The Asian financial crisis – 20 years later




East Asian Economies Remain Diverse

 

It is useful to reflect on whether lessons have been learnt and if the countries are vulnerable to new crises.

IT’S been 20 years since the Asian financial crisis struck in July 1997. Since then, there has been an even bigger global financial crisis, starting in 2008. Will there be another crisis?

The Asian crisis began when speculators brought down the Thai baht. Within months, the currencies of Indonesia, South Korea and Malaysia were also affected. The East Asian Miracle turned into an Asian Financial Nightmare.

Despite the affected countries receiving only praise before the crisis, weaknesses had built up, including current account deficits, low foreign reserves and high external debt.

In particular, the countries had recently liberalised their financial system in line with international advice. This enabled local private companies to freely borrow from abroad, mainly in US dollars. Companies and banks in Korea, Indonesia and Thailand had in each country rapidly accumulated over a hundred billion dollars of external loans. This was the Achilles heel that led their countries to crisis.

These weaknesses made the countries ripe for speculators to bet against their currencies. When the governments used up their reserves in a vain attempt to stem the currency fall, three of the countries ran out of foreign exchange.

They went to the International Monetary Fund (IMF) for bailout loans that carried draconian conditions that worsened their economic situation.

Malaysia was fortunate. It did not seek IMF loans. The foreign reserves had become dangerously low but were just about adequate. If the ringgit had fallen a bit further, the danger line would have been breached.

After a year of self-imposed austerity measures, Malaysia dramatically switched course and introduced a set of unorthodox policies.

These included pegging the ringgit to the dollar, selective capital controls to prevent short-term funds from exiting, lowering interest rates, increasing government spending and rescuing failing companies and banks.

This was the opposite of orthodoxy and the IMF policies. The global establishment predicted the sure collapse of the Malaysian economy.

But surprisingly, the economy recovered even faster and with fewer losses than the other countries. Today, the Malaysian measures are often cited as a successful anti-crisis strategy.

The IMF itself has changed a little. It now includes some capital controls as part of legitimate policy measures.

The Asian countries, vowing never to go to the IMF again, built up strong current account surpluses and foreign reserves to protect against bad years and keep off speculators. The economies recovered, but never back to the spectacular 7% to 10% pre-crisis growth rates.

Then in 2008, the global financial crisis erupted with the United States as its epicentre. The tip of the iceberg was the collapse of Lehman Brothers and the massive loans given out to non-credit-worthy house-buyers.

The underlying cause was the deregulation of US finance and the freedom with which financial institutions could devise all kinds of manipulative schemes and “financial products” to draw in unsuspecting customers. They made billions of dollars but the house of cards came tumbling down.

To fight the crisis, the US, under President Barack Obama, embarked first on expanding government spending and then on financial policies of near-zero interest rates and “quantitative easing”, with the Federal Reserve pumping trillions of dollars into the US banks.

It was hoped the cheap credit would get consumers and businesses to spend and lift the economy. But instead, a significant portion of the trillions went via investors into speculative activities, including abroad to emerging economies.

Europe, on the verge of recession, followed the US with near zero interest rates and large quantitative easing, with limited results.

The US-Europe financial crisis affected Asian countries in a limited way through declines in export growth and commodity prices. The large foreign reserves built up after the Asian crisis, plus the current account surplus situation, acted as buffers against external debt problems and kept speculators at bay.

Just as important, hundreds of billions of funds from the US and Europe poured into Asia yearly in search of higher yields. These massive capital inflows helped to boost Asian countries’ growth, but could cause their own problems.

First, they led to asset bubbles or rapid price increases of houses and the stock markets, and the bubbles may burst when they are over-ripe.

Second, many of the portfolio investors are short-term funds looking for quick profit, and they can be expected to leave when conditions change.

Third, the countries receiving capital inflows become vulnerable to financial volatility and economic instability.

If and when investors pull some or a lot of their money out, there may be price declines, inadequate replenishment of bonds, and a fall in the levels of currency and foreign reserves.

A few countries may face a new financial crisis.

A new vulnerability in many emerging economies is the rapid build-up of external debt in the form of bonds denominated in the local currency.

The Asian crisis two decades ago taught that over-borrowing in foreign currency can create difficulties in debt repayment should the local currency level fall.

To avoid this, many countries sold bonds denominated in the local currency to foreign investors.

However, if the bonds held by foreigners are large in value, the country will still be vulnerable to the effects of a withdrawal.

As an example, almost half of Malaysian government securities, denominated in ringgit, are held by foreigners.

Though the country does not face the risk of having to pay more in ringgit if there is a fall in the local currency, it may have other difficulties if foreigners withdraw their bonds.

What is the state of the world economy, what are the chances of a new financial crisis, and how would the Asian countries like Malaysia fare?

These are big and relevant questions to ponder 20 years after the start of the Asian crisis and nine years after the global crisis.

But we will have to consider them in another article.

By Martin Khor Global Trend

Martin Khor (director@southcentre.org) is executive director of the South Centre. The views expressed here are entirely his own.
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On Mcoin, Bitcoin and points of investment


MCOIN is still very much a talking point, especially in Penang. To the uninitiated, it is the “digital currency” of MBI International, a company involved in a myriad of activities and hogging the limelight for the wrong reasons after being flagged as one of the entities not recognised by Bank Negara.

Since Bank Negara’s warning two weeks ago, the company’s accounts amounting to some RM177mil have been frozen. The cash in question is significantly much more than the previous major scheme that came under probe by Bank Negara and other agencies.

In 2012, the authorities froze RM99.8mil in bank accounts of Genneva Malaysia Sdn Bhd. Also, 126kg of gold were carted away from the office. It has been five years and the investors, most of them ordinary wage earners looking to earn an extra buck from their savings, have yet to receive their money.

One of the reasons is likely that the liabilities of Genneva Malaysia are 10 times more than the assets recovered.

