Heng Swee Keat: The impact of the global financial crisis on Asia
Keynote speech by Mr Heng Swee Keat, Managing Director of the Monetary Authority of
Singapore, at the International Institute of Finance (IIF) Asia Regional Economic Forum,
Singapore, 4 March 2009.
* * *
Introduction
Ladies and Gentlemen,
Good afternoon.
I welcome the International Institute for Finance (IIF) for holding its Asia Regional Economic
Forum in Singapore. It is good to see such a diverse group gathered here for this Forum.
An unprecedented crisis
The most commonly used adjective to describe the current financial crisis is
"unprecedented". Indeed, many aspects have been exceptional -
•
the speed at which events unfolded and triggered a series of domino effects;
•
the scale of the impact, which has become global; the range of financial institutions
and investors affected;
•
the near-perfect correlations of markets and asset classes that had been
uncorrelated when conditions were benign;
• and the range of unconventional measures taken by financial authorities globally to
try and arrest the unfolding crisis.
These features of the crisis are exceptional. But perhaps the most crucial aspect that has
had a profound effect on the dynamics of this crisis and its impact on emerging economies, is
that unlike various past crises, this current crisis originated in the US.
This is unlike various financial crises in the past 25 years or so - which tended to have
certain recurring themes, and which tended to begin in emerging economies before their
knock-on impact was felt internationally. The analytical tools and policy prescriptions for
dealing with such crises became more tried and tested over time, even if applied in too
dogmatic a fashion at times. Global institutions, whether it was the IMF, developed nations,
or a consortium of strong international banks, had the wherewithal to bring sufficient
resources to bear on the problem. Crisis resolution was never easy but did not quite look
insurmountable.
Not so this time.
The epicenter of this crisis is the US - it is the world's largest economy, holder of the
international reserve currency, and home to the largest and most sophisticated financial
system. So we are talking about the core of the global financial and economic system where
severe problems arose and have since spread across borders.
In the US, the "shadow" banking system grew rapidly but was quite opaque in the way it
operated. Before long, problems built up and spread to engulf the "traditional" banking sector.
Within a short time, commercial banking operations were severely impaired. Right now, we
are dealing with the bursting of multiple, overlapping bubbles - the housing bubble, the
household credit bubble and the consumption bubble. Cutting across all three bubbles was
leverage - households overstretched themselves; the financial institutions which were
extending this credit to households were themselves taking on excessive leverage. The
combined effect now is a painful deleveraging process that drives down asset prices, shrinks
balance sheets, and feeds straight into the real economy in the form of credit contraction.
Adverse feedback loops between the financial system and real economy have become
entrenched.
The Eurozone, which accounts for the second largest share of global GDP, has deep
financial linkages with the US. Through these linkages, financial stresses were transmitted
across the Atlantic rapidly. Many banks in Europe, as well as other financial institutions such
as insurance companies and asset managers had large exposures to US assets. Many were
over-leveraged and dependent on benign conditions for liquidity to continue flowing. So they
got sucked into this vortex. We have a similar story of credit evaporating and strains being
felt in the real economy.
Over in Japan, recovery from a decade of economic growth stagnation has been derailed by
the collapse of external demand with serious knock-on effects on domestic activity. Japan's
capacity to support the growth of other advanced and emerging economies is now
diminished.
So a global recession is now upon us. The three economic giants - the US, Europe and
Japan - together accounted for just over 50% of global GDP in 2007. All three cylinders are
sputtering. The impact has already been felt worldwide. How long and how deep this
recession will be is still an unknown, though many economists are predicting a long L-shaped
trajectory. What has become clear is that US households can no longer function as the
engine for the entire world economy. Unfortunately, there is no clear alternative growth driver
in sight yet.
On the financial front, American and European banks that have been at the core of
intermediating global capital flows are severely weakened. Global capital flows, not least
flows into emerging markets, are likely to significantly retract in 2009 - as IIF projections
show. Foreign direct investment is set to ease substantially. Cross-border banking flows as
well.
On the surface, this is not unlike previous financial crises originating in emerging economies.
But there is a critical difference. In those cases, external credit typically dries up due to some
domestic factor triggering a loss of confidence in the host country. Foreign financial
institutions become risk averse, and withdraw. This time, large banks in the developed
countries have certainly also become risk averse. But there is also the important factor that
their own balance sheets have been severely impaired, and so, risk aversion aside, they
have little capacity to lend. In other words, a key factor for capital withdrawal this time is
banks in the developed source countries pulling back to hunker down for their survival.
Emerging economies, many with sound fundamentals, are suffering the collateral damage.
This comes after years of rapid growth fuelled by yield-hungry foreign capital.
For these reasons, the transmission of the shocks in the US and Europe to the rest of the
world has been swift and sharp. Indeed there have been many comparisons to the Great
Depression. Yet, compared to the 1930s, an importance difference today is that news spread
across the globe far more rapidly. Even rural households in China and India can now access
this stream of bad news, real-time, through satellite televisions and the internet. The
hyperefficiency of information flows has in itself introduced new uncertainties as sentiment shifts
rapidly and abrupt loss of confidence becomes self-reinforcing.
