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Info Service on Finance and Development (May08/04) ASIAN COUNTRIES WARNED ABOUT EFFECTS OF GLOBAL FINANCIAL TURMOIL Asian developing countries should be able to 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 significantly contributed by excessive inflows of foreign capital. This
was a central message in a talk at the UN Economic and Social Commission
for Asia and the Pacific (ESCAP) ministerial session in Below report on the ESCAP meeting. It was published in SUNS # 6467, Monday, 5 May 2008. This article is reproduced here with the permission of the SUNS. Reproduction or recirculation requires permission of SUNS (sunstwn@bluewin.ch). With
best wishes Asian
Countries Warned About Effects of Global Financial Turmoil Asian developing countries should be able to 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 significantly contributed by excessive inflows of foreign capital. This
was a central message in a talk at the UN Economic and Social Commission
for Asia and the Pacific (ESCAP) ministerial session 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 policy makers in the Asia-Pacific region to understand the global financial crisis and to prepare to manage its effects on the region’s developing countries. The lunch-time event was the first step for ESCAP to deal with the issue. Replying
to a question, Akyuz (who was formerly Director of the Globalisation
and Development Strategies Division of UNCTAD), said no one knows how
exactly the current The
initial prediction was that it would be only a hiccup, said Akyuz, while
now it is widely believed the The
American consumers will not continue to spend their way as the basis
of global growth as they have done in the past years. Instead, the 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. Earlier, he had said that 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 to the 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. To a question on the management of foreign exchange reserves, 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 termed the first type of contribution to the reserves as “earned reserves” and the second type as “borrowed reserves.” At the start of the session, Akyuz presented his paper, “The current global financial turmoil and Asian developing countries,” which was recently published by ESCAP. The
paper 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. The global credit crunch threatens to reverse this process. 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 (avoiding unsustainable currency appreciations and payments positions) and the fourth (by accumulating more than adequate foreign reserves to counter potential external shocks without recourse to international financial institutions). 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 also poses dilemmas in macroeconomic policy. As a result, 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 capital flows
to emerging markets (including all developing country regions and also
those in There
have been three types of footloose capital motivated by speculative
gains into Asia: capital attracted by the carry trade, capital inflows
seeking to gain from prospective currency appreciation especially in
The
inflows have led to credit, asset and investment bubbles, said Akyuz.
His paper revealed that 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 US$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 the “carry cost” (of the borrowed reserves) to the region is US$50 billion a year. This is how much the region could save per year by paying up its external debt by drawing on reserves. (The amount in region’s borrowed reserves is about the same as the amount of foreign debt of the region). Also, countries with a large stock of US dollar reserves stand to incur considerable losses with the downward pressure on the dollar. Akyuz
concluded that many Asian countries are incurring large reserve costs
and facing macroeconomic policy dilemmas mainly because they choose
to keep their economies open to the surge in capital inflows rather
than imposing tighter control measures. In fact the paper showed that
capital accounts in Looking
at the possible effects of the financial turmoil on Asia, Akyuz said
that the IMF recently lowered its projection of economic growth in 2008
for the The
UN had also made projections based on different scenarios. In its “pessimistic
scenario”, the 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 securitised 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, if 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. In China, especially, there should be a shift from reliance on exports to expanding the domestic market through increases in consumer spending as the growth of consumption has lagged behind investment and export growth, and the share of consumption in GDP is very low, at only 40%. 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. During
question time, the Finance Minister of Another
participant said there is a belief that Asia would not be affected by
the crisis because of the existence of growth locomotives in Another participant said that the management of foreign reserves by the governments is a difficult and sensitive issue. There is too much reliance by Asian countries to have their reserve assets in US securities. An alternative is to place Asian countries’ foreign reserves in Asian-based assets such as through developing a regional bond market.
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