MBI International, which is primarily based in Penang, has a network stretching up to China. According to reports, it has come under pressure from some investors wanting a return of their money.

However, outlets in M Mall in Penang are still accepting Mcoin for the purchase of goods and services. There is no rush to cash out, as one would have expected, considering that the accounts of MBI International have been frozen.

Nonetheless, it is only a matter of time before the value of Mcoin and the ability of MBI International to return money to its investors is put to the test.

Based on previous events that led to companies having their bank accounts seized by the central bank, it would be a long time before the investors are able to retrieve their cash.

There are some who are completely ignorant of the new global order of currencies and money, making comparisons between Mcoin and the rise of cryptocurrencies such as Bitcoin.

If anybody is harbouring any hope that the value of Mcoin would rise just like the phenomenal bull run seen in the world of cryptocurrency, they had better stop dreaming.

There are fundamental differences between instruments such as Mcoin, which in essence is a token to redeem goods at a few outlets, compared to cryptocurrency that is fast gaining traction as an alternative currency around the world.

Mcoin has unlimited supply and its value is controlled by one entity. How the value is derived is not clear.

In contrast, cryptocurrencies such as Bitcoin have a limited supply. And the supply is decentralised – meaning no one entity controls the supply. There is a ledger that tracks all transactions and measures the amount of supply and how much more is available.

The objective of the people behind cryptocurrency is to come up with a currency that is not controlled by central banks. New supply can only come about after hours of a process called `mining’.

The mining process is a complicated one. It involves many hours of programming and utilising high computing skills to predict the next chain in the block of coins. The data used is based on historical transactions and it is said that one block is created every 10 minutes.

Only one successful miner is rewarded with a slice of the cryptocurrency at any one time. He or she can then transact it in an exchange.

The first cryptocurrency is Bitcoin, which began operating in January 2009.

Bitcoin is only one of the hundreds of cryptocurrencies in existence. There are many more new coins coming up, improving on the technology pioneered by Satoshi Nakamoto.

Nobody knows who is Satoshi or if he really exists. However, the legend is that he wanted a currency that is not under the control of central banks, hence the birth of Bitcoin, the first decentralised currency.

The market capitalisation of all cryptocurrency was US$27bil as of April this year – four times more than what the value was in January this year.

Much of the rise is attributed to the volatile US dollar. A few years ago, if anybody had said that cryptocurrency such as Bitcoin would be used to hedge against the US dollar, many would have laughed it off.

Today, however, it is the reality.

The cryptocurrency fever has picked up in China, which has the largest number of “miners” in the world. One reason is said to be because some see it as one way to take capital out of the country.

In India, when the government decided to demonetise the popular 1,000 and 500 rupee notes, there was a 50% increase in the trading of Bitcoin, as people saw it as one way to legalise their black money.

Bitcoin soared past the US$2,500 mark last week, which is a four-fold increase since January this year. There are many other cryptocurrencies, such as Ethereum, that are all seeing a bull run.

The world of cryptocurrency has taken a life of its own. Computer geeks with “blockchain” expertise, the technology that drives the decentralisation settlements of cryptocurrency, are commanding more than US$250,000 per annum.

It is said to be more than what a consultant or a software engineer can earn.

Those who have put their money into cryptocurrency would be laughing all the way to the bank now. But dynamics and fundamentals are complicated. The strength of the cryptocurrency is not based on historical numbers. It does not have an asset backing it.

It is based on future expectations of what the designer of the cryptocurrency offers. It is a complicated investment not meant for the unsophisticated investor.

Only fools will go for investment schemes that are unregulated and offer promises of returns that are unsustainable. They will lose all the time.

The smart investor will rely on traditional stocks and shares with earnings that are visible. Those who are not greedy will surely gain.

The super-smart geeks are banking on the world of cryptocurrency that has a volatile history. Their fate is uncertain.

Source: The Star by M. Shanmugam

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Global Reset 2016~2017


In a world facing challenges and uncertainties, embrace opportunities for success through innovation.

“I went looking for my dreams outside of myself and discovered, it’s not what the world holds for you, it’s what you bring to it. –Anne Shirley”

THE world is currently at a paradox. Tensions and uncertainty for the future are rising in times of prevailing peace and prosperity. While changes are taking place at an incredibly fast speed, such changes are presenting unprecedented opportunities to those who are willing to innovate.

Recently, most global currencies had weakened against the US dollar (USD). This may give rise to some concern, but it is worth placing in proper perspective that most countries would trade with a few countries instead of just one. Furthermore, we are living in a world with low economic growth, increased mobility and rapid urbanisation.

In such a global landscape, it is important to embrace change and innovation in a courageous way to shape a better future. In L.M. Montgomery’s Anne of Green Gables, Anne Shirley said, “I went looking for my dreams outside of myself and discovered, it’s not what the world holds for you, it’s what you bring to it.”

Paradox, change and opportunity

In the World Economic Forum Global Competitiveness Report 2016-2017, World Economic Forum head of the centre for the global agenda and member of the managing board Richard Samans stated that at a time of rising income inequality, mounting social and political tensions and a general feeling of uncertainty about the future, growth remains persistently low.

Commodity prices have fallen, as has trade; external imbalances are increasing and government finances are stressed.

However, it also comes during one of the most prosperous and peaceful times in recorded history, with less disease, poverty and violence than ever before. Against this backdrop of seeming contradictions, the Fourth Industrial Revolution brings both unprecedented opportunity and an accelerated speed of change.

Creating the conditions necessary to reignite growth could not be more urgent. Incentivising innovation is especially important for finding new growth engines, but laying the foundations for long-term, sustainable growth requires working on all factors and institutions identified in the Global Competitiveness Index.

