Global Trends by Martin Khor
Monday 5 May 2008
The financial turmoil
will cause a long adjustment period of slow growth in the
Asian developing countries can counter the ill effects of a global economic slowdown by boosting their domestic spending but several of them face serious risks from “bubbles” in credit, investment and in the equity and property markets, that were partly due to excessive inflows of foreign capital.
This was a main message given
last week to Asian Ministers and policy makers at the UN Economic and
Social Commission for Asia and the Pacific (ESCAP) in
Akyuz was presenting a paper
on the effects of the global financial turmoil on
ESCAP Executive Secretary Dr. Noeleen Heyzer, who chaired the session, highlighted the need for Asian policy makers to understand the global financial crisis and to prepare to manage its effects on the region’s developing countries.
Replying to a question, Akyuz
said no one knows how exactly the current
To a question whether Asia
can escape adverse effects of the global turmoil because it had its
own growth locomotives but was also dependent on the
Asian developing countries now have the scope to undertake such counter-cyclical policies, said Akyuz. Most major Asian countries had positive net foreign reserves and high domestic savings that enable them to increase domestic consumption as an alternative source of growth to offset the slowing of their exports.
Akyuz said what should worry Asian countries instead was the existence of “credit, asset and investment bubbles” in the countries, which is similar to the type of bubble in developed countries. This makes them vulnerable to corrections in the form of sharp falls in the property and stock markets, and to difficulties faced by banks and companies in the private sector.
Akyuz said the main problem in many Asian countries was their openness to capital inflows, which had led to excessive inflows of various types of funds in recent years.
Significant parts of the Asian countries’ high foreign reserves had come from capital inflows, as contrasted with a growth of reserves resulting from trade surpluses. While the build-up of earned reserves (from trade surpluses) is alright, said Akyuz, it does not make sense to add to the foreign exchange reserves by allowing large inflows of capital.
Akyuz traced the source of
the current global turmoil to the “easy money” policy with low interest
rates especially in the
The same factors, including the search for yield by investors, led in recent years to the strong recovery of capital flows to emerging markets, contributing to currency appreciations, asset bubbles, credit expansion and growth in recipient countries.
Akyuz said that drawing from the lessons from the 1997 Asian crisis, there is need to guard against four types of vulnerabilities associated with surges in capital inflows: (1) currency and maturity mismatches in private balance sheets and exposure to exchange rate risks; (2) rapid credit expansion, asset bubbles and excessive investment in property and other sectors; (3) unsustainable currency appreciations and external deficits; (4) lack of self-insurance against a sudden stop and reversal of capital flows, and excessive reliance on outside help and policy advice.
He concluded that most Asian countries acted on the third vulnerability and the fourth (by accumulating foreign reserves to counter potential external shocks).
However, they have not been able to prevent capital inflows from generating asset, credit and investment bubbles, or maturity and currency mismatches in private balance sheets.
This is because the countries were unwilling to impose sufficiently tight controls over capital inflows. This has generated economic fragility in the countries, and the countries are now exposed to certain risks, though not of the kind that devastated the region in the 1990s.
Pinpointing the surge of capital inflows as a problem, Akyuz said inflows to Asian developing countries were $220 billion in 2005, $260 billion in 2006 and $208 billion in 2007.
The inflows have led to credit,
asset and investment bubbles, said Akyuz. The foreign share of transactions
and holdings in equity markets is very high in several Asian countries.
Large capital inflows have led to a bubble in the equity markets. There
has also been a boom in property markets in many countries, including
In 2007, Asian developing countries had over $2 trillion in foreign currency reserves, and half of this is “borrowed reserves” built up from capital inflows. The cost of having these borrowed reserves is high as the return earned on reserves is less than the cost of servicing the foreign capital.
Akyuz estimated that Asian countries are losing $50 billion a year, which is the “carry cost” (of the borrowed reserves). Also, countries with a large stock of US dollar reserves stand to incur considerable losses with the downward pressure on the dollar.
Akyuz’s paper analysed the
possible effects of the global financial turmoil on
On finance, he said Asian economies do not seem to have large direct exposure to securitized assets linked to sub-prime lending. The finance-related impact on Asian countries will be transmitted through capital flows, in conditions of the existence of the bubbles in the countries.
Large drops in equity markets in developed countries can cause sharp corrections in Asian markets, and if this is combined with a reversal of capital flows and contraction in exports, it can have serious impact on growth.
On the trade side, Akyuz
examined the argument made by some about that Asian countries had “decoupled”
their economic growth from the
However, Akyuz pointed out
that the negative effects of a slowdown in the US would be felt not
only directly through reduced exports to the US but also through reduced
exports to Europe (which itself would be affected by the US developments).
Moreover, there would be significant indirect effects; in particular,
Thus, the combination of
severe trade and financial shocks from the sub-prime crisis with domestic
fragilities linked to the credit, asset and investment bubbles could
pose serious policy challenges for Asia, especially in
The appropriate policy response is to expand domestic demand through the fiscal stimulus, said Akyuz. And if difficulties arise in the financial sector, governments may have to arrange for “lender of last resort” financing.
There should be a shift from reliance on exports to expanding the domestic market through increases in consumer spending.
Akyuz warned that in
However, economic fundamentals are strong enough in Asian developing countries to allow them to have a positive policy response. On balance, the countries can continue rapid but reduced growth -- provided they take counter cyclical and structural measures to address domestic fragility and imbalances and counter the adverse effects of external shocks, concluded Akyuz.