TWN Info Service on Finance and Development (May08/04)
8 May 2008
Third World Network


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 Bangkok by Dr Yilmaz Akyuz, a former UNCTAD director and a leading authority on the global economy.

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 (

With best wishes
Martin Khor

Asian Countries Warned About Effects of Global Financial Turmoil
By Martin Khor, Bangkok, 30 April 2008

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 Bangkok by Dr Yilmaz Akyuz, a former UNCTAD director and a leading authority on the global economy.

Akyuz was presenting a paper on the effects of the global financial turmoil on Asia and the possible policy responses open to Asian developing countries to offset these effects. The presentation was made on 29 April at a lunch-time session for Ministers and delegation heads attending the annual ESCAP session.

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 US economic situation would evolve.

The initial prediction was that it would be only a hiccup, said Akyuz, while now it is widely believed the US is already in a recession. “My hunch is the US will not have a deep recession and quick recovery, but a Japan-type situation of erratic and slow growth, over a longer period.”

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 US economy will go through a long period of adjustment, predicted Akyuz.

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 US market, Akyuz said Asian countries could implement counter-cyclical economic policies, as it had done during the 2001 global slowdown.

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 US and to other countries that will be also be affected by the crisis.

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 US and Japan, accompanied by speculative lending and a bubble in property markets, which sowed the seeds of current difficulties.

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 Europe) soared from about US$100 billion at the beginning of the millennium to US$620 billion in 2007. The inflows to Asian developing countries were US$220 billion in 2005, US$260 billion in 2006 and US$208 billion in 2007.

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 China, and investment in asset markets. Of private capital inflows to Asia, about 60% have been in equity investment, a quarter in international bank lending and the remainder are other debt flows including bonds and carry-trade related loans and investments.

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 China, India, Korea, Singapore, Vietnam. The surge in capital flows contributed to the rapid expansion in liquidity and to the bubbles.

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 Asia are more open today than during the Asian crisis.

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 US by 1.3 percentage points while the projected growth of Asian developing countries was 0.5 points lower than the previous estimate.

The UN had also made projections based on different scenarios. In its “pessimistic scenario”, the US would go into recession, while the growth rate for Asia in 2008 would more than halve.

Akyuz’s paper analysed the possible effects of the global financial turmoil on Asia through the finance and the trade mechanisms.

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 US economy, and thus they would not be significantly affected by a slowdown in the US market.

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 China’s exports to the US are affected, other developing countries in Asia that export to China would be affected. For example, China’s imports of intermediate goods (that go into making its exports) from other Asian developing countries would be reduced.

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 China and India.

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 Asia the spillover effects of the global financial turmoil will be felt when the region is facing fragility and imbalances arising from recent trade and financial policies, including credit, asset and investment bubbles and excessive reliance on foreign markets.

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 Bangladesh said that the sub-prime crisis may affect different countries differently. In his view, Bangladesh would not be affected very much. He added that there was a difference between the last Asian crisis and the present situation, as the 1997 crisis was caused by large inflows of private capital and its sudden withdrawal. Now many Asian countries had large reserves. The crisis taught Asian countries the need to build up defences, and that is what the countries have done. Unless the US recession is very deep, Asia can adapt to the crisis.

Another participant said there is a belief that Asia would not be affected by the crisis because of the existence of growth locomotives in India and China within the region. However, the region is heavily dependent on the US market.

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.