Crisis response: decisive action needed
How do we deal with this crisis? Despite its scale and unprecedented nature, it may be
instructive to study the pattern of responses in previous crises. In past crises, the responses
typically go through several overlapping phases. Initially, there is a lack of appreciation of the
scale and severity of the problem. This then gives way to fear and panic as the problem
becomes stark. Next, anger sets in, and a hunt for culprits begins. As the financial and
economic stresses take root, pessimism sets in. If remedial actions are seen to be tentative
and lacking in conviction, recovery is delayed and interrupted by bouts of renewed panic. It
may take some time before the hard realities are accepted, and a level-headed search for
viable solutions sets the path for recovery.
Elements of these have been played out in the current crisis. Initially, the "subprime" issue
was regarded as a manageable problem, confined to a small segment of the US housing
market. Then it triggered seizure in the wider credit markets. After months of turbulence, the
hope was that markets would unclog and financial institutions would be quite unscathed by
the credit losses and liquidity strains. When it became clear that this script was wrong, the
new hope was that the real economy would be largely unaffected, and de-coupling would
spare Asia. All these hopes have been dashed. Confidence is at an all-time low,
uncertainties at an all-time high.
The key lesson here is that we cannot base our actions on sequential responses that
underestimate the severity of the situation. Policy actions have to be decisive and coordinated.
Policymakers, financial institutions, businesses and the general public, especially in those
economies most severely affected, will have to make significant adjustments. Those better
able and faster to adopt the right mindset to confront the new environment will fare better for
it, and reduce the prospect of a long period of malaise.
Even with the right mindset, there is no simple solution to resolve these enormous
challenges. But let me suggest three dimensions that need to be tackled: first, take decisive
action to arrest the negative spiral; second, in doing these, keep an eye on medium term
sustainability; third, consider the global dimension and impact on others. Let me touch on
each of these in turn.
Overcoming present difficulties
First, political consensus has to emerge quickly, so that authorities can take decisive action
to arrest the negative spiral between the financial system and the real economy. Injections of
capital into distressed financial institutions and the removal of toxic assets are crucial. Capital
injections thus far have only matched write-downs recorded to date, leaving insufficient
buffers for estimated future write-downs. The clean-up must be thorough. Only then can the
financial system resume its critical role in credit intermediation. In the US, given the role of
the shadow banking system and credit markets which continue to be impaired, alternatives
need to be found to replace these. Bank balance sheets need not only to be maintained, but
expanded to replace capital withdrawn from credit markets. Viable businesses need to get
enough support to ride out extraordinary pressures. We need to rebuild confidence which is a
key foundation for sustained recovery.
Second, while it is important for us to focus on the "here and now", we also need to look
ahead. While "in the long run, we're all dead", quick fixes can return to haunt us faster than
we expect. After the urgent issues are resolved, financial markets will quickly turn their
attention to other weaknesses. Many of the measures today can lay the seeds for structural
difficulties, if these are not withdrawn as soon as practicable.
For instance, the unprecedented easing of monetary conditions, including quantitative
easing, has been necessary to ensure sufficient liquidity in the system as weak bank balance
sheets suppress intermediation. But excess liquidity remaining in the system longer than
necessary is in turn a recipe for inflation into the medium term. The mechanisms for mopping
up the excess liquidity need to be put in place early. Meanwhile, the scale of fiscal stimulus,
and funding needed to support this, has raised the spectre of destabilised sovereign bond
markets and the crowding out of private borrowings. This does not bode well for private
capital formation, and could create stresses downstream for corporations which do not have
the advantage of sovereign backing. Further, if deficits are seen to be structural, market
reaction could negate much of the effect of fiscal stimulus. There is also the issue of how to
restore private-sector driven intermediation of credit in due course. While government
support for businesses' access to credit is necessary now, it cannot continue indefinitely.
In other words, even as we take unconventional measures, we need to have an eye on
medium-term sustainability, and make clear our "exit" strategy and timing. Just as we must
not be behind the curve in taking action to stabilise markets, we need to anticipate what lies
ahead and plan accordingly. This is crucial because that later-stage "exit" action represents
not just the end of this phase but a crucial transition into another set of conditions with totally
different policy demands.
Third, we need to consider the global dimension of our responses, and the impact on other
economies. For instance, the bank deposit guarantee scheme that first started in Ireland
triggered a domino effect and made its way to this region. To minimise uncertainty, some
degree of coordination to remove these guarantee would be necessary. As governments in
the developed economies inject huge sums of public funds to shore up banks, the instinct is
to place demands on these banks to lend domestically. This may seem sensible individually.
But collectively, this 'abandon-thy-neighbour' policy can trigger a big reduction of credit, and
undermine economic recovery that eventually hurts the developed economies. Protectionist
measures hurt emerging economies most, and they can trigger a backlash that sets the
world back. We must resist such regression.
Asia's responses
Let me now turn to the impact of the crisis on Asia, and responses to that.