Leveraging the opportunities of the Fourth Industrial Revolution will require not only businesses willing and able to innovate, but also sound institutions, both public and private; basic infrastructure, health and education, macroeconomic stability and well-functioning labour, financial and human capital markets.

World Economic Forum editor Klaus Schwab stated in The Fourth Industrial Revolution that we are at the beginning of a global transformation that is characterised by the convergence of digital, physical and biological technologies in ways that are changing both the world around us and our very idea of what it means to be human. The changes are historic in terms of their size, speed and scope.

This transformation – the Fourth Industrial Revolution – is not defined by any particular set of emerging technologies themselves, but by the transition to new systems that are being built on the infrastructure of the digital revolution. As these individual technologies become ubiquitous, they will fundamentally alter the way we produce, consume, communicate, move, generate energy and interact with one another.

Given the new powers in genetic engineering and neurotechnology, they may directly impact who we are, and how we think and behave. The fundamental and global nature of this revolution also pose new threats related to the disruptions it may cause, affecting labour markets and the future of work, income inequality and geopolitical security, as well as social value systems and ethical frameworks.


A dollar story

When set in a global landscape where there is uncertainty for the future, when compared to other countries, Malaysia’s economy is performing quite well.

ForexTime vice president of market research Jameel Ahmad said, “When you combine what is happening on a global level, the Malaysian economy is in quite an envious position.”

For 2016, the USD has moved to levels not seen in over 12 years. The dollar index is trading above 100. This was previously seen as a psychological top for USD.

The Malaysian ringgit (MYR) is not alone in the devaluation of its currency. All of the emerging market currencies have been affected in recent weeks.

Similarly, the British £(GBP) has lost 30% this year, falling from US$1.50 to US$1.25 per GBP. The Euro (EUR) has fallen from US$1.15 to US$1.05 in three weeks.

The China Yuan Renmenbi (CNY) is hitting repeated historic lows against the USD. The CNY is only down around 5%.

Jameel believes that the outlook for the USD will be further strengthened. While the dollar was already expected to maintain demand due to the consistent nature of US economic data, the levels of fiscal stimulus that US Presidentelect Donald Trump is aiming to deliver to the US economy will encourage borrowing rates to go up.

This means that it is now more likely than ever that the Federal Reserve will need to accelerate its cycle of monetary policy normalisation (interest rate rises).

Most were expecting higher interest rates in 2017. Trump has also publicly encouraged stronger interest rates. However, when considered that Trump is also promising heavy levels of fiscal stimulus, there is a justified need for higher interest rates, otherwise inflation in the United States will be at risk of getting out of control.

The probability for further gains in the USD due to the availability of higher yields from increased interest rates will mean further pressure to the emerging market currencies.

With populism resulting in victories in both the United States’ presidential election and the EU referendum in the United Kingdom in 2016, attention should be given to the real political issues in Europe and the upcoming political elections in 2017, such as those in Germany and France.

Jameel said, “Until recently, political instability was only associated with developing economies. We are now experiencing a strong emergence across the developed markets. This might lure investors towards keeping their capital within the emerging markets longer. Only time will tell.”

In Malaysia’s case, the economy is still performing at robust levels, despite slowing headline growth. Growth rates in Malaysia are still seen as significantly stronger than those in the developed world.

There are going to be challenges from a stronger USD and other risks such as slowing trade, but the emerging markets are still recording stronger growth rates than the developed world.

Adapting to creative destruction

In a world where changes are taking place rapidly, the ability to adapt to changes plays an important role in encouraging innovation and growth. Global cities are achieving rapid growth by attracting the talented, high value workers that all companies, across industries, want to recruit.

In an era where 490 million people around the world reside in countries with negative interest rates, over 60% of the world’s citizens now own a smartphone and an estimated four billion people live in cities, which is an increase of 23% compared to 10 years ago, these three key trends are shaping our times.

Knight Frank head of commercial John Snow and Newmark Grubb Knight Frank president James D. Kuhn shared that the era of low to negative interest rates has reduced investors’ expectations on what constitutes an acceptable return. The financial roller coaster ride that led to this situation has made safe haven assets highly sought after.

A volatile economy has not stopped an avalanche of technological innovation. Smartphones, tablets, Wi-Fi and 4G have revolutionised the spread of information, increased our ability to work on the move, and led to a flourishing of entrepreneurship.

Fast-growing cities are taking centre stage in the innovation economy and in most of the global cities, supply is not keeping pace with demand for both commercial and residential real estate.

Consequently, tech and creative firms are increasingly relying upon pre-let deals to accommodate growth, while their young workers struggle to find affordable homes.

As the urban economy becomes increasingly people-centric, regardless of a city being driven by finance, aerospace, commodities, defence or manufacturing, the most important asset is a large pool of educated and creative workers.

Consequently, real estate is increasingly a business that seeks to build an environment that attracts and retains such people.

Knight Frank chief economist and editor of global cities James Roberts said, “We are moving into an era where creative people are a highly prized commodity. Cities will thrive or sink on their ability to attract this key demographic.

“A characteristic of the global economy in the last decade has been the phenomenon of stagnation and indeed decline, occurring alongside innovation and success. If you were invested in the right places and technologies, the last decade has been a great time to make money; yet at the same time, some people have lost fortunes.

“The locations that have performed best in this unpredictable environment have generally hosted the creative and technology industries that lead the digital revolution, and disrupt established markets.” The rise of aeroplanes, automobiles and petroleum created economic booms in the cities that led the tech revolution of the 1920s and 30s. Yet elsewhere, recession descended on locations with the industries that lost market share to those new technologies like ship building, train manufacturing and coal mining.

In a world where abundant economic opportunities in one region live alongside stagnation elsewhere, it is not easy to reconcile the fact that countries that were booming just a few years ago on rising commodity prices are now adapting to slower growth.

Just as surprising are Western cities that are now thriving as innovation centres, when they were dismissed as busted flushes in 2009 due to their high exposure to financial centres.

