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Morgan Stanley names nations exposed to Euro volatility

26 Jul 2011

The investment bank believes that the biggest Eurozone-risk to Asian credit markets is funding related. It sees China as a safe haven, but names Australia, Korea, and Indonesia as most exposed.

The crisis in the Eurozone could impact Asian sovereigns and banks by way of funding risk associated with a deterioration in global funding markets, according to a July 25 Morgan Stanley report.

According to the report, the US investment bank believes that China and its banks are a safe haven in the region, whereas Australia, Indonesia, Korea and Thailand are the most exposed. It also argued that if Asian banks are unable to fund themselves China could step in by using its gargantuan foreign exchange reserves.

Morgan Stanley is overall bearish on the crisis: “the key insight into the euro debt crisis—400% debt/GDP and no growth—is that there is no single ‘solution’ to it,” the bank’s report stated. “It is too complex and involves too many conflicting interests.”

The report splits the possible funding complications into three key risks: reliance on wholesale funding, reliance on foreign exchange funding, and level of government support including foreign exchange reserves.

It notes that Asian banks are the most ‘sheltered’ in the world from global wholesale markets due to raising deposits a great deal since the Asian crisis. “But at the higher end both Korea and Australia are still exposed, although both have made deliberate attempts to bring that down since 2008,” the report said.

With regard to foreign exchange funding, the Morgan Stanley report noted that Australian banks once again are particularly exposed due to their reliance on funding in overseas currencies.

The investment bank predicts that Asian sovereigns will need to raise US$600 billion in external funding this year and considers a country’s coverage ratio—ratio of government’s foreign exchange reserves versus liabilities—a key indicator of funding risk. Korea and Indonesia are the weakest with only 1.9 times and 2.1 times coverage respectively.

Moody’s also believes that South Korea and Indonesia look the most exposed to volatility in the global fixed income markets.

“In general all the markets are interconnected because of globalisation so there would be ripples [if the Eurozone crisis worsens] but there wouldn't be a tsunami that would overwhelm the Korean system,” said Thomas Byrne, a senior vice president for Moody’s, covering sovereign risk.

However the longer a crisis lasted, the more pressure Korea would be under. “If there were a sudden stop in credit from European investors for a period of more than three months, Korean banks would likely start to encounter liquidity stress and some banks could look again for government support, as in late-2008,” Byrne said.

Indonesia is another country more exposed than most to the vagaries of international investor demand.

“The Indonesian government has large exposure to external creditors both in rupiah-denominated debt and foreign currency-denominated debt so there could be a sell-off there if Indonesia is perceived to be a vulnerable country for whatever reason,” said Byrne.

“But it isn't a vulnerable country,” he countered, “because it has current account surpluses, a smaller than targeted budget deficit and it doesn't have the same vulnerability that we see in the Southern European countries.”

Morgan Stanley suggests that should there be a real funding shortfall in the region, China could step in.

“China has FX reserves exceeding US$3 trillion, more than enough to cover Asia ex-Japan’s entire financing needs of US$600 billion over the next year and for the following five years out,” it says, noting that Asia’s coverage ratio rises from four times to nine times in 2011 if China is added to the mix.

26 Jul 2011