Asset and currency markets of all emerging economies with strong international reserves and investment positions, including China, have been hit on several occasions in the past ten years. Office buildings at night, Hong Kong - Credit: Bigstock

By Yilmaz Akyüz
GENEVA, Switzerland, Jul 27 2017 (IPS)

Debates are taking place on whether there will be another financial crisis, whether in some part of the world or that is global in scope.  Governments draw lessons from financial crises to adopt measures to prevent their recurrence.  However, such measures are often designed to address the root causes of the last crisis but not the next one.  More importantly, they can actually become the new sources of instability and crisis. 

Much of what has recently been written about the Asian crisis on the occasion of its 20^th anniversary praises the lessons drawn and the measures implemented thereupon.  But they often fail to appreciate that while these might have been effective in preventing the crisis in 1997, they may be inadequate and even counterproductive today because they entail deeper integration into global finance.

An immediate step taken in Asia was to abandon currency pegs and move to flexible exchange rates in order to facilitate external adjustment and prevent one-way bets for speculators.  This has a lot to commend it, but its effects depend on how capital flows are managed.

Under free capital mobility no regime can guarantee stable rates.  Currency crises can occur under flexible exchange rates as under fixed exchange rates.   Unlike fixed pegs, floating at times of strong inflows can cause nominal appreciations and encourage even more short-term inflows.  Indeed nominal appreciations have been quite widespread during the surges in capital inflows in the new millennium, including in some East Asian economies.

Second, most emerging economies, including those in Asia, have liberalized foreign direct investment regimes and opened up equity markets to foreigners on the grounds that equity liabilities are less risky and more stable than external debt.  As a result, non-resident holdings as a percent of market capitalization have reached unprecedented levels, ranging between 20 and 50 per cent compared to 15 per cent in the US.

This has made the emerging economies highly susceptible to conditions in mature markets.  Since emerging economies lack a strong local investor base, the entry and exit of even relatively small amounts of foreign investment now result in large price swings.

Yilmaz Akyüz, chief economist of the South Centre, Geneva.

Third, they have also sought to reduce currency mismatches in balance sheets and exposure to exchange rate risk by opening domestic bond markets to foreigners and borrowing in their own currencies.  As a result sovereign debt in many emerging economies is now internationalized to a greater extent than that in reserve-currency countries.

Whereas about one-third of US treasuries are held by non-residents, this proportion is much higher in many emerging economies, including in Asia.  Unlike US treasuries this debt is not in the hands of foreign central banks but in the portfolios of fickle investors.

Although opening bond markets has allowed the sovereign to pass the currency risk to lenders, it has led to loss of autonomy over domestic long-term rates and entailed a significant exposure to interest rate shocks from the US.  This could prove equally and even more damaging than currency exposure in the transition of the US Fed from low-interest to high-interest regime and normalization of its balance sheet.

Fourth, there has been extensive liberalization of the capital account for residents.  Corporations have been encouraged to become global players by borrowing and investing abroad, resulting in a massive accumulation of debt in low-interest reserve currencies since 2008.

They have also borrowed through foreign subsidiaries.  These are not always repatriated and registered as capital inflows and external debt, but they have a similar impact on corporate fragility.  Hence the reduction in currency mismatches is largely limited to the sovereign while private corporations carry significant exchange rate risks.

Fifth, limits on the acquisition of foreign securities, real estate assets and deposits by resident individuals and institutional investors have been raised or abolished.  A main motive was to relieve upward pressures on currencies from the surge in capital inflows.  Thus, liberalization of resident outflows was used as a substitute to restrictions over non-resident inflows.  Although this has led to accumulation of private assets abroad, these would not be readily available at times of capital flight.

Sixth, banking regulations and supervision have no doubt improved, restricting currency and maturity mismatches in bank balance sheets.  However, banks now play a much less prominent role in the intermediation of international capital flows than in the 1990s.  International bond issues by corporations have grown much faster than cross-border bank lending directly or through local banks and a very large part of capital inflows now goes directly into the securities market.

These measures have failed to prevent credit and asset market bubbles in most countries in the region.  Increases in non-financial corporate debt since 2007 in Korea and Malaysia are among the fastest, between 15 and 20 percentage points of GDP.  At around 90 per cent of GDP Malaysia has the highest household debt in the developing world.  In Korea the ratio of household debt to GDP is higher than the ratio in the US and the average of the OECD.