Roberts said, “This is creative destruction at work in the modern context. The important lesson for today’s property investor or occupier of business space, is to ensure you are on-the ground where the ‘creation’ is occurring and have limited exposure to the ‘destruction’. This is not easy, as the pace of technological change is accelerating at a speed where the old finds itself overtaken by the new.

“However, real estate in the global cities arguably offers a hedged bet against this uncertainty due to the nature of the modern urban economy, where those facing destruction, quickly reposition towards the next wave of creation.”

The industries that drive the modern global city are not dependent upon machinery or commodities but people, who deliver economic flexibility.

A locomotive plant cannot easily retool to make electric cars, raising a shortcoming of the single industry factory town. Similarly, an oil field in Venezuela has limited value for any other commercial activity.

However, a modern office building in a global city like Paris can quickly move from accommodating bankers in rows of desks to techies in flexible work space. Therefore, there is adaptability in the people in a service economy city which is matched by the city’s real estate.

In the people-driven global cities, a new industry can redeploy the ‘infantry’ from a fading industry via recruitment. Similarly, the professional and business service companies that served the banks, now serve a new clientele of digital firms.

In contrast, manufacturing or commodity-driven economies face greater barriers when reinventing themselves.

Today, landlords across the world struggle with how to judge the covenants of firms who have not been in existence long enough to have three years of accounts, but are clearly the future.

Consequently, both landlord and tenant need to approach real estate deals with flexibility. Landlords will need to give ground on lease term and financial track record, and occupiers must compensate the landlord for the increased risk via a higher rent.

Another big challenge for the Western global cities will be competition from emerging market cities that succeed in repositioning themselves away from manufacturing, and towards creative services. The process has started, with Shanghai now seeing a rapid expansion of its tech and creative industries.

The big Western centres still lead in services, but the challenge from emerging markets cities did not end with the commodities rout. They are just experiencing creative destruction and will emerge stronger to present a new challenge to the West.

From Mak Kum Shi The Star/ANN
 

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Malaysian Central Bank raises defence; weak currency


  Bank Negara_Defence
 
Malaysia banks told to set minimum CA ratio at 1.2% of total loans

PETALING JAYA: Banks have been told to have a minimum collective assessment (CA) ratio of 1.2% by the end of next year, sending a strong signal to the industry to improve its standards of prudence.

According to a circular from Bank Negara to financial institutions early last week, all banks are required to set aside a minimum of 1.2% of total loans effective Dec 31, 2015.

The requirement, effectively, will put a stop to the present situation where banks are left to set aside their CA ratio based on their own risk assessment of their asset profile.

“Most banks have maintained a CA ratio of lower than 1.2% because there is no minimum set by Bank Negara. This circular effectively sets the standard for a minimum requirement,” said a banker.

The CA ratio was previously known as the general provisions that all banks were required to adopt. The general provisions requirement was a minimum of 1.5% of total loans, a ratio set by the central bank.

However, after the introduction of the new accounting standards three years ago, the general provisions requirement was replaced with a CA ratio, with banks free to set their own ratio.

The central bank no longer set the minimum requirement for banks to comply with in regards to the provisions.

According to a research report by CIMB, banks that had a CA ratio of less than 1.2% as of September last year were Malayan Banking Bhd, Public Bank Bhd, Affin Bank Bhd and Alliance Bank Malaysia Bhd.

Bankers, when contacted, were divided on the impact that the requirement would have on their bottom lines.

According to one banker, the move to comply with the ruling will not impact profitability because the additional amount required to be set aside can be transferred from retained earnings.

“Funds out of retained earnings will not impact the profit and loss (P&L) account of banks. It’s not a P&L item,” he said.

However, it would affect the dividend payout ability of banks, added the banker.

Another banker said the financial institution was seeking clarification from Bank Negara on whether to set aside the provisions from its profits.

“If that were the case, then it would impact profitability,” said the banker.

OCBC Bank (M) Bhd country chief risk officer Choo Yee Kwan said the background to the new requirement was that Bank Negara wanted to ensure that impairment provisions could keep pace with strong credit growth.

“In addition, the regulator would like to promote consistency in practices in ensuring adequate rigour and data quality in arriving at the appropriate level of collective impairment and the factors that are considered by banking institutions.

“Adequate impairment provisions serve as necessary buffers against potential credit losses; hence, they can reduce the likelihood of systemic risk for the banking sector,” he said in an e-mail response to StarBiz.

He said the sector might witness an increase in the overall level of impairment provisions at the industry level.

“Nevertheless, this should be seen positively, as the higher credit buffers would now render the sector stronger,” he noted.

CIMB Research in a report stated that the proposed new guideline could have a negative impact on banks based on its theoretical analysis.

It pointed out that several banks would have to increase their CA provisions under the new ruling and this would lead to a rise in the banks’ overall credit costs.

“Those which do not meet the requirements would have to increase their CA (and ultimately credit cost) in 2014-2015, even if their asset quality is improving. For banks with a CA ratio of above 1.2%, the new ruling would limit the room for them to further reduce their CA ratios,” CIMB Research explained.

According to CIMB Research’s estimates, banks’ net profits could be lowered by around 0.5% (for Hong Leong Bank Bhd) to 11% (for Public Bank) in 2014 to 2015 if a minimum requirement of 1.2% for the CA ratio were implemented.

Another analyst, however, is of the view that the new requirement from Bank Negara would have a negligible impact on the operations and earnings of banks.

“We think it is not a major concern for most banks because, firstly, the grace period for the implementation of the new guideline is long. Secondly, the minimum ratio of 1.2% will not comprise of only the CA component alone, but is also a combination of the CA and the statutory or regulatory reserve.

“In general, we see the new guideline as a measure to standardise the way banks gauged their capital buffers.
“The bottom line is, we think the new guideline will only serve to further strengthen banks’ capital buffers,” the analyst added.

