symptomatic of fragilities in the financial sector that pose a significant risk of crisis if not urgently remedied?
Inherent in both warning metrics is a departure of credit from some type of norm. In the case of the BIS measure, if debt as a share of GDP accelerates to a level 6% higher than over the previous decade, the experience of other economies over time has shown that this dynamic is typical of an economy experiencing significant financial distress. For the IMF measure, if private credit has grown faster than nominal economic growth for an extended period, say 3-5 years, then this is also symptomatic of an economy where the function of credit is no longer aligned to that of the real sector of the economy, again a marker of likely imminent financial distress.
So where does Asia stand in relation to these metrics and are there more benign explanations for the sharp rise in credit intensity seen to date.
In terms of credit growth relative to its long run average we find that it is the two financial capitals of Asia that appear to be most susceptible to having had too strong a domestic credit cycle. Policy makers in both centres are already aware of that with a number of macro-prudential measures having been introduced in Singapore to lend cooling to the property sector. Hong Kong’s credit growth also appears to have been aligned to the property sector (see Hong Kong section on page 21) and measures to restrict purchases of property by non-residents appear to be cooling both property price and credit growth here.
We would tend to view the Philippines recent uptick of credit growth relative to its long run average as more symptomatic of financial deepening rather than reflecting an early warning signal of potential distress. On the second metric, when we compare the credit growth cycle to nominal GDP growth, the Philippines looks benign. Also on this metric, Singapore and Hong Kong have elevated readings compared to nominal GDP growth.
The two economies where these metrics suggest some further monitoring is required are Thailand and Indonesia. On the metric of credit growth relative to its long run average, Thailand credit growth has continued to remain strong over the past three years. Indeed, Bank of Thailand commentary in the past year has singled out the strength in credit growth as an ongoing constraint to the downward flexibility of the policy rate. The concern on Indonesia relates to the second metric, where we can see that credit growth has progressively been outperforming nominal GDP growth by a progressively larger margin over the past four years, bucking a regional trend for credit growth to generally re-couple back towards nominal GDP growth. Indeed, policy makers in Indonesia are aware of this with growing macro-prudential measures likely under the new BI Governor.
It will be particularly important for policy makers in Indonesia to demonstrate considerable resolve in taming the domestic credit cycle. As one of the two twin-deficit economies in Asia, highly-mobile international capital could be quick to pass harsh judgement on funding Indonesia’s current account. Fortunately for Indonesia, the pre-emptive policy decisions to raise rates and reduce subsidies (one makes domestic money stickier, the other should reduce the size of the fiscal deficit) appears to have placed Indonesia in a more beneficial position relative to the other twin-deficit economy, India. It may be a contributory factor. The other is that Indonesia clearly has a leverage to firmer demand in both the US and Japan (Japan is its largest export market) whereas India remains largely endogenously driven by a rural consumption dynamic. In this environment, India appears to be the weakest link in the chain of Asian economies vulnerable to capital outflow.
Read More: Indian Rupee Touches An All Time Low
China: With The Benefit Of Hindsight, The Punchbowl Could Have Been Taken Away A few Drinks Ago
Sure, Asia has vulnerabilities to capital outflows, but a disorderly unwind that morphs into a crisis is not the sequential outcome. The fact that Emerging Asia generally now enjoys current account surplus, sizeable FX reserves and a stronger macro-prudential position should firewall economies from a repeat of 1997-98. Still, credit cycles have been excessive and with the benefit of hindsight, the punchbowl could have been taken away sooner. We believe policy makers are now in the process of trying to take away it from a well imbibed crowd. There may be some belligerence from those who insist on one more for the road. Ultimately the move to more prudent policy settings now will prevent an Asian hangover as capital outflows continue to turn the regional liquidity party into a more sober affair.
China: Assessment Of Risks Around Our Core View
Given recent financial market and capital outflow dynamics over the past month we update the risk profile around our core view. The belly of the curve is still populated by a largely benign view on the regional outlook given the higher certainty we place on a more durable US and Japan backdrop falling into place. In the previous month we had a slightly fatter tail on the upside to our risk profile, which we have flattened out this month. We have slightly widened the tail on our downside risk scenario of disorderly capital outflows from the region.
Read More: China Liquidity Squeeze, Shibor Jump to Last for How Long?
As we noted last month, “A disorderly repatriation of capital in the event of a quick and significant rise in old-world yields is the downside risk tail event and will be smartly met by macro-prudential measures across the region”. We are pleased to see that this policy response appears to be falling into place which will mitigate the size of the downside risk.
China: Rates Forecast
While the recent liquidity squeeze has eased, we think it is
