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June 16, 2000 VOL. 29 NO. 23 | SEARCH ASIAWEEK
Shock-Resistant Asia? The region is somewhat cushioned for a U.S. slowdown Asia is better positioned now than in the heady days preceding the Crisis in 1997 to absorb negative external shocks, especially those from the United States. Intra-regional trade is a major cushion against a potential drop in U.S. import demand. And the sharp improvement in Asia's external accounts, with less foreign debt and large foreign exchange reserves, gives it a big buffer against rising U.S. interest rates. I am doubtful that, as some believe, the cycle of tightening U.S. interest rate increases is over. One week's financial market rally doesn't make a trend. We have to see more convincing evidence for a sustained slowdown in the U.S. economy. Something will have to give in the face of rising U.S. interest rates and it will be Asia's currencies, with a greater downside risk for ASEAN's. One important buffer is trade. If rising U.S. interest rates crash the real economy and financial markets, they will hurt Asia's recovery by reducing import demand. The U.S. is Asia's largest single export market, accounting for almost one-quarter of the total. Moreover, following a correction in U.S. stocks, there might be an indirect negative impact on Asian equity markets, which could hurt consumer spending in the region. If the chronic U.S. current- account deficit forces a sharp drop in the dollar, it will also hurt Asian exports by making them dearer. These fears are real but they should not be exaggerated. Recovery in intra-regional trade, which accounts for 40% of Asia's total exports, will help cushion the potential negative-demand shock from the U.S. Experience also shows that U.S. dollar depreciation would not correct that country's current-account deficit quickly. For 20 years, U.S. current deficit balances have not responded to exchange rate movements as depicted by classical theory. There is scarcely a close relationship between the U.S. current account and real effective exchange rate movement. If this experience continues, then even a sharp fall in the dollar may not necessarily mean that Asian exporters would suddenly find themselves unable to sell to the U.S. Further, Federal Reserve rate hikes may not kill the U.S. economy due to structural change in the relationship between money and GDP growth. All this suggests that U.S. import demand might not dry up. Another positive that Asia has today is its lower debt burden. External accounts have improved. Asia has pared external debt and made some progress in debt restructuring since the Crisis, though much more needs to be done. Total foreign bank borrowing by East Asia fell from $820 billion in 1997 to $505 billion last year. In terms of debt-to-GDP ratios and foreign exchange reserves-to-short term foreign debt ratios -- both important aggregate financial gauges -- Northeast Asia and Singapore have less onerous debt burdens than other ASEAN economies. Lower debt burdens mean that Asian economies are now less susceptible to the pressure of capital withdrawal by foreign creditors. This permits them not to follow U.S. rate hikes in lockstep, thus helping to offset the negative impact of rising interest rates and a decline in global liquidity. Then there's the cash cushion. Asia has huge foreign exchange reserves. As the region slipped into recession last time, current-account deficits turned into huge surpluses, drawing in U.S. dollars. These inflows, if left unattended, would have put upward pressure on the region's currencies. Unwilling to sacrifice the competitive benefit of weak currencies, Asian central banks bought U.S. dollars aggressively, swelling foreign-exchange reserves and keeping the exchange rates down. But this intervention also risked flooding the local markets with domestic currencies and reigniting inflation later. The central banks "sterilized" their U.S. dollar purchases by issuing bonds to the banking system, mopping up the cash they released. Asia's financial system is thus flush with a huge stockpile of short-term bonds maturing in the coming months. Korea is a case in point. There the amount of monetary stabilization bonds issued has soared along with foreign exchange reserves created since the Crisis. South Korea, Malaysia and Taiwan together have over $110 billion in foreign-exchange sterilization bonds maturing soon. Raising taxes to repay these bonds is not feasible, due to weak consumer confidence. Witness Japan's consumption tax hike in 1996, which killed a fragile economic recovery and plunged the economy into a recession that has lasted till now. If Asian authorities were to print money to repay just one quarter of these bonds, it would amount to massive monetary expansion. There will be pressure on currencies. Asia possesses a large cash cushion against rising U.S. interest rates. Due to local financial woes and reform pains, central banks have every incentive to keep interest rates low for as long as possible. But in the face of strong U.S. rate hike momentum, something would have to give. Asian authorities will have to let their currencies fall to take some of the rate shocks. The greatest currency risks are in the ASEAN countries, which, except for Malaysia and Singapore, have relatively high foreign debt burdens. Write to Asiaweek at mail@web.asiaweek.com
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