By Cecilia Kok and Daljit Dhesi StarBiz, Asia News Network

Silver lining in weak currency

Weaker currencies are a boon for Malaysia and Indonesia, helping to tip the balance of trade back in their favour, as exporters benefit from rising demand for goods and commodities from advanced economies, coupled with steady growth in China.The favourable trade surplus, economists said, would ease the pressure on these emerging countries’ deteriorating external accounts, which is a major sore point for foreign investors.

They added that rising exports would provide the much-needed tailwind for Asian economies to sustain growth even as domestic demand moderated.

Malaysia on Friday reported a 2.4% growth in exports in 2013, backed by a 14.4% jump in December that exceeded the market’s expectation by a wide margin.

“We still maintain our long-term view of impending growth momentum in the coming quarters,” Alliance Research economists Manokaran Mottain and Khairul Anwar Md Nor said in a report.

They predicted exports in 2014 to grow at a faster pace of 5%, backed by steady but improving export demand from advanced economies.

While imports grew at a faster pace than exports in 2013, Malaysia continued to enjoy a strong trade surplus.

The favourable trade surplus combined with an anticipated smaller services deficit and transfer outflows would translate into a larger current account surplus of RM16.7bil or 6.6% of gross domestic product (GDP) in the last quarter of 2013.

“The cumulative current account surplus is estimated to reach RM37.8bil or 3.9% of GDP in 2013, helping to assuage fears of a current account deficit,’’ CIMB Research economist Lee Heng Guie said.

This, he said, was positive for the ringgit and the capital market.

The ringgit, along with other emerging Asian currencies, have been under pressure since June last year after the US Federal Reserve began talking and later started to reduce its quantitative easing (QE).

The US Fed first pared its monthly bond purchases programme from the original US$85 billion a month to $75 billion in January. This was cut further by $10 billion starting from February.

“Capital outflows from emerging markets are likely to continue in the months ahead as the Federal Reserve winds down its QE3 programme,” said Macquarie Bank Ltd’s Singapore-based head of strategy for fixed income and currencies Nizam Idris.

Fears about the US Fed tapering down the supply of cheap money to the market first surfaced in May last year and it triggered a huge sell-off on emerging market assets.

Countries such as Indonesia and India had seen their currencies depreciate the most in 2013, Both economies had wide current account deficits.

Last year, the Indian rupee plummeted the most in two decades, while rupiah depreciated by about 20% against the US dollar over the past 12 months.

Not helping emerging market currencies is the recovery in advanced economies, such as a rebound in economic growth in the US which rose by 3.2% in the fourth quarter of last year.

But if economic recovery in the US and eurozone were to stay on course, so would demand for cheaper emerging market exports. This, in turn, would help shrink the huge current account deficits that had hobbled countries such as Indonesia, India and Turkey.

For many emerging economies, 2014 had gotten off to a grim start.

Concern over the Chinese economy’s marked slowdown and the Argentine peso’s steep slide in January has brought upon renewed pressure on the currency market.

But the current market volatility does not portend weaker growth.

CIMB Research in Indonesia observed that the strains in the financial markets did not translate into a significant slowdown in the economy as the country’s real GDP growth accelerated to 5.7% in the last quarter of 2013.

Its exports surged in December, while imports slowed on the weaker rupiah. This helped to widen its trade surplus to $1.52 billion, the largest since November 2011.

The favourable trade numbers narrowed its current account deficit of $4.06 billion.

CIMB Research expects growth in Indonesia “to trough” in the first half of 2014 as the lagged effect of the rupiah depreciation and Bank Indonesia’s aggressive policy-tightening cycle in June-November 2013 works through the economy.

“Pre-election bounce in consumption should offset the weakness, allowing Indonesia to post 5.6% GDP growth in 2014,’’ it said.

Malaysia, too, is on track for sustained growth. CIMB Research projected GDP growth in the third quarter would probably expand by 5.3%, taking the full year growth rate to 4.7% for 2013. – The Star/ANN

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Capital controls: From heresy to orthodoxy


THINK ASIAN By ANDREW SHENG

Principles for formulating capital control policies must take local conditions into account.

ON Sept 1, 2011, it would be 13 years to the day when Malaysia first introduced capital controls to stem the effects of the Asian financial crisis on the domestic economy. In 1998, it was heresy to introduce capital controls on capital flows, since it was the International Monetary Fund (IMF) orthodoxy to liberalise the capital account.

From the perspective of history, one tends to forget that in 1945, when the IMF was first established, the consensus opinion among bankers and academics alike was for hot money to be controlled. Indeed, the intellectual father of the IMF, John Maynard Keynes, remarked that “what used to be heresy is now endorsed as orthodoxy.”

In the old days, courtesy to living persons and the statute of limitations would allow history to be written only after 60 years when official archives are opened to the public.

Today, we live in an age of unfettered information, when oral and documented history can be published rapidly, from authorised biographies issued shortly after a leader leaves office to unauthorised leakages from Wikileaks.

The publication of a new book by Datuk Wong Sulong, former group chief editor of The Star, called Notes to the Prime Minister: the Untold Story of How Malaysia Beat the Currency Speculators, only two months after the IMF announced in April 2011 new thinking on capital inflows, is a remarkable achievement.

Sixty-six years after the IMF was formed, capital controls have moved full circle from orthodoxy to heresy and back again to (qualified) orthodoxy.

The book comprises 45 Notes written by Tan Sri Nor Mohamed Yakcop, Minister in the Prime Minister’s Department, between Oct 3, 1997 and Aug 21, 1998 to then Prime Minister Tun Dr Mahathir Mohamad.

In short, they were the key briefs that helped Dr Mahathir make up his mind on the key economic policies to help combat the Asian financial crisis.

