THE GLOBAL FINANCIAL TURMOIL

1
THE GLOBAL FINANCIAL TURMOIL
AND ITS IMPACT ON EAST ASIA
IIR
Presenter Pham Tuong Van
2
The causes of the current financial turmoil

• Problems in the U.S subprime mortgage market
• Risks in the market for asset-backed commercial
  paper and the credit crunch
• Increasing investors caution and re-assessment
  of the risks associated with assets, creating a
  chasing down spiral
• In some countries, it coincided with the end of
  an overlending/ borrowing period, and
  over-optimism about the economic prospect.
• Developments in U.S subprime were more a trigger
  than a fundamental cause of the financial turmoil
  

3
The scope of the current financial turmoil

• The credit crunch situation in banking sector.
  Significant deterioration in market functioning
• Raising costs of credit access for enterprises,
  negatively affecting investment
• Slump in stock markets world wide, stocks lost
  20 -40 of their peak values
• Big financial institutions experienced serious
  losses or bankrupcity
• Exchange rate volatality and weakening trade
  performance
• Dramatical volatality of oil and gold prices
• High inflation in many countries

4
SE Index world wide
5
Slump in stock markets
Dow Jones Index
FTSE Index
Hangseng Index
Nikkei 225 Index
6
Consequences

• Wanning investor confidence
• A repricing of risky assets and deleveraging by
  investors. Risk asset prices are under downward
  pressure across the developed and emerging world
• Wider payment difficulties with mortgages and
  corporate bankruptcies.
• More aggressive rationing of credit on the part
  of banks, with adverse feedback effects into the
  real economy. Banks under pressure to improve
  their balance sheets force investors to liquidate
  even their good investments to meet margin
  requirements. As this process expands, more
  assets will be sold, triggering further price
  declines in a debt deflation spiral.
• Worst senario systemic financial crisis,
  including bank failures, declining asset prices
  and widespread insolvency problems

7
Forecasting the good, the bad and the ugly

• According to The Economist Intelligence Unit
• Scenario 1 (60 probability) the turmoil will be
  contained by timely monetary policy action, with
  only a modest effect on the global economy.
• Scenario 2 (30 probability) the US falling into
  recession, with substantial fallout in the rest
  of the world.
• Scenario 3 (10 probability) the US could enter
  recession, corrective action fails, and severe
  economic repercussions cascade from the US into
  the world economy with devastating effect.

8
Forecasting the good, the bad and the ugly
9
Implications for East Asia

• On financial and investment aspects
• Deteriorating global financial conditions rising
  uncertainty and risk aversion. Serious downward
  pressure in all regional stock markets.
• Wanning external as well as regional investors
  confidence
• Volatile currency swings, affecting East Asian
  trade performance
• US companies would cut back on investment abroad
  as profit falls and financial conditions tighten.
  Also, the portfolio inflows by foreign
  institutional investors could reverse rapidly in
  the event of a flight to safety.
• Companies in the regions still rely heavily on
  banks and financial markets for funding, both of
  which will be hit by tightening credit. Also,
  profit falls would reduce opportunities for local
  businesses to self-fund investments.

10
Implications for East Asia

• Should it be another Asian 1997 crisis or like
  the Japanese bubble burst in 90-91 and its lost
  decade?
• East Asia now is far better placed to withstand
  financial shock than it was in 1997.

11
East Asian balance of payments 1997 - 2007
Source World Bank data
12
East Asia Non Performing Loan ratios 2002-2007
13
Implications for East Asia
The NPL ratios of East Asian economies have
declined dramatically during the last 5 years
Chinas NPL ratio was just 7.5 at end-2006,
compared with almost 30 in 2001.
China is the largest oversea holder of US
mortgage-backed securities around USD 260
billion, mostly through the central banks
international reserve holdings. Yet, the majority
of China's US mortgage-backed securities were
underwritten by US government agencies (as Fannie
Mae and Freddie Mac), which made them less risky
and allowed them to keep their value.
Unlike before the 1997-98 crisis, many regional
economies now have large foreign reserves,
stronger current-account positions and more
flexible exchange-rate regimes (although in some
cases still heavily managed). Extensive
regulatory reforms and consolidation have
improved the health of the banking sector in a
number of countries. Commercial banks net
foreign asset positions are also generally much
healthier
14
Implications for East Asia
Countries in the region have so far remained
sound macro economic-indicators, thus, direct
impacts of the US financial turbulence on
regional banking system and balance sheets have
been limited up to now.
Yet, a sharp US slowdown could indirectly expose
financial-sector weaknesses that have been hidden
until now as a result of strong economic growth
and buoyant asset prices in the region.
15
Implications for East Asia
On trade aspect

• Weakening demand from the US would hurt East
  Asian trade-dependent economies.
• Most Asian countries still send a substantial
  share (typically 13-20) of their exports to the
  US. Just as importantly, many of the exports that
  Asia sends to China are ultimately destined for
  the US as well, and therefore again dependent on
  US demand.

