Would a regional fund help get Asia through the financial crisis?

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ImageAs mentioned in the last blog post, capital flows have dropped off significantly across Asia. The decreasing capital flows, from foreign direct investment to bank credit, appears to be an additional drag (along with sharp declines in exports and industrial production) on economic growth and recovery. So, is there some potential for a regional solution to deal with this crisis-related phenomenon?

According to the Institute of International Finance, the peak inflow of private capital was $296 billion in 2007, which shrunk 77% to $59 billion last year. The expected inflows will rise to $88 billion in 2009, but this still only amounts to 30% of the peak. The decline was led by a rapid contraction in private credit from banks, which moved from $167 billion in 2007 to negative $3 billion in 2008, and to negative $27 billion by the end of this year. This large shift is attributable to foreign (i.e., US and European) banks pulling back from Asia in order to shore-up their own financial health, including reducing leverage and bolstering capital levels.

Estimates of the total refinancing needs of corporations across Asia range to upwards of $200 billion this year, and the World Bank issued a warning (pdf) in March that developing countries worldwide are facing a $250-700 billion financing shortfall in 2009 and “as private sector creditors shun emerging markets.” The corporate refinancing risks are viewed as largely manageable by some of the major ratings agencies, and although it is true that corporations are severely constrained in accessing international bond markets for debt financing, companies in the region have much greater access to domestic bank financing (about 45% of debt financing on average is from banks).

In fact, many corporations rely heavily on short-term bank financing. Therefore, corporations are actually more exposed to the risk of trouble within banking systems and the potential that banks cannot continue to provide short-term lines of credit. This appears to already be happening in the case of smaller-sized companies in many emerging markets in Asia as the banks reduce their loan growth and focus lending on large corporate clients.

The ability of governments within the region to fill the gaps in capital inflows has become increasingly constrained because fiscal spending has climbed, fiscal revenues have dropped, and risk aversion by investors for government debt has increased. The region has seen a serious drop-off in late 2008 in net foreign capital inflows into the bond markets, resulting in a rapid spike in the spreads on major Asian countries’ sovereign debt. The appetite for local currency debt also has been seriously impacted in many countries as well, driving the spreads on domestic government debt higher.

So, given the financing needs of firms and the limited ability of governments to provide adequate direct support for financial institutions and firms at this time, could a regional fund – supported by international financial institutions such as the World Bank – help to fill the void?

Such an approach has been proposed in a general way within the international community, but tangible action has yet to be taken. For example, the “Recommendations by the Commission of Experts (pdf) of the President of the General Assembly on reforms of the international monetary and financial system,” of March 19, 2009, led by Nobel laureate economist Joseph Stiglitz, advocated mobilizing additional development funds by creating a new credit facility managed by the World Bank to leverage the liquidity available in sovereign wealth funds and countries with high foreign reserves. In addition, as part of the November 18, 2008, G20’s “Washington Action Plan” (pdf) to address the global financial crisis, a key priority was for international financial institutions to “explore ways to restore emerging and developing countries’ access to credit.” G20 leaders also pledged (pdf) to make available an additional $850 billion of resources through the global financial institutions, such as the World Bank, to support growth in emerging market and developing countries by helping to finance counter-cyclical spending, bank recapitalization, infrastructure, trade finance, balance of payments support, debt rollover, and social support.

All of these grand ideas and big picture issues could feasibly be addressed in key East Asian economies under a regional fund approach, but will any action be taken?


James Seward

Senior Financial Officer

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