Book offers deep insights

For both historians and practicing policymakers, this new book offers deep insights into the serendipity and the practice of successful policy decision-making. There is an element of serendipity, because Dr Mahathir recalled that he spotted Nor Mohamed walking down a street in Kuala Lumpur just before he left for Buenos Aires in September 1997 via Hong Kong, where he attended the World Bank Annual Meetings and clashed publicly with George Soros on currency trading.

On Sept 29, 1997, he summoned Nor Mohamed to meet him in Buenos Aires, because he needed someone who understood currency trading. It is a tribute to a politician trained as a doctor that he was willing to spend repeated sessions with an experienced currency trader to understand the intricacies of modern financial markets.

Reading the 45 Notes in historical sequence, one gets a far better appreciation of how the decision to impose capital controls was arrived at. The Notes not only have historical value, but also current-day applicability, as they explain not only offshore currency, the psychology of fear and greed that drive markets, but also market manipulation in thinly traded emerging market currencies.

The major problem of the proponents of the Washington Consensus in 1997 was that most of them were macro-economists who had little understanding or experience of how the markets actually worked. Free markets became a dogma and objective in their own right, rather than the means to an end for better livelihood for all.

The Notes also revealed that in complex decisions under uncertainty, it was vital to understand clearly the key parameters for action. Note 7 clearly pointed out that Malaysia was different from other countries under currency attack because it did not have large short-term external debt. Note 11, dated Oct 21, 1997, spelt out the factors that determined exchange rates, with a particularly illuminating explanation of market manipulation.

Market manipulation was seen as due to concerted effort by hedge funds, using large gearing and available tools and then triggering the element of fear among the long-term investors who have legitimate currency risk.

In other words, if the wolves can trigger the herd to move, then the fundamentals can move. The perception of fear changes the whole game.

Effect of CLOB

Note 39 dated July 9, 1998 is an important study of the effect on Malaysia of the central limit order book (CLOB) for trading of Malaysian shares in Singapore. The Note identified that the CLOB was a convenient way for capital outflows.

Hence, one of the most effective ways for exchange control was to impose the condition that Malaysian shares could only be traded on a Malaysian exchange, which came on Aug 31, 1998, with exchange controls imposed on the following day.

In Dr Mahathir’s words, “during the financial crisis, we faced two parallel situations; the ringgit was falling rapidly and Malaysian shares were also falling rapidly. So we had to put an end to both.”
50th Mederka Malaysian National Day celebratio...Image via Wikipedia
The IMF has come out with six key principles for formulating capital control policies.

The first is that there is no “one-size-fits-all” policy mix. The second is that capital controls should fit long-term structural reforms. Third, capital controls are only one tool and not a substitute for the right macro policies. Fourth, capital controls can be used on a case-by-case basis, in appropriate circumstances. Fifth, the medicine should treat the ailment, and finally, the policy must consider its effect on other market participants.

It is hard to argue against these common sense “motherhood” principles. The trick in real life policy-making is how to apply them to local conditions.

On of the features of the current Chinese capital controls is that China also has a large amount of Chinese shares listed outside capital controls, such as Chinese shares listed in Hong Kong, Singapore and New York.

This is a book that is a must read for all emerging market policymakers interested in liberalising their capital accounts and for IMF experts to ponder emerging market experience.

I recommend that this new book be translated into Chinese, so that Chinese policymakers interested in internationalising the renminbi can look at the Malaysian experience.

Tan Sri Andrew Sheng is author of the book, From Asian to Global Financial Crisis.

Related post:

The untold story of Malaysia foreign exchange controls

Stronger Malaysian ringgit seen


Stronger ringgit seen

BY DALJIT DHESI daljit@thestar.com.my

Economists expect the ringgit to strengthen further against the US dollar

PETALING JAYA: Economists expect the ringgit to further strengthen against the greenback and attract extensive capital inflow into the region. It will also lead to possible further hikes in statutory reserve requirement (SRR) to stem excess liquidity if the global financial volatility worsens following the US credit rating downgrade.

Standard and Poor’s (S&P’s) had last Friday downgraded the world’s largest economy a notch lower to AA+ from a triple A rating since the credit rating was issued to the US in 1917.

MIDF Research chief economist Anthony Dass said he expected the ringgit to strengthen against the US dollar at an average 2.97 for the year supported by a combination of healthy economic fundamentals and strong inflow of liquidity.

Stronger ringgit: Dass expects the ringgit to trade at an average 2.97 to the greenback for the year.

He added that the stronger ringgit against the US dollar would help cushion some level of imported inflation, which would give some breathing space for Bank Negara on further raising the overnight policy rate (OPR), which now stood at 3%.

“We have now placed a 30% odd for the OPR to stay at 3% for the rest of the year and expect the central bank to raise it by another 25 basis points (bps) in the second half of this year,” Dass said.

Much depends on the direction of the ringgit, the global commodity and food prices, liquidity and whether there will be further relaxation of subsidies.

Underpinned by healthy economic fundamentals and benefiting from the regional net inflow of funds, liquidity inflow into Malaysia has been strong, forcing the central bank to raise the SRR by 300 bps to 4% between April-June 2011. SRR are non-interest deposits kept at the central bank to mop up excess liquidity in the financial system.

With lingering uncertainties on the global front, Dass said he expected Malaysia, like other Asian ex-Japan economies, to continue to see inflow of funds. While this would strengthen the ringgit, he said ample liquidity would add pressure on inflation, adding that he was not ruling out the possibility of further hikes in SRR by another 50 bps to 100 bps should the inflow of liquidity pose a problem.

RAM Holdings economist Jason Fong, in response to a query from Starbiz, said if the financial volatility in the US turned out to be very significant and persistent, the impact on its external markets, including Malaysia, could be substantial.

One of the worst case scenarios would entail extensive capital flight from US-centric assets, he said. In this scenario, he added that there would be considerable decline in the value of the US dollar, causing an appreciation of US-denominated assets, particularly commodities.

