government borrowing have changed.
Assessing the damage
Ali has worked out a number of scenarios for the impact of a US slowdown on the region: a 1% fall in US output for two years would mean a 0.45% fall for Asian growth for the first year, then a 1.5% fall in the second; a 1% fall in US output for two years coupled with a 10% drop in the US dollar against Asian currencies would mean a 2% drop in growth for Asia for two years. Any bleaker than that in the US, and the picture gets steadily worse in Asia. In no circumstances does Asia come out unscathed, and if Europe and Japan slow down too then the numbers get nastier.
Not everyone shares this view. Tim Condon is managing director and head of research for Asia for ING Financial Markets. “All year we’ve been slicing our forecast for US growth and raising our forecast for Asian growth,” he says. “I see the region restructuring around what’s happening in China. There’s a really powerful economic integration story going on.” China’s needs, especially for commodities, are driving growth and change across the region to serve those needs, and will continue to do so, he says. “It’s going to be a wrenching process, but it’s releasing powerful productivity gains that are capable of driving GDP growth. With the exception of Thailand, all our ex-Japan Asian forecasts have gone up, and we’re not out of line with consensus on that.”
Market view
Debt specialists in Asia remain, by and large, positive. “In Asia, you’ve seen risk aversion in contrast to America’s risk-seeking attitude,” says Claudio Piron, who heads Asian currency research and FX trading strategies at JP Morgan in Singapore. “That’s created a lot of macro buffers, and that’s where Asia looks appealing.
“There’s a concern on the micro side in Asia, with corporate governance issues,” he adds. “But to some extent the lack of sophistication and innovation here has been a blessing in disguise.”
Damien Wood, who manages the Asian credit research team at Credit Suisse, says: “Asia is in midstream in its credit cycle, whereas the US is right at the very end. By holding an Asian bond, you’re more likely to get upgraded in the coming year. By holding a US bond, you’re more likely to get downgraded.”
John Stuermer, managing director at Bear Stearns Singapore, adds: “Asia simply hasn’t gotten the recognition it deserves. As the markets begin to recover, we’ll see more interest in Asian credit again. My only concern is inflation. We have all this money. My God, how the money comes in.”
Bubbly?
And this last may prove to be as big a threat as a US slowdown: a feeling that flows into Asia, particularly following the US rate cuts, may be creating a bubble in emerging markets.
That said, the growth figures in Asia are more than positive: they’re exceptional. When the Philippines grew at 7.3% in the first half of 2007, it represented its fastest level in almost 20 years. Indonesia is, as Ali puts it, “coming out of a deep slumber”; growth is at around 6% (though Mulyani admits “it would be difficult to boost the growth rate to 7-8% unless there has been a good and reliable infrastructure to support investment and economic activity.”)
Vietnam, where the economy grew an estimated 8.3% in the first nine months of the year, has become a new engine of growth; Malaysia, sometimes a laggard in competitiveness in recent years, has seen its stock market rise 25% per year to date as it liberalizes its financial markets and makes progress in financial reform; and only Thailand, the quirky outlier, where an unelected government thinks it’s a great idea to impose capital controls the rest of the region gave up on a decade ago, seems shaky. The region as a whole has $2.6 trillion of reserves compared to about $490 billion in 1995, and the true powerhouses – China and India – are on a whole other scale of development and potential, now accounting for 55.3% of the GDP of developing Asia, according to the ADB.
Fundamentals like this would take some derailing. The idea of an independent Asia still has its fans, and they have ammunition in the region’s GDP numbers. But then, they did in 1997, too.