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THE GLOBAL FINANCIAL TURMOIL. AND ITS IMPACT ON EAST ASIA. IIR. Presenter: Pham Tuong Van. The causes of the current financial turmoil. Problems in the U.S subprime mortgage market Risks in the market for asset-backed commercial paper and the credit crunch
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THE GLOBAL FINANCIAL TURMOIL AND ITS IMPACT ON EAST ASIA IIR Presenter: Pham Tuong Van
The causes of the current financial turmoil • Problems in the U.S subprime mortgage market • Risks in the market for asset-backed commercial paper and the credit crunch • Increasing investors’ caution and re-assessment of the risks associated with assets, creating a chasing down spiral • In some countries, it coincided with the end of an overlending/ borrowing period, and over-optimism about the economic prospect. • Developments in U.S subprime were more a trigger than a fundamental cause of the financial turmoil
The scope of the current financial turmoil • The credit crunch situation in banking sector. Significant deterioration in market functioning • Raising costs of credit access for enterprises, negatively affecting investment • Slump in stock markets world wide, stocks lost 20% -40% of their peak values • Big financial institutions experienced serious losses or bankrupcity • Exchange rate volatality and weakening trade performance • Dramatical volatality of oil and gold prices • High inflation in many countries
Slump in stock markets Dow Jones Index FTSE Index Hangseng Index Nikkei 225 Index
Consequences • Wanning investor confidence • A repricing of risky assets and deleveraging by investors. Risk asset prices are under downward pressure across the developed and emerging world • Wider payment difficulties with mortgages and corporate bankruptcies. • More aggressive rationing of credit on the part of banks, with adverse feedback effects into the real economy. Banks under pressure to improve their balance sheets force investors to liquidate even their good investments to meet margin requirements. As this process expands, more assets will be sold, triggering further price declines in a debt deflation spiral. • Worst senario: systemic financial crisis, including bank failures, declining asset prices and widespread insolvency problems
Forecasting: the good, the bad and the ugly According to The Economist Intelligence Unit: • Scenario 1 (60% probability): the turmoil will be contained by timely monetary policy action, with only a modest effect on the global economy. • Scenario 2 (30% probability): the US falling into recession, with substantial fallout in the rest of the world. • Scenario 3 (10% probability): the US could enter recession, corrective action fails, and severe economic repercussions cascade from the US into the world economy with devastating effect.
Implications for East Asia On financial and investment aspects: • Deteriorating global financial conditions: rising uncertainty and risk aversion. Serious downward pressure in all regional stock markets. • Wanning external as well as regional investors’ confidence • Volatile currency swings, affecting East Asian trade performance • US companies would cut back on investment abroad as profit falls and financial conditions tighten. Also, the portfolio inflows by foreign institutional investors could reverse rapidly in the event of a flight to safety. • Companies in the regions still rely heavily on banks and financial markets for funding, both of which will be hit by tightening credit. Also, profit falls would reduce opportunities for local businesses to self-fund investments.
Implications for East Asia Should it be another Asian 1997 crisis or like the Japanese bubble burst in 90-91 and its lost decade? East Asia now is far better placed to withstand financial shock than it was in 1997.
East Asian balance of payments 1997 - 2007 Source: World Bank data
Implications for East Asia The NPL ratios of East Asian economies have declined dramatically during the last 5 years: China’s NPL ratio was just 7.5% at end-2006, compared with almost 30% in 2001. China is the largest oversea holder of US mortgage-backed securities – around USD 260 billion, mostly through the central bank’s international reserve holdings. Yet, the majority of China's US mortgage-backed securities were underwritten by US government agencies (as Fannie Mae and Freddie Mac), which made them less risky and allowed them to keep their value. Unlike before the 1997-98 crisis, many regional economies now have large foreign reserves, stronger current-account positions and more flexible exchange-rate regimes (although in some cases still heavily managed). Extensive regulatory reforms and consolidation have improved the health of the banking sector in a number of countries. Commercial banks’ net foreign asset positions are also generally much healthier
Implications for East Asia Countries in the region have so far remained sound macro economic-indicators, thus, direct impacts of the US financial turbulence on regional banking system and balance sheets have been limited up to now. Yet, a sharp US slowdown could indirectly expose financial-sector weaknesses that have been hidden until now as a result of strong economic growth and buoyant asset prices in the region.