The US financial volatility might also cause investors to put their money into safe haven assets such as precious metals, like gold, Fong noted.

Furthermore, he said if there were further US debt rating downgrade within the next two years as pointed out by S&P, then banks (depending on its portfolio weightings in US Treasuries) might slow down lending activities to meet international banking guidelines and this could slow domestic lending and cause consumption and investment to decline.

Fong said a larger-than-usual capital inflow would likely put upward pressure on the ringgit, causing Malaysia’s exports to be more uncompetitive.

He said the rating agency maintained its economic growth forecast of 5.6% for Malaysia this year but acknowledged that the downside risk to growth had risen in the last few months.

This included a prolonged US slowdown coupled with a deteriorating external economic environment, he noted.

AmResearch Sdn Bhd director of economic research Manokaran Mottain reckons that the impact on Malaysia from the US credit rating downgrade will be minimal as the local economy is more domestic-oriented.

Countries more exposed to US Treasuries, including Japan and China, would face the brunt in the near term. China would be pressured to ease the grip on a weaker yuan policy, he added.

For Malaysia, the biggest impact will be in the currency market, with the ringgit rallying again towards RM2.93 per dollar again. The ringgit was traded at RM3.019 to a US$1 yesterday.

In the medium term, a possible quantitative easing (QE3) in the US would lead to the appreciation of the regional currencies, including the ringgit – which is expected to rally towards RM2.90 per dollar before settling between the RM2.80-RM2.90 range for this year.

Manokaran, who is maintaining the country’s gross domestic product forecast at 5% this year, said the Government had trimmed its exposure to the G3 and plans to boost domestic demand. Apart from the US, the G3 also include Japan and the European Union.

European choice: Greek bailout Mark II – it’s a default !


WHAT ARE WE TO DO By TAN SRI LIN SEE-YAN

The European debt crisis has evolved rather quickly since my last column, “Greece is Bankrupt” (July 2). The European leadership was clearly in denial. The crisis has lurched from one “scare” to another. First, it was Greece, then Ireland, then Portugal; and then back to Greece. On each occasion, European politicians muddled through, dithering to buy time with half-baked solutions: more “kicking the can down the road.” By last week, predictably, the crisis came home to roost. Financial markets in desperation turned on Italy, the euro-zone’s third largest economy, with the biggest sovereign debt market in Europe. It has 1.9 trillion euros of sovereign debt outstanding (120% of its GDP), three times as much as Greece, Ireland and Portugal combined.

Greece austerity vote: Q & A Over the next two weeks the EU must come up with a second Greek bailout which could be as high as £107billion on top of the £98billion in rescue loans agreed for Greece in May

The situation has become just too serious, if contagion was allowed to fully play out. It was a reality check; a time to act as it threatened both European integration and the global recovery. So, on July 21, an emergency summit of European leaders of the 17-nation euro-currency area agreed to a second Greek bailout (Mark II), comprising two key elements: (i) the debt exchange (holders of 135 billion euros in Greek debt maturing up to 2020 will voluntarily accept new bonds of up to 15 to 30 years); and (ii) new loans of 109 billion euros (through its bailout fund and the IMF). Overall, Greek debt would fall by 26 billion euros from its total outstanding of 350 billion euros. No big deal really.

Contagion: Italy and Spain

By mid-July, the Greek debt drama had become a full-blown euro-zone crisis. Policy makers’ efforts to insulate other countries from a Greek default, notably Italy and Spain, have failed. Markets panicked because of disenchantment over sloppy European policy making. For the first time, I think, investors became aware of the chains of contagion and are only now beginning to really think about them.

The situation in Italy is serious. At US$262bil, total sovereign claims by international banks on Italy exceeded their combined sovereign exposures to Greece, Ireland, Portugal and Spain, which totalled US$226bil. European banks account for 90% of international banks’ exposure to Italy and 84% of sovereign exposure, with French & German banks being the most exposed. Italy & Spain have together 6.3 trillion euros of public and private debt between them. Reflecting growing market unease, the yield on Italy’s 10-year government bonds had risen to 5.6% on July 20, and Spain’s, to 6%, against 2.76% on German comparable bunds, the widest spread ever in the euro era.

Italy and Spain face different challenges. Spain has a high budget deficit (9.2% of GDP in 2010, down from 11.1% in 2009) the target being to take it down to 6% in 2011 which assumes high implementation risks. Its debt to GDP ratio (at 64% in 2011) is lower than the average for the eurozone. The economy is only gradually recovering, led by exports. But Spain suffers from chronic unemployment (21%, with youth unemployment at 45%), weak productivity growth and a dysfunctional labour market.

It must also restructure its savings banks. Spain needs to continue with reforms; efforts to repair its economy are far from complete and risks remain considerable. Italy has a low budget deficit (4.6% of GDP) and hasn’t had to prop-up its banks. But its economy has barely expanded in a decade, and its debt to GDP ratio of 119% in 2010 was second only to Greece. Italy suffers from sluggish growth, weak productivity and falling competitiveness. Its weaknesses reflect labour market rigidities and low efficiency. The main downside risk comes from turmoil in the eurozone periphery.

Another decade of stagnation also poses a major risk. But both Spain and Italy are not insolvent unlike Greece. The economies are not growing and need to be more competitive. The average maturity of their debt is a reasonable six to seven years. But the psychological damage already done to Europe’s bond market cannot be readily undone.

