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Asia s Capital Flows: The Tapering Effect-Remember 1997 ?
( From Asean News, FT,Wiki, Reuters. Bestineconomics, Slate, Stockcharts, IMF )
Summary of The Asian financial crisis
The Asian financial crisis was a period of financial crisis that gripped much of Asia beginning in July 1997, and raised fears of a worldwide economic meltdown due to financial contagion. This regional financial crisis started by the Hedge fund manager George Soros by manipulating the Bandwagon effect that intended to attack the weak and unregulated currencies for the capital gain by forcing the currencies to float to appreciate and depreciate to the level of the estimated exchange rates in the international currency market, that crushed the efforts by the buy-in and sell-out of the local currencies of the local governments by those without sound fiscal policy history (fiscal surplus), strained foreign reserve and with lack of rigid financial supervision to defend the attack, ultimately as the result of the series of financial attacks that paralyzed the specific government's continuing fiscal accountability, that led and affected many other economies to national bankruptcies like South Korea .
The crisis started in Thailand with the financial collapse of the Thai baht after the Thai government was forced to float the baht (due to lack of foreign currency to support its fixed exchange rate), cutting its peg to the U.S. dollar, after exhaustive efforts to support it in the face of a severe financial overextension that was in part real estate driven. At the time, Thailand had acquired a burden of foreign debt that made the country effectively bankrupt even before the collapse of its currency. As the crisis spread, most of Southeast Asia and Japan saw slumping currencies, devalued stock markets and other asset prices, and a precipitous rise in private debt.
Indonesia, South Korea and Thailand were the countries most affected by the crisis. Hong Kong, Malaysia, Laos and the Philippines were also hurt by the slump. China, Taiwan, Singapore, Brunei and Vietnam were less affected, although all suffered from a loss of demand and confidence throughout the region.
Foreign debt-to-GDP ratios rose from 100% to 167% in the four large Association of Southeast Asian Nations (ASEAN) economies in 1993–96, then shot up beyond 180% during the worst of the crisis. In South Korea, the ratios rose from 13 to 21% and then as high as 40%, while the other northern newly industrialized countries fared much better. Only in Thailand and South Korea did debt service-to-exports ratios rise.
Although most of the governments of Asia had seemingly sound fiscal policies, the International Monetary Fund (IMF) stepped in to initiate a $40 billion program to stabilize the currencies of South Korea, Thailand, and Indonesia, economies particularly hard hit by the crisis. The efforts to stem a global economic crisis did little to stabilize the domestic situation in Indonesia, however. After 30 years in power, President Suharto was forced to step down on 21 May 1998 in the wake of widespread rioting that followed sharp price increases caused by a drastic devaluation of the rupiah. The effects of the crisis lingered through 1998. In 1998 the Philippines growth dropped to virtually zero. Only Singapore and Taiwan proved relatively insulated from the shock, but both suffered serious hits in passing, the former more so due to its size and geographical location between Malaysia and Indonesia. By 1999, however, analysts saw signs that the economies of Asia were beginning to recover. After the 1997 Asian Financial Crisis, economies in the region are working toward financial stability on financial supervision.
Level of Debt
The ASEAN countries ( Indonesia, Malaysia, the Philippines, Singapore and Thailand, Brunei, Burma (Myanmar), Cambodia, Laos, and Vietnam ) are seeing again a scenario similar to 1997. Debt build up seem again being the solution to keep economic growth rates.
So bank credit to GDP in Asia (excluding Japan) is now running at levels higher than in the 1997-8 Asian financial crisis as shown in the graph below.
More Credit Please
The rising credit intensity in these economies may not be as pronounced as in China ; nonetheless, it is a cause for concern. On average, commercial credit as a proportion of GDP for the region's five largest economies - Indonesia, Malaysia, Singapore, Thailand and the Philippines - is approaching the pre-1997 crisis peak of 75 percent, according to Breakingviews calculations.
According to HSBC’s Frederic Neumann, the reason why the region has managed to bounce back from the most recent crisis and maintain strong growth thereafter, is “explained by its ability to push up leverage and offset lacklustre demand growth from consumers in the West.”
The big decline in reserve growth and surpluses for ASEAN countries coincides with a debt issuance boom to offset the lack of liquidity.
On the face of it external debt levels don’t look like anything to worry about. South Korea for instance has gross external debt at 40 percent of GDP compare that with 140 percent in Hungary or 70 percent in Poland. But gross external debt has risen sharply since 2007, in China it stood at $785 billion by mid 2012, compared with $373 billion in 2007. Indonesia’s has risen to $240 billion from $134 billion and Thailand’s external debt is at $118 billion compared to $74 billion, RBS points out.