16
East Asian highly trade-dependent economies
Exports as percentage of GDP
17
Intra trade may help East Asia to decouple from
US economic slowdown?

• The more integrated, the more structurally
  vunerable the region is through the trade
  channel. Intra-Asian trade has surged in recent
  years (accounting for 51 of the total regional
  trade volume), but this largely reflects the
  increasing integration of supply chains across
  Asia.
• East Asian countries tend more to produce inputs
  and intermediate goods and raw materials that are
  exported to China in turn China, given its lower
  labor cost, processes these inputs and assembles
  them into final goods that are exported to the
  US.
• According to the ADB, 70 of trade within Asia
  (excluding Japan) consists of intermediate goods
  used in manufacturing processes, and a large
  share of goods still ultimately end up in rich,
  developed countries.
• East Asia, therefore, would face the prospect not
  only of weaker demand from the US, but also of
  weaker demand from China.

18
Implications for Japan

• Growth in Japan over the last five years averaged
  1.7, of which more than one-third came directly
  from exports. Consequently, a downturn in export
  demand from a languishing US economy will
  undermine the Japanese expansion.
• Japan has limited room for a policy response,
  since short term interest rates are already at
  0.5 and the country boasts the worst fiscal
  position of the developed world.
• Also, Japans prospects will be undermined by a
  sharp appreciation of the yen, as dollar falls
  further.

19
Implications for China

• The implications for China specifically is
  important to the rest of the regional outlook,
  given the huge contribution the country makes to
  regional (and global) growth and the strong
  linkages with the US.
• The more integrated into the global economy, the
  more vunerable the country is to external shocks.
  After its entry to the WTO in 2001, China is now
  more entrenched in global supply chains, thus,
  more vunerable to turmoil in other markets.
• China has its own problem before the turmoil
  break out inflation, overpricing stocks,
  (signals of an overheating economy)
• China holds about 260bn in US mortgage-backed
  securities, largely as part of its reserves and
  stakes in foreign commercial banks.
• Exports of goods and services accounted for
  around 40 of Chinese GDP, double the share a
  decade earlier. Weakening demand from the U.S
  would negatively impact on Chinas growth.

20
Implications for China

• Yet, Chinas economy may be least affected among
  the region for reasons belows
• the majority of China's US mortgage-backed
  securities were underwritten by US government
  agencies, which made them less risky and allowed
  them to keep their value.
• Chinas NPL ratio was just 7.5 at end-2006,
  compared with almost 30 in 2001.
• China has a largely closed financial system
  despite moves under way to ease restrictions on
  outward investment, which help them decoupled
  from the financial contagion
• Historic data shows the correlation between US
  recessions and Chinese economic growth is very
  little
• WB forecast China's economy will grow by 10.8
  this year, down from 11.3 in 2007.

21
Implications for Vietnam

• The more integrated into the world economy, the
  more Vietnams economy affected by the up and
  down in the world economy. Yet, the economy has
  its own issues before the global turmoil break
  out.
• High inflation (2007 12, first quarter of 2008
  15) as the results of various factors
  (over-expanding money supply in the previous
  years, untimely and insufficient monetary policy,
  oil price hike, large capital inflow with weak
  risk management policy)
• Bubble bursting in stock market and adjustment in
  real estate market
• Drying up of liquidity as the consequence of
  tightening monetary policy and rising uncertainty
  (interbank interest rates reached record heigh in
  Feb 2008)
• Increasing trade deficit (gt USD 12 billion)

22
Vietnam Inflation rate
23
Vietnam signs of financial vulnerabilities?
24
Easing risk factors

• Vietnams economic fundamentals remained sound.
• Big SOE play important roles as the driver of the
  economy
• SME competitiveness and performance were enhanced
  significantly
• Vietnam remain the recipient of large inflow of
  FDI and remittances in the near future
• Capital account has not been fully liberalized
• Appropriate macro-policies are being applied,
  promising a favorable outcome.

25
Policy recommendation?

• Reducing the dependence of East Asian currencies
  on US dollar (in the context of dollar
  volatality) CMI Multilateralization, Asian
  Currency Cooperation
• Enhancing intra- trade flows in East Asia,
  reducing the impact of the slowdown in US demand
  on EA exports
• Finding new channels to help enterprises to cope
  with the current drying-up of liquidity
• Improving financing supervision capability (legal
  framework, organizational arrangement skills and
  coordination) as well as risk pricing capacity