International Reserves

Asian economies, like many others, are commended for building self-insurance by accumulating large amounts of international reserves.  Moreover, an important part of these came from current account surpluses, not just capital inflows.  Indeed, all countries directly hit by the 1997 crisis made a significant progress in the management of their external balances in the new millennium, running surpluses or keeping deficits under control.

However, whether or not these reserves would be sufficient to provide adequate protection against massive and sustained exit of capital is highly contentious.  After the Asian crisis, external vulnerability came to be assessed in terms of adequacy of reserves to meet short-term external debt in foreign currencies.

However, there is not always a strong correlation between pressure on reserves and short-term external debt.  Often, in countries suffering large reserve losses, sources other than short-term foreign currency debt play a greater role.  Currencies can come under stress if there is a significant foreign presence in domestic deposit and securities markets and the capital account is open for residents.

A rapid and generalized exit could create significant turbulence with broader macroeconomic consequences, even though losses due to declines in asset prices and currencies fall on foreign investors and mitigate the drain of reserves.

In all four Asian countries directly hit by the 1997 crisis, international reserves now meet short-term external dollar debt.  But they do not always leave much room to accommodate a sizeable and sustained exit of foreign investors from domestic securities and deposit markets and capital flight by residents.

This is particularly the case in Malaysia where the margin of reserves over short-term dollar debt is quite small while foreign holdings in local securities markets are sizeable.  Indeed its currency has been under constant pressure since mid-2014.  As foreign holders of domestic securities started to unload ringgit denominated assets, markets fell sharply and foreign reserves declined from over $130 billion to $97 billion by June 2015.  In October 2015 the ringgit hit the lowest level since September 1998 when it was pegged to the dollar.  Currently it is below the lows seen during the turmoil in January 1998.

Deepening integration into the inherently unstable international financial system before attaining economic and financial maturity and without securing multilateral mechanisms for orderly and equitable resolution of external liquidity and debt crises could thus prove to be highly costly.
In Indonesia reserves exceed short-term dollar debt by a large margin, but foreign holdings in its local bond and equity markets are also substantial and the current account is in deficit.  The country was included among Fragile 5 in 2013 by Morgan Stanley economists for being too dependent on unreliable foreign investment to finance growth.

Capital account regimes of emerging economies are much more liberal today both for residents and non-residents than in the 1990s.  Asset and currency markets of all emerging economies with strong international reserves and investment positions, including China, have been hit on several occasions in the past ten years, starting with the collapse of Lehman Brothers in 2008.

The Lehman impact was strong but short-lived because of the ultra-easy monetary policy introduced by the US.  Subsequently these markets came under pressure again during the ‘taper tantrum’ in May 2013 when the US Fed revealed its intention to start reducing its bond purchases; in October 2014 due to growing fears over global growth and the impact of an eventual rise in US interest rates; in late 2015 on the eve of the increase in policy rates in the US for the first time in seven years.

These bouts of instability did not inflict severe damage because they were temporary, short-lived dislocations caused by shifts in market sentiments without any fundamental departure from the policy of easy money.  But they give strong warnings for the kind of turmoil emerging economies could face in the event of a fundamental reversal of US monetary policy.

Should self-insurance built-up prove inadequate, economies facing large and sustained capital flight would have two options.  First, seek assistance from the IMF and central banks of reserve-currency countries.  Or second, engineer an unorthodox response, even going beyond what Malaysia did during the 1997 crisis, bailing in international creditors and investors by introducing, inter alia, exchange restrictions and temporary debt standstills, and using selective controls in trade and finance to safeguard economic activity and employment.

The Asian countries, like most emerging economies, seem to be determined not to go to the IMF again.  But, serious obstacles may be encountered in implementing unilateral heterodox measures, including creditor litigation and sanctions by creditor countries.  Deepening integration into the inherently unstable international financial system before attaining economic and financial maturity and without securing multilateral mechanisms for orderly and equitable resolution of external liquidity and debt crises could thus prove to be highly costly.

This paper draws on a recent book by the author; Playing with Fire: Deepened Financial Integration and Changing Vulnerabilities of the Global South, Oxford University Press, 2017. 

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Women sleep on a crowded train in Myanmar. Globally, some 1.2 billion people live on less than 1.25 dollars a day. Credit: Amantha Perera/IPS

By Amantha Perera
COLOMBO, Jul 24 2014 (IPS)

Millions still live in poverty and even those who have gained the security of the middle-income bracket could relapse into poverty due to sudden changes to their economic fortunes in South Asia, the latest annual Human Development Report by the United Nations Development Programme (UNDP) revealed.