And if one were to compare, corporate, financial and household debt, the picture in many countries looks frightening. In China for instance it tops 200 percent of GDP, a consequence of the government’s 4 trillion yuan stimulus in 2009 . And non-financial corporate debt to GDP levels in China and South Korea are higher than in the euro zone and the United States.
Growth Become Debt Dependent
Growth is strong across the region. Thailand's GDP jumped almost 19 percent from a year earlier in the final quarter of 2012. Malaysia and the Philippines saw better-than-expected expansion of 6.4 percent and 6.8 percent in the same period, respectively. Growth in Indonesia has been above 6 percent in five years out of the past six. Singapore is at full employment.
So growth coming from the ASEAN contries are still highly credit dependent. In fact, there are mounting signs of a rising credit intensity of GDP growth in Asia : while lending growth slowed in many Asian markets over the past year, it slowed by less than GDP growth. So it seems that more and more debt is needed to generate one percentage point of GDP growth.
Historically speaking, most EM crises have been borne on the back of excessive capital inflows. And in many Asian countries, the consequence of these flows has been over-easy monetary policy that has left citizens and companies addicted to cheap money. Personal and corporate indebtedness levels have spiralled even higher in the past five years as governments across the continent responded to the 2008 credit crunch by unleashing billions of dollars in stimulus.
So what’s the significance of the rising credit intensity of Asian economic growth – surely it could be considered an accompaniment to greater economic maturity?
So it seems that ASEAN countries also had become debt addicted and that only continuous improvements in productivity can be the cure for that.
Too few investors are aware of the problems that may be piling up. While interest rates remain low the leverage increase continues. With the FED starting to talk about the Tapering and with the Bank of Japan joining the western central banks in aggressive monetary easing, there’s little chance of any early change in the financial climate.
It will be crucial to follow the emerging markets capitals flows and currencies to see if it is a temporary situation or can turn into a flight to liquidity as in 1997. Is is a Perfect Storm in the process ?
Investors have been jittery about the impact that the FED Tapering may have on emerging markets. But the first impact of it have been the rise in real interest rates in the US as we will see the kind of dominos effect on the Emerging Markets.
US Real Rates - a Definition
Real interest rates are simply the nominal headline yields that bond investors earn in “risk-free” US Treasuries less the rate of inflation. Normally real rates are positive, investors earn a nominal return higher than inflation. But sometimes the Fed drives real rates negative, forcing real losses in purchasing power upon bond investors. Inflation erodes their investments faster than nominal yields grow them.
Macro Trading Signal
Real interest rates are a powerful macro trading indicator, but it is important to realize their signals operate at a secular scale. It is a process that can take years to have a reversal in trend. I think we are at the crossroad. Please take a thorough look at the charts below. They speak by themselves. On the chart below, observe the major trend in US real interest rates and the trend in the Emerging High Yield Rates. When US real rates are on the rise,
ML High Yield Emerging Markets Corporate Yield % ( Blue / Left Scale )
US Treasury Constant Maturity 10 years minus US CPI Quarterly Year-Over-Year % ( Red / Right Scale )
In that kind of environment, where the global capital flows tend to be back to the US when real rates are rising, we observe the rise in volatility in Emerging Markets stocks as shown by the chart below...
ML High Yield Emerging Markets Corporate Yield % ( Blue / Left Scale )
CBOE Emerging Markets ETF Volatility Index( Red / Right Scale )
EM Currencies and Stocks
If there is some global capital outflows from emerging markets to the US, it means that portfolio managers are selling EM currencies (we took the CEW ETF for emerging currencies and ASEA ETF for emerging stocks in Asia) to be back in the US Dollar as shown by the chart below...
Wisdom Tree Emerging Currency Fund ETF CEW ( Red / Right Scale )
ASEAN 40 Index ETF ASEA ( Black / Left Scale )
EM Stocks and Bond Flows
So the consequences of the Tapering talk has been very violent in terms of outflows in Emerging Markets (EM) either in equity or bonds as shown by the chart below...
That correction in prices is normal after a very strong performance. But illiquidity of those emerging markets can create a turmoil and that
drip-drip of currency weakness can become a flood and trigger more flows. It is what happened in 1997, what has been called later the Asian Financial Crisis.
But two very crucial factor is different than 1997 for those emerging countries; Japan s Abenomics with a huge devaluation of the Yen and the level of debt is even bigger than in 1997 can create that spill over effect and make the situation even more sensitive.