Asian economies will slow considerably. Those that are more highly dependent on external
demand will contract more sharply than the rest. But unlike during the Asian Financial Crisis,
the fundamentals in Asian financial systems and economies are generally sound. Banks are
well-capitalised and have limited direct exposures to toxic assets. Corporate and household
balance sheets are stronger. Current account positions are healthier and external liabilities
manageable. The policy responses in several countries have been decisive and robust.
Central banks in the region have appropriately eased monetary policy, and governments
have put in place a range of fiscal and other measures to support lending and to cushion the
impact of the global crisis.
Nevertheless, considerable risks remain for Asian economies. The extent of demand
contraction for Asia depends on how long and deep the recession is in the US and Europe.
That remains an unknown. Credit flows to corporations have been affected by the heightened
risk aversion of domestic banks as well as by some pull-back by global banks. A few
economies have experienced considerable capital outflows. The economic contraction will
certainly affect the loan books of banks. Should the downturn be deep and prolonged, the
resilience of banks with weaker risk management systems will be severely tested. It is
necessary to remain vigilant.
However, Asia's economic performance and policy responses so far provide assurance that
the medium-term growth story remains compelling. FDI and domestic investments have
increased over the years, and intra-region production networks have deepened. Both the
hard and soft infrastructures have improved significantly in the last decade. Domestic
consumption's contribution to growth has grown steadily, and will play a bigger role in future.
The drive towards deeper regional integration remains unabated. Just days ago, ASEAN
signed the Agreement Establishing the ASEAN-Australia-New Zealand Free Trade Area, and
re-affirmed its commitment to implement the ASEAN Economic Community.
One important question for many participants here today is the policy direction of Asian
governments towards the financial sector. I believe that authorities in the region will continue
with the twin track of developing the banking system and capital markets. The importance of
a well-functioning financial system in supporting economic growth and wealth creation is well
recognised in this region. The need for funding to promote investment, develop infrastructure
and facilitate urbanisation will return. Once growth resumes, the wealth that is generated has
to be properly deployed. In this regard, global financial institutions, whose commitment and
capacity are being tested by this crisis, need to take a medium-term view of their businesses
in this region.
Singapore's response and commitment
Let me now briefly say a few words on Singapore's responses. Like everywhere else,
Singapore has experienced tightening credit conditions. We have taken action to address
both the inter-bank money markets, as well as the flow of credit from banks to corporations.
In the inter-bank money markets, MAS remains focused on ensuring that both the Singapore
Dollar and the US Dollar markets continue to function smoothly. For the Singapore Dollar
market, we have and will continue to ensure sufficient liquidity, through our monetary
operations and standing facility. For the US Dollar market, we established a US$30 billion
swap line with the US Federal Reserve. This line is alongside other swap lines that the Fed
has with 13 other central banks, including several in Europe and Asia.
As a major funding centre, we took precautionary measures to ensure that global financial
institutions operating here continue to have access to US dollar liquidity. The Federal
Reserve on its part recognised the importance of providing US dollar liquidity to financial
institutions through central banks in sound, well managed and systemically important
financial centres, so as to improve global US dollar liquidity conditions as necessary. We
have not had to use the swap line, nor do we see any impending need. But the precautionary
measure has served us well. We will continue to be vigilant in anticipating issues, and in
taking proactive measures to strengthen the resilience of our system.
With regards to the flow of credit from banks to corporations, we believe this is best
facilitated through government schemes to co-share some of the risks with banks. In
February, the Government announced the Special Risk-Sharing Initiative (SRI). Under this
Initiative, the Government will absorb 75% of the risk for insurance covering working capital
and trade-financing loan facilities. The Government will also absorb 80% of the risk for
bridging loans which go towards meeting firms' working-capital needs. We also have
schemes for SMEs and micro-loans.
Apart from ensuring that the financial system continues to function effectively, the
Government has, as in past periods of downturns, used fiscal measures to minimise the
impact of the crisis. This involves targeted help for families and companies, while continuing
to build capabilities to prepare for the upturn. This time, a creative Jobs Credit Scheme has
been added to help companies keep their workers.
Conclusion
Ladies and Gentlemen, these are very challenging times. The global economy is in
recession, and the financial system remains fragile. We need tough, decisive and
forwardlooking actions in the core economies that are deeply affected.
Asian economies have also been severely affected, and policy adjustments are necessary.
However, the medium-term prospects for growth remain strong. The secular trend in the
growth of Asian enterprises and corporations, growing intra-regional trade, and the demands
for infrastructure financing will generate new opportunities for corporate and institutional
businesses. Wealth creation and the rise of the Asian middle class, coupled with the low
penetration of financial services will drive the growth of personal financial services.
I am confident that when the dust settles, global financial institutions which rebuild their
resilience and stay engaged in our region will increase the value of their Asian franchises.
Asia will continue to provide strong growth opportunities and geographical diversification
benefits. Some Asian financial institutions will also develop strong operations, brand names
and a regional footprint. They will play their role in driving Asia's continued growth.
In Singapore, while we are working to cushion the impact of the crisis, we are also building
capabilities in the economy and the financial sector for the upturn.
I wish you all a fruitful two days of deliberations and interaction.
Thank you.