Several Asian economies are either in or moving toward the crisis danger zone, as Asian economic fundamentals have deteriorated and financial imbalances have bubbled to the surface in recent years, say economists at Nomura, adding fuel to the recent bear market in emerging Asian equities. Since the global financial crisis, which has rattled Asian export markets since 2008, current-account trends have seen dramatic changes while rising debt-to-GDP ratios come as growth slows and fears that tighter Fed policy will reduce capital flows to emerging markets.
According to Nomura, in a report published at the end of last month, on a four-quarter rolling sum basis, the surplus for the Asia 11 (China, Hong Kong, India, Indonesia, Japan, Korea, Malaysia, Philippines, Singapore, Taiwan and Thailand) has narrowed from a peak of $726 billion, or 6.3% of GDP, in the third quarter of 2007 to $327 billion (1.6% of GDP) in the fourth quarter of 2012 – the smallest surplus recorded since the Asian financial crisis in 1997.
Shrinking surpluses are “early warning signs of weakening economic fundamentals, including slowing potential growth, overheating domestic economies and a rapid build-up of debt,” say the economists at Nomura, though on a net basis the deterioration of Asian current accounts is bullish for global economic rebalancing.
Since Asian countries have been running large current-account surpluses for such an extended period of time, economists have been reluctant to accept this new normal of deficits, says Nomura.
As things stand, China, Hong Kong and India are in the high-risk danger zone category and Indonesia is at the lower end of this high-risk zone. Korea, Taiwan and the Philippines are the three exceptions where current-account surpluses have not narrowed and are thus considered the least vulnerable. In fact, Asia's private debt-to-GDP ratio at 167% is higher than in the run-up to the Asian crisis in 1996 at 127%.
Monetary policy has played an important part in the build-up of financial imbalances – and growing domestic consumption – in the region, as can be seen through the juxtaposition of financial and business cycles in countries in Asia, in particular in China.
In China, the financial and business cycles have been out of sync since March 2011 – more than any other Asian country – highlighting how strong credit growth has led to the build-up of financial imbalances as well as rising asset prices in certain economies.
To reach this conclusion, economists at Nomura adapted methodology from the Bank for International Settlements (BIS) to make it relevant to emerging economies in Asia.
According to the BIS, when assessing industrialized countries in the 1960s, it is possible to measure the build-up of risk of financial crises in real time – through the average of the deviations of real domestic credit, domestic credit-to-GDP and real property prices from historic trends – to trend a financial cycle. Indeed, according to BIS, financial cycle peaks are closely associated with financial crises.
From Nomura’s revised method, a typical financial cycle in emerging Asia lasts between 17 and 18 years, compared with five to six years for the standard business cycle. As a result, there are often episodes when Asia's financial cycles and business cycles move out of sync.
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| Source: Nomura |
When financial cycles last longer than the business cycle, this can result in a time inconsistency problem, explains the report. For instance, central banks might focus on a standard economic downturn in the business cycle while ignoring the build-up of the financial cycle. While this can contain recessions in the short term, “it only postpones the day of reckoning at the cost of larger recessions down the road”, says the report. Indeed, at a time when the region needs to diversify growth drivers, Asia’s domestic economic fundamentals continue to be a cause for concern. While domestic consumption, spurred on by the rise of the middle classes in the region, has seen consumption driving growth to a certain extent, insufficient new investments can still result in supply bottlenecks potentially slowing growth, as is the case in India.
However in China, the narrowing current-account surplus comes amid fears over the country’s continued dependency on its debt-fuelled investment boom, and the fact domestic consumption is still failing to pick up the slack in headline nominal GDP terms.
The fear is that, as while Asia has kept rates too low for too long in recent years, tighter global and domestic liquidity conditions will exact a heavy toll on growth at the peak of Asia's credit cycle.
