Warning signs
Oct 25th 2001
>From The Economist print edition
Asia's slump could once again strain the region's financial system
The economic news from East Asia gets worse by the day. Singapore is
suffering its worst recession for almost 40 years: real GDP fell by 5.6% in
the year to the third quarter. Taiwan, Malaysia, Hong Kong, Thailand and the
Philippines are already in or close to recession. How vulnerable is Asia to
another financial crisis?
In 1997 pegged exchange rates, high foreign-currency borrowing and weak bank
supervision left many Asian financial systems horribly vulnerable to a sharp
fall in exports and capital outflows. Most of the region's economies now have
flexible exchange rates, current-account surpluses, large foreign reserves
and sounder banking systems?all of which suggests that another crisis is
unlikely. But a new report by Sun-Bae Kim at Goldman Sachs in Hong Kong
reaches a more sobering conclusion: not only is Asia suffering a more severe
economic shock than it did before the crisis of 1997-98, but its financial
system is, overall, no stronger than it was then.
One gauge of the size of the economic shock hitting the financial system is
the slowdown in the rate of growth of nominal GDP. This is a proxy for the
capacity of the economy to generate cash flow, from which debts must be
serviced. Most economies have seen a much sharper fall in nominal growth over
the past year than leading up to the 1997 crisis (see chart). In Malaysia,
the year-on-year rate of nominal GDP growth has fallen from 20% in early 2000
to minus 2% in the second quarter of this year.
How bad this cash-flow shock is depends upon the level of private-sector
debt, and upon how many of the outstanding loans are already non-performing.
In East Asia as a whole, private-sector debt is smaller in relation to GDP
than in 1997, but non-performing loans now amount to 15% of GDP, up from 11%
before the 1997 crisis.
If the economic shock is bigger, do financial systems have thicker buffers
than in 1997? They certainly look healthier today on various measures of
liquidity. In 1997 foreign lenders triggered a liquidity crunch by refusing
to roll over loans. Today, the foreign borrowing of the financial system
amounts to 30% of foreign-exchange reserves, down from 70% in 1997.
On various measures of solvency, however, many Asian financial systems look
wobbly. The average capital-adequacy ratio of the banks is slightly lower
than at the end of 1996. Ratios of government debt to GDP are much higher
today than in 1997, leaving governments less able to bail out banking systems
again. Public-sector debt has risen from an average of 28% of GDP at the end
of 1996 to 45% of GDP today.
The worrying conclusion is that although Asia's financial system is less
vulnerable to a sudden liquidity crisis, there is a risk of a deeper, more
drawn-out deflation, exacerbated by domestic debt?similar to that in Japan.
China alone looks better placed than in 1997: the economic shock currently
hitting China is milder than in the lead-up to the previous crisis, when
deflation was more severe. Nor does its financial system look significantly
more exposed (thanks largely to a currency that is only partially
convertible). Goldman Sachs reckons that the most vulnerable financial
systems are in Malaysia, Taiwan, Thailand and Indonesia.