How volatile capital flows and increasing credit could lead to another Crisis in Asia
We have seen since the global financial crisis that there has been a surge in capital from the developed world to the developing world. As returns rates are lower in the developed world due to expanding monetary policy, more opportunity for higher investment is overseas. This increase in liquidity to the emerging Asian market has several implications if not managed could have drastic consequences.
As the Asian market is experiencing rapid domestic growth, higher international credit flows into the region tends to hamper the ability of policy makers to constrain credit, especially if most of the credit is extended from foreign institutions.
This has concerns as if local firms and households shift from domestic currency liabilities to avoid possible monetary tightening; it could negate the ability of domestic monetary policy makers. This in turn exposes domestic firms and households to currency risk. (Avdjiev, McCauley, & McGuire, 2012). This is a concern as this can affect the exchange rate as borrowers exchange foreign for domestic currency for the purpose of purchasing domestic goods affecting the trade balance of Asian economies.
If we look at the impact of the western worlds monetary policy on Asia, the imminent reduction of quantitative easing in the US could lead to a retraction of investment. This could seriously lead to a deterioration of growth and a problem of paying short-term debt. The Asian Development Bank said, “The region’s ratio of short-term debt to total external debt is almost 65%, much higher than other emerging regions, where the corresponding figure is generally below 50%” (Ponnudurai, 2013). This outflow could serious affect the ability of Asia to pay its bills in the short term as in a crisis; short-term debt is the first to be pulled making it a major source of vulnerability for the future.
If we look to the similarities of Credit to GDP growth in Asia pre the 1997 Asian financial crisis we see a similar pattern to the rise in credit growth presently. Although it is hard to say what factors constitute a financial bubble and in turn a crash, the evidence suggests a lack of supervision in regards to credit and capital inflow.
As another Asian Financial Crisis now would have horrific consequences for the world economy. By June of last year Asia’s credit had climbed to 104% while the US credit growth decreased to 62% (Breereton- Fukui, 2012). Although this was partly borne from the government led stimulus in the region as the co-head of Asian economic research at HSBC, Frederic Neumann said "I believe we are at the beginning of a major debt cycle in Asia. We are certainly seeing the early symptoms of a debt bubble emerging” (Breereton- Fukui, 2012).
This has an effect in the long term for the health of the economy as shown in the recent Global Financial Crisis as economies where more credit was dominated in foreign currency at the onset of the crisis also suffered larger reductions in credit and suffered larger contractions in output during the crisis (Avdjiev, McCauley, & McGuire, 2012).
Even if most of Asia appears robust with respect to indicators that have historically signalled balance of payments crises à la 1997, the region is still vulnerable to a tightening in financial conditions prompted by higher global interest rates and capital outflows (Ponnudurai, 2013). Because growth has been in large part driven by an increase in debt in recent years, financial stress will inevitably weigh on the pace of economic expansion in most of the region. In short, Asia faces a growth problem, not a classic balance of payments crisis.