The deal: Europeanisation of Greek debt

The new bailout deal soughts to ring-fence Greece by declaring “Greece is in a uniquely grave situation in the eurozone. This is the reason why it requires an exceptional solution,” implying it’s not to be repeated. Most don’t believe it. But to its credit, the new deal cuts new ground in addition to bringing-in much needed extra cash – 109 billion euros, plus a contribution by private bondholders of up to 50 billion euros by mid-2014. For the first time, the new framework included solvent counterparties and adequate collateral. For investors, there is nothing like having Europe as the new counterparty instead of Greece. This europeanisation of the Greek debt lends some credibility to the programme. Other new features include: (i) reduction in interest rates to about 3.5% (4.5% to 5.8% now) and extension of maturities to 15 years (from 7 years), to be also offered to Ireland and Portugal; (ii) the European Financial Stability Facility (EFSF), its rescue vehicle, will be allowed to buy bonds in the secondary market, extend precautionary credit lines before States are shut-out of credit markets, and lend to help recapitalise banks; and (iii) buy collateral for use in the bond exchange, where investors are given four options to accept new bonds carrying differing risk profiles, worth less than their original holdings.

The IIF (Institute of International Finance), the industry trade group that negotiated for the banks, insurance funds and other investors, had estimated that one-half of the 135 billion euros to be exchanged will be for new bonds at 20% discount, giving a savings of 13.5 billion euros off the Greek debt load. Of the 109 billion euros from the new bailout (together with the IMF), 35 billion euros will be used to buy collateral to serve as insurance against the new bonds in exchange, while 20 billion euros will go to buy Greek debt at a discount in the secondary market and then retiring it, giving another savings of 12.6 billion euros on the Greek debt stock.

Impact of default

Once again, the evolving crisis was a step ahead of the politicians. There are fears that Italy and Spain could trip into double-dip recession as global growth falters, threatening the debt dynamics of both countries. This time the IMF weighed in with serious talk of contagion with widespread knock-on effects worldwide. Fear finally struck, forcing Germany and France to act, this time more seriously. The first reaction came from the credit rating agencies. Moody’s downgraded Greece’s rating three notches deeper into junk territory: to Ca, its second-lowest (from Caa1), short of a straight default. Similarly, Fitch Ratings and Standard & Poor’s have cut Greece’s rating to CCC.

They have since downgraded it further. They are all expected to state Greece is in default when it begins to exchange its bonds in August for new, long-dated debt (up to 30 years) at a loss to investors (estimated at 21% of their bond holdings). The rating agencies would likely consider this debt exchange a “credit event”, but only for a limited period, I think. Greece’s financial outlook thereafter will depend on whether the country would likely recover or default again. History is unkind: sovereigns that default often falters again.

What is also clear now is the new bailout would not do much to reduce Greece’s huge stock of sovereign debt. At best, the fall in its debt stock will represent 12% of Greece’s GDP. Over the medium term, Greece continues to face solvency challenges. Its stock of debt will still be well in excess of 130% of GDP and will face significant implementation risks to financial and economic reform. No doubt the latest bailout benefitted the entire eurozone by containing near-term contagion risks, which otherwise would engulf Europe. It did manage to provide for the time being, some confidence to investors in Ireland, Portugal, Spain and Italy that it’s not going to be a downward spiral. But the latest wave of post-bailout warnings have reignited concerns of contagion risks and revived investor caution.

Still, the bailout doesn’t address the very core fiscal problems across the eurozone. This is not a comprehensive solution. It shifted additional risks towards contributing members with stronger finances and their taxpayers as well as private investors, and reduces incentives for governments to keep their fiscal affairs under strict check. This worries the Germans as it weakens the foundation of currency union based on fiscal self-discipline. Moreover, the EFSF now given more authority to intervene pre-emptively before a state gets bankrupt, didn’t get more funds.

German backlash appears to be also growing. While the market appears to be moving beyond solvency to looking at potential threat to the eurozone as a whole, the elements needed to fight systemic failure are not present. At best, the deal reflected a courageous effort but fell short of addressing underlying issues, leading to fears that Greece-like crisis situations could still flare-up, spreading this time deep into the eurozone’s core.

Growing pains

The excitement of the bailout blanked out an even bigger challenge that could further destabilise the eurozone sluggish growth. The July Markit Purchasing Managers Index came in at 50.8, the lowest since August 2009 and close enough to the 50 mark that divides expansion from contraction. And, way below the consensus forecast. Both manufacturing and services slackened. Germany and France expanded at the slowest pace in two years in the face of a eurozone that’s displaying signs it is already contracting. Looking ahead, earlier expectations of a 2H’11 pick-up now remains doubtful.Lower GDP growth will require fiscal stimulus to fix, at a time of growing fiscal consolidation which threatens a downward spiral. At this time, the eurozone needs policies to restart growth, especially around the periphery. Without growth, economic reform and budget restraints only exacerbate political backlash and social tensions. This makes it near impossible to restore debt sustainability. Germany may have to delay its austerity programme without becoming a fiscal drag. This trade-off between growth and austerity is real.

IMF studies show that cutting a country’s budget deficit by 3% points of GDP would reduce real output growth by two percentage points and raise the unemployment rate by one percentage point. History suggests growth and austerity just do not mix. In practical terms, it is harder for politicians to stimulate growth than cut debt.

Reform takes time to yield results. And, markets are fickle. In the event the market switches focus from high-debt to low-growth economies, a crisis can easily evolve to enter a new phase one that could help businesses invest and employ rather than a pre-mature swing of the fiscal axe. Timing is critical. It now appears timely for the United States and Europe to shift priorities. They can’t just wait forever to rein in their debts. Sure, they need credible plans over the medium term for deficit reduction. More austerity now won’t get growth going. The surest way to build confidence is to get recovery onto a sustainable path only growth can do that. Without it, the risk of a double-dip recession increases. Latest warnings from the financial markets in Europe and Wall Street send the same message: get your acts together and grow. This needs statesmanship. The status quo is just not good enough anymore.

Former banker Dr Lin is a Harvard educated economist and a British chartered scientist who now spends time writing, teaching and promoting the public interest. Feedback is most welcome; email: starbizweek@thestar.com.my.

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