Implications for East Asia On trade aspect: • Weakening demand from the US would hurt East Asian trade-dependent economies. • Most Asian countries still send a substantial share (typically 13-20%) of their exports to the US. Just as importantly, many of the exports that Asia sends to China are ultimately destined for the US as well, and therefore again dependent on US demand.
East Asian highly trade-dependent economies Exports as percentage of GDP
Intra trade may help East Asia to decouple from US economic slowdown? • The more integrated, the more structurally vunerable the region is through the trade channel. Intra-Asian trade has surged in recent years (accounting for 51% of the total regional trade volume), but this largely reflects the increasing integration of supply chains across Asia. • East Asian countries tend more to produce inputs and intermediate goods and raw materials that are exported to China; in turn China, given its lower labor cost, processes these inputs and assembles them into final goods that are exported to the US. • According to the ADB, 70% of trade within Asia (excluding Japan) consists of intermediate goods used in manufacturing processes, and a large share of goods still ultimately end up in rich, developed countries. • East Asia, therefore, would face the prospect not only of weaker demand from the US, but also of weaker demand from China.
Implications for Japan • Growth in Japan over the last five years averaged 1.7%, of which more than one-third came directly from exports. Consequently, a downturn in export demand from a languishing US economy will undermine the Japanese expansion. • Japan has limited room for a policy response, since short term interest rates are already at 0.5% and the country boasts the worst fiscal position of the developed world. • Also, Japan’s prospects will be undermined by a sharp appreciation of the yen, as dollar falls further.
Implications for China • The implications for China specifically is important to the rest of the regional outlook, given the huge contribution the country makes to regional (and global) growth and the strong linkages with the US. • The more integrated into the global economy, the more vunerable the country is to external shocks. After its entry to the WTO in 2001, China is now more entrenched in global supply chains, thus, more vunerable to turmoil in other markets. • China has its own problem before the turmoil break out: inflation, overpricing stocks,… (signals of an overheating economy) • China holds about $260bn in US mortgage-backed securities, largely as part of its reserves and stakes in foreign commercial banks. • Exports of goods and services accounted for around 40% of Chinese GDP, double the share a decade earlier. Weakening demand from the U.S would negatively impact on China’s growth.
Implications for China Yet, China’s economy may be least affected among the region for reasons belows: • the majority of China's US mortgage-backed securities were underwritten by US government agencies, which made them less risky and allowed them to keep their value. • China’s NPL ratio was just 7.5% at end-2006, compared with almost 30% in 2001. • China has a largely closed financial system despite moves under way to ease restrictions on outward investment, which help them decoupled from the financial contagion • Historic data shows the correlation between US recessions and Chinese economic growth is very little • WB forecast: China's economy will grow by 10.8% this year, down from 11.3% in 2007.
Implications for Vietnam • The more integrated into the world economy, the more Vietnam’s economy affected by the up and down in the world economy. Yet, the economy has its own issues before the global turmoil break out. • High inflation (2007: 12%, first quarter of 2008: 15%): as the results of various factors (over-expanding money supply in the previous years, untimely and insufficient monetary policy, oil price hike, large capital inflow with weak risk management policy) • Bubble bursting in stock market and adjustment in real estate market • Drying up of liquidity as the consequence of tightening monetary policy and rising uncertainty (interbank interest rates reached record heigh in Feb 2008) • Increasing trade deficit (> USD 12 billion)
Easing risk factors • Vietnam’s economic fundamentals remained sound. • Big SOE play important roles as the driver of the economy • SME competitiveness and performance were enhanced significantly • Vietnam remain the recipient of large inflow of FDI and remittances in the near future • Capital account has not been fully liberalized • Appropriate macro-policies are being applied, promising a favorable outcome.
Policy recommendation? • Reducing the dependence of East Asian currencies on US dollar (in the context of dollar volatality): CMI Multilateralization, Asian Currency Cooperation • Enhancing intra- trade flows in East Asia, reducing the impact of the slowdown in US demand on EA exports • Finding new channels to help enterprises to cope with the current drying-up of liquidity • Improving financing supervision capability (legal framework, organizational arrangement skills and coordination) as well as risk pricing capacity