“In South Asia 44.4 percent of the population, around 730 million people, live on 1.25−2.50 dollars a day,” said the report, released in Tokyo Thursday.

It went on to warn that despite the region’s gains, the threat of more of its citizens being pushed back into poverty was very real and that there were large disparities in income and living standards within nations.

“Many who recently joined the middle class could easily fall back into poverty with a sudden change in circumstances,” the report’s authors stressed.

“The most successful anti-poverty and human development initiatives to date have taken a multidimensional approach, combining income support and job creation with expanded healthcare and education opportunities." -- UNDP Human Development Report 2014
Here in Sri Lanka, categorised as a lower middle-income country by the World Bank in 2011, overall poverty levels have come down in the last half-decade.

The Department of Statistics said that poverty levels had dropped from 8.9 percent in 2009 to 6.7 percent by this April. In some of the richest districts, the fall was sharper. The capital Colombo saw levels drop from 3.6 percent to 1.4 percent. Similar drops were recorded in the adjoining two districts of Gampaha and Kalutara.

However the poorest seemed to getting poorer. Poverty headcount in the poorest area of the nation, the southeastern district of Moneralaga, increased from 14.5 percent to 20.8 percent in the same time period.

The disparity could be larger if stricter measurements aren’t used, argued economist Muttukrishna Sarvananthan.

“There is a very low threshold for the status of employment,” he told IPS, referring to the ‘10 years and above’ age threshold used by the government to assess employment rates.

“Such a low threshold gives an artificially higher employment rate, which is deceptive,” he stressed.

The UNDP report said that in the absence of robust safeguards, millions ran the risk of being dragged back into poverty. “With limited social protection, financial crises can quickly lead to profound social crises,” the report forecast.

In Indonesia, for instance, the Asian Financial Crisis of the late 1990s saw poverty levels balloon from 11 percent to 37 percent. Even years later, the world’s poor are finding it hard to climb up the earnings ladder.

“The International Labour Organisation estimates that there were 50 million more working poor in 2011. Only 24 million of them climbed above the 1.25-dollars-a-day income poverty line over 2007–2011, compared with 134 million between 2000 and 2007.”

Globally some 1.2 billion people live on less than 1.25 dollars a day, and 2.7 billion live on even less, the report noted, adding that while those numbers have been declining, many people only increased their income to a point barely above the poverty line so that “idiosyncratic or generalised shocks could easily push them back into poverty.”

This has huge implications, since roughly 12 percent of the world population lives in chronic hunger, while 1.2 billion of the world’s workers are still employed in the informal sector.

Sri Lanka, reflecting global trends, is also home to large numbers of poor people despite the island showing impressive growth rates.

Punchi Banda Jayasundera, the secretary to the treasury and the point man for the national economy, predicts a growth rate of 7.8 percent for this year.

“This year should not be an uncomfortable one for us,” he told IPS, but while this is true for the well off, it could not be further away from reality for hundreds of thousands who cannot make ends meet or afford a square meal every day.

While the report identified the poor as being most vulnerable in the face of sudden upheavals, other groups – like women, indigenous communities, minorities, the old, the displaced and the disabled – are also considered “high risk”, and often face overlapping issues of marginalisation and poverty.

The report also identified climate change as a major contributor to inequality and instability, warning that extreme heat and extreme precipitation events would likely increase in frequency.

By the end of this century, heavy rainfall and rising sea levels are likely to pose risks to some of the low-lying areas in South Asia, and also wreak havoc on its fast-expanding urban centres.

“Smallholder farmers in South Asia are particularly vulnerable – India alone has 93 million small farmers. These groups already face water scarcity. Some studies predict crop yields up to 30 percent lower over the next decades, even as population pressures continue to rise,” the report continued, urging policy-makers to seriously consider adaptation measures.

Sri Lanka is already talking about a 15-percent loss in its vital paddy harvest, while simultaneously experiencing galloping price hikes in vegetables due to lack of rainfall and extreme heat.

It has already had to invest over 400 million dollars to safeguard its economic and administrative nerve centre, Colombo, from flash floods.

“We are getting running lessons on how to adapt to fluctuating weather, and we better take note,” J D M K Chandarasiri, additional director at the Hector Kobbekaduwa Agrarian Research Institute in Colombo, told IPS.

