Forex Marketz Daily Forex News – Fully Markets Update
Frederic Neumann: The simple truth behind Asia worries
“It ain’t 1997,” is a popular refrain making the rounds in Asian markets at the moment: emerging Asia is at risk of sliding into a 1997-style currency crisis. Think again. Challenges abound, to be sure. But the region is a lot more resilient today than it was nearly 20 years ago.
Foreign exchange reserves, for the most part, are a lot higher. Most borrowing has occurred in local, rather than in “hard” currencies. And current account balances are either in surplus or, if in deficit, manageable. Not a picture that suggests imminent calamity.
Why, then, the worries? Debt — plain and simple. Just like in the mid-1990s, credit has expanded much faster than gross domestic product in recent years. Rapidly increasing leverage often portends trouble. Not just in emerging markets, mind you. Developed economies learned the lesson all over again in 2008.
A number of Asian economies, such as China, Malaysia, Thailand, Hong Kong and Singapore, have seen credit expand at an uncomfortably rapid pace in recent years. With growth now slowing, hard questions arise.
But the dissimilarities to 1997 outweigh the similarities. Back then, many Asian economies tightly managed their currencies. With the seeming absence of exchange-rate risk, this encouraged offshore borrowing, generally in U.S. dollars. As current account positions were mostly in deficit, central banks had acquired too few reserves to defend their pegs. When these came unstuck, and currencies plunged, borrowers where left with soaring debt-servicing burdens. Bankruptcies ensued, and investment collapsed. Unpleasant memories.
Today, the overall picture looks much healthier. Scarred by the earlier shake-up, central bankers built substantial foreign exchange reserves, helped by persistent current account surpluses in most economies. A much bigger share of foreign borrowing has been undertaken in local currencies, sheltering debtors from the immediate balance sheet impact that sliding currencies would otherwise have had.
True, some have still borrowed in dollars, tempted by cheaper funding costs than what was available onshore. But, in aggregate, the share of hard-currency credit is lower than it was back in the mid-1990s.
Every crisis, of course, comes in a different guise. Traditional risk indicators, therefore, may not be an entirely reliable guide to future vulnerabilities. For example, even countries with current account surpluses can experience substantial capital outflows — either by residents or foreign creditors.
At the very least, this should prove disruptive, tightening financial conditions and thus, harming growth. Foreign investors, for one, hold a substantial share of local bonds in many economies, with their sudden withdrawal bound to push up funding costs for companies and, eventually, consumers.
But, this is where another dissimilarity with 1997 is relevant. Back then, the U.S. Federal Reserve had raised interest rates substantially, having begun its tightening cycle three years earlier. Japanese banks, also, once ready conveyers of capital to the region, had become a lot more cautious due to mounting losses back home.
Today, while the Fed may still raise rates before the end of the year, an aggressive tightening path remains unlikely. Long-term dollar rates, more important nowadays for emerging markets than those of shorter tenors, remain remarkably stable. The Bank of Japan, meanwhile, is keeping its foot firmly on the gas.
All this raises the important distinction between stock and flow. Wobbly growth in emerging markets and a stronger dollar have sharply curtailed capital inflows to the region in the past couple of years. In recent months, the tide has even reversed. This has started a re-pricing process of emerging market debt, brought about primarily by an adjustment of exchange rates. This amounts to a tightening of financial conditions, which, given the credit intensity of growth across the region, is bound to weigh on the overall pace of expansion for quite a while.
A crisis, however, requires a full-blown adjustment of the stock of emerging market investments. Residents would have to shift a substantial share of their assets abroad, and foreigners aggressively sell-down their holdings, even if this involves substantial losses. For all the jitters in recent months, there is no sign that such panic has taken hold. And it shouldn’t.
Fundamentally, most Asian countries possess excess savings with which to finance future growth. Plus, as long as global interest rates remain relatively well-anchored, the current re-pricing of emerging market assets should prove sufficient to restore balance.
None of this means that the current turmoil should be taken lightly. In essence, however, emerging Asia faces a growth problem, possibly even a lasting one, but not one of imminent financial stress. Deteriorating growth prospects, of course, can over time engender broader problems. But a determined push at structural reforms could help restore the confidence required to keep things on an even keel.
This would also go a long way towards insulating individual economies from the pernicious effect of contagion — that dreaded phenomenon when financial turmoil in one market spills over into others with initially sound fundamentals. Just because it “ain’t 1997,” this does not mean Asian officials should avoid the hard choices required to attain lasting prosperity.
Frederic Neumann is co-head of Asia economics research at HSBC.
