Asia has power to shield itself from eurozone fallout
Europe’s debt crisis has created some unlikely bedfellows. At the G20 summit in June, non-European countries rich and poor, East and West, spoke with rare unity in rebuking their European counterparts: Your crisis, they said, is dragging us down.
|Sanjay Mathur, RBS Chief economist, non-Japan Asia|
The threat of an imploding euro area dominated discussion in Mexico; but beyond imploring European leaders to act, what more can Asian countries do?
‘Not much’ was the unwelcome message to Asia’s export dynamos, who face a prolonged downturn in their most important market. But despite their apparent impotence, policymakers from Beijing to Bangkok have an important role to play in ensuring that any pullback from Asia by retrenching European banks does not choke off credit to the region and cause even more damage. The Lehman crisis in 2008-09 showed how vulnerable Asia was to foreign bank deleveraging, wherever the crisis had its roots. Between June and December 2008, foreign bank lending to the region fell by USD220 billion. We need no reminder of the damage that did to Asia’s asset markets. This time around, the drawback has been orderly...so far. The most recent data shows eurozone banks cut their exposure by around USD40 billion in the final quarter of last year in an effort to reduce risk and meet EU demands for stronger capital buffers.
The danger is that a serious escalation of the eurozone crisis, for example a Greek exit or a full-blown banking crisis in Spain, could trigger a far more rapid reduction in European bank exposure to Asia.
Asia faces several threats. European lenders provide up to a third of the region’s trade and project finance, highly specialised lending that is not easily replaced. A sudden retreat by European banks would probably prompt other foreign lenders and local banks to draw in their horns. One facet of the Lehman crisis was how contagious deleveraging became, from the 2012 biggest global banks through to the smallest local deposit holder. The IMF estimates that for every US dollar a foreign bank cut in lending during the crisis, domestic banks reduced their liabilities by 70 cents.
Asian stock markets would also be vulnerable to a bout of severe risk aversion. During the Lehman crisis, the drop in the stock of Asian-based portfolio capital was equivalent to almost 7 per cent of the region’s GDP. The primary international centres – Hong Kong and Singapore – are most vulnerable to such a re-run, but so too are the likes of South Korea, India and Indonesia, which are home to substantial foreign holdings.
Nevertheless, Treasury officials and central bankers in most of Asia should feel confident that, in planning for the worst, they have a formidable toolkit. Already loose monetary policy may have diminished some central bank firepower but public and private balance sheets are strong.
Asian central banks have over USD5 trillion of foreign currency reserves at their disposal should they need to stabilise the financial sector by supplying local or foreign currency. That should go a long way to ensuring markets have enough liquidity, especially when these reserves can be bolstered by other regional defences such as ASEAN’S “Chiang Mai” reserve pool, which is poised to double in size to USD240 billion. Swap lines with the US Federal Reserve could be an important source of liquidity for those suffering an acute dollar shortage. They proved important for Hong Kong, South Korea and Singapore during the Lehman crisis and could be again for more vulnerable countries such as India or Korea.
Will they be called upon, though? They carry a stigma acquired during the 1997-98 financial crisis but, 15 years on, policymakers need to change their mindset and be more willing to use these lines.
Asia’s banks are generally in good shape – well capitalised and not weighed down by sizeable bad debts. Those facing a liquidity squeeze should be able to call on the deep pockets of the region’s central banks. There is significant latitude for central banks in countries such as India, Indonesia, Korea and Malaysia to encourage lending by relaxing reserve requirements. China’s first interest rate cut since 2008 shows Beijing is worried that a slowdown abroad is affecting its domestic economy. China and other Asian economies will need to think up more stimulus measures to invigorate home markets and offset falling trade with Europe. Eurozone imports from Asia are already down 9.6 per cent from their September 2011 peak, a trend not helped by the weak euro.
Recent data showing an easing of Asia’s trade surplus suggests that it has made some progress in boosting domestic demand; but it must do more. Mature economies like Taiwan and Korea should consider tax cuts or more generous welfare. Malaysia and the Philippines have scope to fast-track infrastructure projects worth a cumulative USD600 billion. In China there is scope to boost farm spending, build more social housing and encourage consumer spending. The bad news is that it will still take the best part of a decade for Asia to plug the shortfall in exports caused by a slump in European spending. In the meantime, Asia needs to be ready to use its financial firepower to ease the pain.
The contents of this document are indicative and are subject to change without notice. This document is intended for your sole use on the basis that before entering into this, and/or any related transaction, you will ensure that you fully understand the potential risks and return of this, and/or any related transaction and determine it is appropriate for you given your objectives, experience, financial and operational resources, and other relevant circumstances. You should consult with such advisers as you deem necessary to assist you in making these determinations. The Royal Bank of Scotland plc (“RBS”) will not act and has not acted as your legal, tax, regulatory, accounting or investment adviser or owe any fiduciary duties to you in connection with this, and/or any related transaction and no reliance may be placed on RBS for investment advice or recommendations of any sort. RBS makes no representations or warranties with respect to the information and disclaims all liability for any use you or your advisers make of the contents of this document. However this shall not restrict, exclude or limit any duty or liability to any person under any applicable laws or regulations of any jurisdiction which may not lawfully be disclaimed.
Where the document is connected to Over The Counter (“OTC”) financial instruments you should be aware that OTC derivatives (“OTC Derivatives”) can provide significant benefits but may also involve a variety of significant risks. All OTC Derivatives involve risks which include (inter-alia) the risk of adverse or unanticipated market, financial or political developments, risks relating to the counterparty, liquidity risk and other risks of a complex character. In the event that such risks arise, substantial costs and/or losses may be incurred and operational risks may arise in the event that appropriate internal systems and controls are not in place to manage such risks. Therefore you should also determine whether the OTC transaction is appropriate for you given your objectives, experience, financial and operational resources, and other relevant circumstances.
RBS and its affiliates, connected companies, employees or clients may have an interest in financial instruments of the type described in this document and/or in related financial instruments. Such interest may include dealing in, trading, holding, or acting as market-makers in such instruments and may include providing banking, credit and other financial services to any company or issuer of securities or financial instruments referred to herein.
RBS is authorised and regulated in the UK by the Financial Services Authority, in Hong Kong by the Hong Kong Monetary Authority, in Singapore by the Monetary Authority of Singapore, in Japan by the Financial Services Agency of Japan, in Australia by the Australian Securities and Investments Commission and the Australian Prudential Regulation Authority ABN 30 101 464 528 (AFS Licence No. 241114) and in the US, by the New York State Banking Department and the Federal Reserve Board. The financial instruments described in this document are made in compliance with an applicable exemption from the registration requirements of the US Securities Act of 1933. In the United States, securities activities are undertaken by RBS Securities Inc., which is a FINRA/SIPC member and subsidiary of The Royal Bank of Scotland Group plc.
The Royal Bank of Scotland plc. Registered in Scotland No. 90312. Registered Office: 36 St Andrew Square, Edinburgh EH2 2YB.