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The Global Financial Crisis and Asia-Pacific

The Global Financial Crisis and Asia-Pacific Anwar Nasution The origin of the crisis

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The Global Financial Crisis and Asia-Pacific

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  1. The Global Financial Crisis and Asia-Pacific Anwar Nasution

  2. The origin of the crisis • The current sub-prime mortgage debacle originated in the U.S. and erupted in the summer of 2007. Similarly to the Asian crisis of 1997-98, it was precipitated by a crisis of confidence among short-term creditors that caused them to withdraw funds from the shadow banking system; • The shadow banking system includes finance companies, hedge funds and investment banks that buy mortgages and loan from banks as well as other corporate bonds and assets, repackage and sell them in sophisticated but arcane ways to financial investors around the world; • The credit crunch in the U.S, financial market spread quickly around the globe. Short-term credit markets froze and inter-bank money markets of many countries were disrupted as banks stopped lending to each other; • The crisis has in fact strengthened the position of the U.S. as the global financial superpower. This has been due to the fact that, in the process of flight to safety, investors have been shifting their portfolios to the U.S. dollar and government commercial papers. As interest rates are now close to zero, the U.S. Government actually gets paid for borrowing money. 2

  3. Impacts of the global crisis on Asia-Pacific economies • The negative effects of the global economic crisis filtered into the export-oriented Asia-Pacific through the current and capital accounts of the balance of payments: • lower exports due to both: (i) falling foreign demand for this region’s exports; and (ii) falling commodity prices; • decrease in the number of incoming tourists; • reduction of remittances from citizens working overseas; • pulling of funds back to banks’ head offices in the U.S. and Europe choking off capital inflow to this region. 3

  4. Economic contraction and slow growth • The Asia-Pacific has neither (i) sufficiently robust domestic demand; nor (ii) large intra-regional trade to offset the impact of falling exports to their main markets in the U.S. and Europe. Emerging economies are suffering from a double blow as their growth is also driven by foreign capital inflows; • The economies of Japan, Australia and ANIEs are predicted to shrink in 2009. Emerging economies are predicted to grow at a lower than the minimum rates that require to absorb new entrants to the labor force. 4

  5. Relatively healthy banks in Asia-Pacific • The banking system is the core of financial industry in the Asia-Pacific, while the shadow banking system in this region is still in the early stage of development; • The banking systems of this region have been relatively sound, better capitalized and better supervised after the crisis in 1997; • Banks in this region have a high deposit to output ratio and are not big buyers of U.S. asset backed securities; • The central banks in this region have been accumulating foreign reserves. Along with low interest rate and deposit guarantee, all of these provide buffer for the banks; • Potential problems may arise from two sources, namely: (i) falling external demand for the production of their corporate customers and falling commodity prices; (ii) increasing external debt burden due to the depreciation of their domestic currencies. This problem is particularly facing by those banks with large foreign debt to finance domestic credit. 5

  6. Policy responses to overcome the crisis This region has adopted four policy responses to overcome the global crisis: • Easing the adverse effects of the global credit crunch by stabilizing the financial systems, restoring the flow of credit and lowering interest rates. As traditional monetary policy has proved to be less effective, the central bank of Japan is now switching to monetary easing by buying government securities and corporate bonds to flood households and companies with cash. It is expected that some of this will be spent to boost aggregate demand; • Seeking extra financial resources for meeting liquidity in foreign currencies. Japan, Australia, New Zealand, Korea and Singapore have secured currency swap arrangements with the U.S. Federal Reserve Bank. Other countries have received resources from ADB, bilateral swap arrangements under the Chiang Mai Initiatives, and other arrangements; • Introducing massive fiscal stimulus for the expansion of aggregate demand and restoring economic growth; • Gradually replacing the export-oriented growth strategy by tapping large potential domestic markets; 6

  7. Strengthening the Financial System Like in other countries, the authorities in this region address the liquidity and solvency problems of their financial systems by: • Banning short selling of shares of financial institutions and their clients; • Reserving public funds to capitalize banks as precautionary measure in case they need them. Aside from failures of minor banks in Indonesia and the Philippines, there has been no big bank bail out in this region; • Removing assets from banks’ balance sheets in the cases of Japan and Korea; • Restoring trust to banks by broadening the coverage and increasing the size of banks’ liabilities insured by deposit insurance companies; • Providing guarantees, as in the cases of Australia and Korea, for foreign borrowings of their private sector to avoid disruption of foreign trade and investment. 7

  8. Fiscal Policy • Countries with strong fiscal position, low debt levels and huge external reserves can afford to introduce large fiscal stimulus. The countries with large fiscal stimulus include China, Japan, Australia and Singapore. Singapore and Japan have partly financed the stimulus packages by withdrawing from their fast external reserves; • To magnify the impacts on aggregate demand and improve income distribution, all countries in this region are paying attention to the structure and timing of the fiscal stimuli; • The impacts of tax cut on aggregate demand are much higher in countries with good tax administration, while they are ineffective in countries with weak tax administration and rampant tax evasion and avoidance. 8

  9. Recommendations for regional policy coordination • Coordinate sporadic national programs for mutual benefit; • Ward off both trade and financial mercantilism that would deepen the recession. The signing of Asean-Australia-New Zealand Free Trade Agreement at the 14th Asean Summit on February 27 in Hua Hin, Thailand, is encouraging; • The huge foreign exchange reserves of this region are unevenly distributed. To facilitate regional trade and investment, the bilateral swap arrangements under the Chiang Mai Initiatives should be expanded. More financial resources should be made available to the countries in need, either through ADB or bilateral arrangements. Part of the financial resources should be used to build modern infrastructure that is so badly needed for future growth in this region. 9

  10. Recommendations …………. • The present global crisis requires global solutions. For its own interests, this region should work hand in hand with other regions to promote global economic growth, to resist protectionism and not to disrupt the stability of the U.S. dollar; • This region should also encourage the reform of international financial architecture to pursue four objectives. First, to increase resources made available for the financing of world economic growth. Second, to rationalize the principles for using IMF and World Bank financial resources. Third, to rationalize the selection process of the top management of these two institutions. Fourth, to reallocate their quota according to their current economic strength 10

  11. Recommendations …………… • The financial resources for promoting global economic growth can be enlarged by increasing quotas of both the IMF and the World Bank, and by one time allocation of Special Drawing Rights (SDR) of the IMF; • The principles to borrow from the Bretton Woods institutions can be rationalized by relaxing the conditionality for countries facing difficulties mainly due to external shocks, and not as a result of bad economic policies; • The selection process of the top management of the IMF and the World Bank can be rationalized by ending the present exclusive reservation of the World Bank President Director to an American and the IMF Managing Director to a European; • Given their economic strength, the quota and role of the Asia-Pacific region should be increased in the management of the twin multilateral financial institutions. 11

  12. Source: Financial Times, Friday, April 3, 2009, page 4. 12

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