Smart investments in childhood education and youth employment could act as a bulwark against shocks, the report suggested, since these long-term measures are crucial in interrupting the cycle of poverty.

The report also urged policy makers to look at development and economic growth through a holistic prism rather than continuing with piecemeal interventions, noting that many developed countries invested in education, health and public services before reaching a high income status.

“The most successful anti-poverty and human development initiatives to date have taken a multidimensional approach, combining income support and job creation with expanded health care and education opportunities and other interventions for community development,” the reported noted.

(END)

By Supachai Panitchpakdi
GENEVA, Jul 9 2013 (IPS)

Almost five years have passed since the global financial crisis, and the world economy is still reeling from its consequences. The main reason for this is the continued stagnation in developed countries, which is adversely affecting economic dynamism in other regions.

Supachai Panitchpakdi, secretary-general of the United Nations Conference on Trade and Development (UNCTAD)

Indeed, growth in the advanced economies is likely to slow down from 1.2 percent in 2012 to only 0.8 percent in 2013. If developed countries remain unable to revive their economies, there is a risk that this mediocre pace of growth may yet turn into a global recession.

At this juncture, we therefore face a dual challenge: first, we must urgently take measures to restore stable and sustained growth in the world economy, so as to truly overcome the crisis. Second, and perhaps even more importantly, we must ensure that such a devastating financial crisis cannot recur. This will require making significant reforms to global economic governance, far beyond what has been achieved so far.

Slow growth in the advanced economies and thus in the world economy is partly the natural consequence of a credit crunch and sharply reduced demand in the aftermath of a crisis. However, in many countries, these effects are being exacerbated by severe austerity policies.

Despite years of unprecedented monetary expansions in the United States, Europe and, more recently, Japan, banking credit provided to the private sector has stagnated, or even decreased. The problem is not the supply of money, but aggregate demand.

Desperately needed are measures to support demand. And yet, austerity policies are contracting demand by raising taxes and reducing expenditure, just when such expenditure would be most required. In this way, several countries that have adopted austerity policies have now been pushed into a double-dip recession.

In addition, since these austerity programmes hamper growth – and, consequently, public revenues – they do not achieve their target of fiscal consolidation either.

It is therefore time to reassess the merits of the current policy approach.

The second key challenge is to prevent a recurrence of the crisis. The financial meltdown at the heart of the financial system has reminded us of a lesson we should already have learnt after the Asian Financial crisis (1997-1998), namely that deregulated financial markets do not allocate resources efficiently and are prone to herd-behaviour and crises.

Nevertheless, after the initial flurry of measures to bail out banks and companies in need of liquidity, enthusiasm to address the wider systemic origins of the crisis quickly faded.

At the national level, there have been efforts to strengthen regulation of the financial sector in the U.S. But at the global level, reforms have been limited to a slight revision of the Basel Capital Adequacy accord, as well as a number of measures to address tax havens. It is not clear whether these measures could have prevented the financial crisis, had they been in place in 2007. And yet, even these minor steps are beginning to be rolled back.

More importantly, the reforms have not addressed the more fundamental problems of our global financial architecture. The current system based on deregulated capital markets and floating exchange rates has not prevented prolonged misalignments of exchange rates, or the build-up of large current account imbalances. It has also failed to avert the disorderly expansion of short-term capital movements, which are a major factor of economic instability.

In order to address these issues, much bolder reforms will be required. The United Nations Conference on Trade and Development (UNCTAD) has long argued that international monetary and financial relations should be governed by rules similar to those currently governing the use of trade policy measures in the World Trade Organisation (World Trade Organisation).

In a world where tariffs and international trade are increasingly governed by a set of rules to prevent “beggar-thy-neighbour” policies and foster trade liberalisation, it is incomprehensible that similar rules do not exist for the global financial system. And this is despite the fact that even small realignments of exchange rates can wipe out any gains from trade liberalisation, or that exchange rate crises have repeatedly shown themselves to have devastating effects.

A multilateral system of rules could ensure that exchange rates better reflect long-run fundamentals, and credibly prevent the build-up of imbalances.

Similarly, there is a need to rein in the large volumes of speculative capital flows. Such unregulated capital flows generate a risk not only in the recipient country, but also in the source economy, where the solvency of banks may be undermined by their exposure to asset bubbles in foreign countries.

