Is Asia Prepared For The Next Crisis?
In years past, they were the kinds of seismic shifts that forebode big trouble from Bangkok to São Paulo. Huge spikes in oil prices. The U.S. Federal Reserve preparing to hike interest rates for the third time in four months. Big swings in the value of the dollar against the euro and the yen. Whenever financial tremors start rumbling through the global economy, they tend to rock vulnerable developing nations the hardest.
But do an eagle-eye survey of emerging markets these days, and the scene is curiously tranquil. In fact, much of the developing world, and especially Asia, is in its best financial shape in memory. Former crisis spots like Thailand, Malaysia, Russia, and India are posting healthy economic growth, pushing out surging exports, and accumulating mountains of foreign reserves. And a surprising number of emerging markets boast sound budgets and healthier banks. With important exceptions, such as Venezuela, Argentina, and Ecuador, even most of Latin America sports decent budget and current-account numbers. "You are seeing some of the best fiscal and monetary policies in emerging markets in a long time," says Mohamed A. El-Erian, manager of PIMCO's $15 billion emerging-market bond portfolio.
When the captains of global finance gather in Washington on Oct. 1 for the annual meetings of the International Monetary Fund, World Bank, and G-7 industrial nations, the risk of a crisis in emerging-market debt will not be at the top of their minds. Instead, the bigger worries these days are how to stimulate more growth in Europe and what to do about America's huge balance-of-payments and fiscal deficits, which are approaching a combined $1 trillion.
Developing nations, meanwhile, have become the darlings of the investment community. They are on track to raise some $80 billion in fresh debt financing this year, up 20% since 2003 and twice 2002 levels, according to the Bank for International Settlements. What's more remarkable is that perceived credit risk in emerging markets has not been rising -- but diminishing. The spread between U.S. Treasuries and sovereign debt tracked by JPMorgan EMBI Global (JPM ), which tracks bonds in 31 developing economies, has narrowed slightly over the past year -- to around 415 basis points. Mexico paid just 170 basis points over the London Interbank Offer Rate (LIBOR) in January for a 5-year, $1 billion bond it floated to refinance older debt. That was Mexico's lowest-ever spread against LIBOR. The spread of Mexican bonds against U.S. Treasuries has fallen to 146 basis points from 265 last year.
The Philippines also illustrates investors' greater tolerance for risk. On Aug. 23, President Gloria Macapagal Arroyo declared her country was "in the midst of a financial crisis," with more than one quarter of the government budget going to service $60 billion in foreign debt, which is equal to 135% of gross domestic product. Yet just two weeks later, investors snapped up Manila's $1 billion bond to bail out its money-losing, state-owned National Power Co.
A whole host of factors is behind the resurgence of emerging markets. Strong growth in the U.S., the world's biggest consumer market, is the most important. But so is the powerful rise of China, which clocked 9% growth in the first half and now ranks as the world's third-biggest importer. China is the economic engine of East Asia, where 40% of exports now stay within the region, while the U.S. absorbs only 20%. China has almost single-handedly sparked a global commodity price boom that has been a godsend to resource rich regions like Latin America. Brazil, a producer of iron ore, steel, and soybeans, has seen its exports swell over the past two years, helping the government balance the budget and keep the volatile real stable. Copper exporters Peru and Chile have also benefited. The China-influenced commodity boom has allowed Brazil to refinance its debt with foreign exchange earnings. On Sept. 9, Moody's Investors Service (MCO ) nudged up Brazil's credit rating from B2 to B1, four notches closer to investment grade.
In Asia, economies are becoming far less dependent on exports and dollar fluctuations. The Asian Development Bank estimates that the surplus in Asia's current accounts -- a measure of trade in goods and services -- will fall to 2.8% of GDP this year, down from 4.6% in 1998. But the ADB is predicting 7% growth for the region this year, as domestic demand compensates for any slowdown in exports. "We have witnessed a period of synchronized growth in Asia," notes ADB economist Pradumna B. Rana, who says the region's global economic environment "hasn't been this good in three decades."
Huge strides have been taken in cleaning up Asia's sick banking systems, though Beijing still needs to do more. Commercial banks in South Korea, Indonesia, Malaysia, and Thailand, hit hard by the 1997 financial crisis, now all boast capital adequacy ratios well above the 8% mandated by the Bank for International Settlements. Stronger banks mean more consumer lending for Asia's burgeoning middle class.
One of the developing world's bulwarks against instability is its healthy pot of foreign reserves. Asia's central banks have amassed some $2 trillion in foreign currency reserves, led by Japan's $819 billion. China is sitting on $470 billion, which is growing at $10 billion to $15 billion a month. Even India, which in 1991 was flat broke, has $117 billion. Many countries had impressive reserves before the 1997 crisis. But they also had fixed-exchange rates and their companies had massive short-term debts in U.S. dollars. When Asian currencies came under attack and crashed, making their debt service more expensive, much of Asia's corporate sector faced insolvency. Now, most emerging markets in Asia and elsewhere have flexible exchange rates that rise and fall more gradually. And their corporations are raising more capital in local markets, making them less vulnerable to currency risk.
