Roubini Global Economics: How severely will Asia be affected by the global recession?
By RGE Monitor
The prognosis for Asia’s financial sector in 2009 is relatively better compared to other emerging economies and also compared to the region’s own experience in 1997-98. Even so, further GDP contractions and asset market corrections are likely as the external environment continues to deteriorate and domestic demand falters.
Asian economies do have fewer mismatches in external debt, lower imbalances in the government, corporate and banking sector balance sheets than their counterparts in emerging Europe, and as a whole used less leverage. Fortunately, ample foreign exchange reserves held by most countries in the region – even before the introduction of Fed swap lines and the IMF’s short-term liquidity facility – fully cover short-term debt and minimize the threat of a financial crisis. Intra-Asia swap agreements are helping provide liquidity to Asian countries with less ample reserves.
However, given the exposure of Asian economies to exports and to global liquidity, Asia is unlikely to lead the global economic recovery, being reliant instead on resumption of demand from the US Even so, solid macro fundamentals and a greater capacity to take fiscal and monetary measures will help Asian emerging economies recover faster and stronger, as compared to others. Those countries able to take on more aggressive fiscal and monetary responses, will outperform – but some of the recent responses including those of China risk exacerbating, not reducing overcapacities and domestic imbalances.
There are five critical areas of risk for Asia’s financial markets in the coming months:
1. Asset markets will witness further corrections
Real estate: exposure is the soft spot for Asia. With financing shortages and slowing domestic demand, further correction in real estate prices is expected in 2009. Commercial real estate is only now coming under significant pressure, especially in Asia’s financial centers but with the retrenchment of corporations further declines are likely, having a knock-on effect on construction.
Currencies: Deleveraging and easing capital flows will continue to take its toll on Asian currencies even as the export contraction weighs on the external balances of many and constrains countries from allowing currencies to appreciate. The deterioration of the global economy and need for dollar liquidity in Asia and globally will continue to support the dollar in the near-term.
With both equity and property markets yet to hit a bottom, banks will face rising delinquencies and non-performing loans.
2. Government debt will continue to grow
While rising bond issues make yields attractive, investor interest in Asian bond markets might remain low in 2009 given the risk of domestic growth slowdown, credit crunch and rising bond issues in developed countries (considered a ‘safer-haven’).
Credit ratings of India and Taiwan have been downgraded on growing fiscal vulnerabilities while ratings remain ‘on watch’ for South Korea, Indonesia, Philippines, Thailand, Malaysia and Vietnam. Risk of sovereign default in Asia remains extremely low even in the case of Pakistan, where the IMF may step-up its rescue. In the case of Indonesia, the ADB may join in offering guarantees on bonds.
3. External debt will remain a risk
South Korea scores the lowest in the region on financial sector health. It has the highest loan-to-GDP ratio in Asia (of over of over 130%) with foreign-currency mismatches from bridge financing, and close to US$24.5 billion of foreign-currency short-term debt maturing in 2009, of which over half is held by branches of foreign banks. Currency swap lines with US, Japan and China only provide a band-aid. Asset quality is deteriorating rapidly as NPLs doubled in 2008 to 1.11% of total loans while delinquencies grew 46% y/y in December 2008, leading banks to curtail credit growth. Net interest margins (NIMs) are falling as the increase in long-term, high-rate bank funding via time deposits and bonds offset the Bank of Korea’s policy rate cuts. A government-backed bank recapitalization fund may provide some relief when it begins capital injections in March. But this may be offset by Japanese fiscal year-end repatriations, which could have Japanese investors refusing to rollover the US$1.98 billion of Korean short-term foreign-currency debt due in March.
Depreciating currencies pose additional risk to roll-over debt in South Korea, Indonesia and Pakistan. But swap lines with the Fed and with Asian central banks, as well as funds from multilateral agencies reduce the risk of default.
4. Easing external balances
In particular the slowdown in G3 demand and slowing of China’s domestic demand will limit its ability to support Asian trade. Trade between China and East Asia has contracted more than trade with all partners.
Much lower inflows or even outflows of portfolio funds (especially in South Korea, India, Indonesia), and slowing FDI (China, Vietnam, India, Indonesia), foreign bank lending (South Korea, India, China) and remittances (Philippines, China, India) will put pressure on the capital account.
Large foreign exchange reserves will be sufficient for most central banks to intervene in FX markets and defend their plunging currencies.
5. Strains in credit access and the banking sector
Private sector debt has increased in recent years especially in South Korea, Hong Kong, Taiwan, Indonesia, India and Singapore. Credit shrinkage and de-leveraging will be painful in these countries and as serious a risk to growth as the contraction in exports.
Slowing growth, domestic demand and cooling labor markets raise bank non-performing loans, delinquencies and deterioration in asset quality in most countries. While governments are stepping in to support public banks and force them to keep lending to firms and households, lending by private banks (including foreign branches) will continue to trend down.
Hence, given the depth of problems in the US and global economy, fiscal and monetary policies in US and China, in spite of being aggressive are still behind the curve and will have limited impact. Without a recovery in the US and global economy there cannot be a sustainable recovery of Chinese or Asian growth. With the US recovery requiring lower consumption and trade deficit, China and other surplus countries’ growth will need to depend more on domestic demand and less on exports.
Source: Arpitha Bykere, Rachel Ziemba and Mikka Pineda, RGE Monitor, March 8, 2009.
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