Financial supervision should therefore be applied at both ends of capital movements. Already, the International Monetary Fund (IMF) has recently changed its position on the use of capital controls under certain circumstances. However, a multilateral arrangement (such as the “Tobin tax”) would probably be more effective.

It is clear that truly preventing future financial crisis will require an overhaul of the current system tantamount to a new Bretton Woods. Any such system must, of course, give greater voice to developing nations than they have so far enjoyed in the international financial institutions.

(END/COPYRIGHT IPS)

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By Supachai Panitchpakdi
GENEVA, May 9 2013 (IPS)

The global repercussions of the 2007-2008 financial crisis are a stark reminder of the economic interdependence in our globalising world. No country was spared from the shock waves that originated in the financial systems of developed economies.

Supachai Panitchpakdi, secretary-general of the United Nations Conference on Trade and Development (UNCTAD). Credit: UNCTAD.

Transmitted through both trade and financial channels, they led to an economic slowdown in most countries, and even outright recessions in others.

These recent events call for a thorough examination of the different kinds of possible shocks to the external economic environment and the channels through which they spread. We also need to better understand the factors that determine countries’ vulnerability to such shocks, and how we can strengthen the resilience of different economies.

Perhaps the most obvious case of an external shock is that of a financial crisis, such as the Asian Financial Crisis initiated in the early summer of 1997, or the most recent global financial crisis.

These shocks have demonstrated that countries need to build resilience against the shortcomings of our international monetary and financial system. The most pertinent shortcoming is the failure to avoid a disorderly expansion of short-term capital movements, which have been a major factor in creating economic instability.

Partly as a result of the experiences of the Asian Financial Crisis, many developing countries have built up their resilience and are in a stronger position today to withstand shocks originating in international capital markets than in previous decades.

Lower debt-to-GDP ratios and improved debt management have been contributing factors in this resilience. But the most important factor in shielding these countries from the volatility of capital flows has likely been their accumulation of foreign exchange reserves.

However, reserve accumulation as an insurance against the instability of capital markets is a costly policy measure, and one that is always second best to multilateral measures to better regulate these markets.

Furthermore, not all countries have been able to build up such a “war chest”. Indeed, some countries are now left with little reserves to cope with future needs that may arise in international financial markets, making them more vulnerable to external shocks.

A second external shock that has recently affected many developing countries is the sharp slowdown in demand for their exports in the developed markets after the recent financial crisis.

In the decade preceding the crisis, many developing countries were able to benefit from a trade-led expansion, allowing them to achieve growth rates that were sometimes four or five percentage points higher than those of the developed world.

This resulted in a significant shift in the balance of the world economy, with developing countries accounting for a growing share of trade and growth, and led some pundits to argue that we were about to witness a “de-coupling”, which would see developing countries continue to grow despite the unsatisfactory performance of developed countries.

However, prospects in the developing world remain heavily influenced by the growth dynamism in the developed countries. To the extent that developing countries continue to rely on exports to developed countries as their key growth driver and have to cope with unfettered capital flows generating boom and bust cycles, their economies will remain vulnerable to shocks to their external economic environment.

Most forecasts predict that the current difficult external environment is likely to remain for the near future, with only a slow recovery towards a weak growth path in advanced economies.

This suggests that developing and transition economies will need to reduce their export orientation to developed economies if they want to continue to grow and increase their resilience to external economic shocks. Instead, they will need to rely more on domestic, regional and South-South trade. Thus they will need to adapt their development strategy in order to strengthen resilience.

On the other hand, coordinated measures at the multilateral level to expand global demand would be preferable. For example, increasing domestic demand in advanced countries with a current account surplus would stimulate global demand while helping to reduce global imbalances. This would be more appropriate than the current process of global rebalancing, which is being led by demand compression in deficit countries, accentuating the risks of a global economic downturn.

These are only two examples of significant external shocks that developing countries are vulnerable to. Identifying external shocks and mitigating their impact on trade and development requires the availability of statistical tools that capture the growing interdependence of national economies.

Among the many measures that are available, the terms of trade is a key indicator of the impact of external shocks, especially in countries with a high share of external trade relative to gross domestic product.

The United Nations Conference on Trade and Development (UNCTAD) has been particularly active in this area, pursuing the development of more disaggregated terms of trade figures by estimating the contribution of different product groups to changes in the terms of trade.

All these issues require the attention of policymakers, as a better understanding of the problems will help in finding solutions.

(END/COPYRIGHT IPS)

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