Out from Under
That's been a boost to Asia's booming market for the securitization of commercial and government debt. Standard & Poor's estimates Asian securitization volumes total $46 billion annually, most of it in local currency. Banks and companies in South Korea, Thailand, Malaysia, Taiwan, and other countries are bundling up credit-card receipts, commercial and residential mortgage payments, and even future airline ticket revenues and reselling them to investors. Hong Kong joined the parade in May, raising $770 million by securitizing future bridge and tunnel tolls. The trend strengthens banks' balance sheets, frees capital for more lucrative business, and spreads risk. "If Asian banks can sell their mortgages, there is less chance that entire institutions will collapse if something bad happens," says Standard & Poor's (MHP ) sovereign analyst Joydeep Mukherji.
Asian banks have also gotten out from under the bad loan mess that lingered for years after the 1997 crisis. Asset management companies set up by governments in Indonesia, Korea, Malaysia and Thailand have mopped up the worst bad loans, unburdening banks by pulling the plug on deadbeat borrowers. Korea Asset Management Corp. alone has assumed at least $90 billion in dud assets since 2000, and has worked out 63% of them. As a result, Korea's nonperforming loans have fallen from $53 billion, or 12.9% of all lending, in 1999, to just $15.6 billion, or 2.5% of lending, as of June. Foreign investment banks have played a big role as well. In July, for instance, the Bank of the Philippine Islands sold $150 million in bad loans to Morgan Stanley (MWD ).
Thailand is perhaps making the best use of domestic capital markets. In 1999, when the nation was still recovering from its currency and debt crash, Kasikorn Bank (formerly Thai Farmers Bank) paid 11% when it raised $1.08 billion from a hybrid 5-year domestic bond issue. But last year, Kasikorn, now regarded as one of Thailand's best-managed banks, redeemed those bonds after it was able to raise $309 million in new bonds, paying 3.75% in the first five years and 4.25% for the next five. Corporate blue-chip Siam Cement PLC, meanwhile, paid as little as 3.25% for $310 million in bonds floated last year. "The tide has turned, banks are now able to get great rates compared to their desperate situation in 1999," says Andrew Stotz, head of research at Macquarie Securities (Thailand) Ltd.
Indonesia, once a regional basket case, has also made great strides in cleaning up its bank and corporate sector, which are beginning to attract foreign suitors again. Later this month, the government plans to sell off Bank Permata, the country's sixth largest, for an estimated $400 million. There are 10 bidders. Yet Indonesian reform has only gone so far. An example: Indonesia's fiscal deficit, which has fallen from a high of 3% of the GDP in 2001 to 1.3% this year, may balloon again because of fuel subsidies the government pays to oil companies to keep retail kerosene prices low. "If oil prices remain high and fuel subsidies are not cut, Indonesia's fiscal position could become significantly worse," says Cliff Tan, Southeast Asian economist at Citigroup in Singapore.
Oil near $50 per barrel is just one of the fault lines lurking inside the world economy that could send developing nations into a tailspin. Another is an overheated Chinese economy that runs off the rails. Beijing is under intense international pressure to widen its trading band on the yuan, which is fixed at 7.8 to the dollar and helps fuel high-speed growth by keeping exports cheap. "China is important not just because of its bilateral surplus but because other countries are keying their currency policies on China," says Goldman Sachs Vice-Chairman Robert D. Hormats. "In a way, you have a renminbi zone in Asia."
Currency intervention by China and other Asian nations makes it even harder for the U.S. to close an enormous current account deficit that is expected to pass $550 billion this year. America is luring only enough foreign investment to cover two-fifths of the deficit. So it must borrow the rest overseas -- to the tune of $1.5 billion a day. On Sept. 14, the Commerce Department reported that the current account deficit widened to $166.2 billion in the latest quarter, up from $147.2 billion in the first quarter and a record 5.7 % of GDP. "The major source of systemic risk to the global economy is no longer emerging markets," says PIMCO's El-Erian. "Something has to be done about the U.S. deficit."
Fortunately, other nations continue to recycle their export earnings and capital flows back into the U.S. But this game can't go on forever. If America keeps digging a bigger balance-of-payments hole, the chances of a dollar crash rise as foreign investors view Treasuries as a huge credit risk. Or, the Fed could impose punishingly high rates to boost domestic savings and keep the overseas crowd in the game. Either way, the U.S. economy would get whacked and depress global growth. Some critics say Europe and Japan share the blame because their mature economies are growing too slowly to import much from the U.S. But C. Fred Bergsten, director of the Institute for International Economics in Washington, thinks the U.S. and the IMF also need to push harder on China and other Asian nations to let their currencies rise against the greenback. "If the Asians don't move, we will head to a dollar crash," he says.
With any luck, it won't come to that. The dollar already has fallen 28% vs. the euro since the start of 2002 with little damage to the global system. Some analysts, such as Nick Bennenbroek, chief currency economist with Brown Brothers Harriman & Co. in New York, think the dollar will resume its orderly decline later this year. Yet even optimists concede the day is approaching when foreign central banks will look for ways to diversify their export earnings beyond Treasuries, such as by buying more euros or setting up regional reserve funds. Asian monetary authorities, for example, are looking for ways to expand a $36 billion fund set up in 2003 to fight speculative attacks on their currencies.
Emerging markets in Asia and elsewhere have made impressive strides to safeguard themselves from the next financial panic. But as they keep hoarding dollars and manipulating their currencies, it's time they pay more heed to whether their policies are healthy for the global system -- or are instead sowing the seeds for the next nasty storm.
By Brian Bremner in Tokyo and Pete Engardio in New York, with Frederik Balfour in Hong Kong, Assif Shameen in Kuala Lumpur, and John Moody in Mexico City