Asia has nothing to fear
except monsters
By Alan Boyd
SYDNEY - Asia has limited exposure to the US subprime loans fallout, so we can
all take a ringside seat while Europe and North America sort through the
debris. Right? Wrong.
It's true that the tsunami rippling through the lowest and riskiest level of US
mortgage lending has no direct bearing on this region. Asian stocks have been
oversold in the equities fallout and logically their markets should by now have
become safe havens for nervous investors.
But crises have a way of breeding paranoia and sapping consumer confidence long
after the initial bruising has subsided,
even when most stockholders are mere spectators in a drama being played out on
distant shores.
Asian banks are more equipped than most to handle credit strains, having spent
heavily on improved risk-management and regulatory systems after the 1997-98
East Asian economic meltdown. There is even a culture of corporate governance
sprouting in boardrooms.
Balance sheets are generally in good shape thanks to healthy consumer growth
and a flood of cheap financing in global money markets that has left banking
systems awash with liquidity.
Capital inflows in East Asia, which has the continent's most developed
economies, reached a record US$269 billion in 2006, according to the Asian
Development Bank. The downside is that this windfall has exposed many economies
to exchange volatility when the funds are withdrawn - as they often are during
market upheavals.
Jong-Wha Lee, head of the ADB's office of regional economic integration, said
last month that despite growing nervousness over the collapse of the subprime
market, "We do not see this trend of short-term investors withdrawing money
from Asia at this point."
Banks have improved their business models and asset quality by provisioning for
dodgy assets. However, the ADB also noted that the full extent of bad loans in
financial systems might not have been disclosed, especially in Thailand and
Indonesia.
"The continued and possibly understated high levels of non-performing loans are
a concern ... Any economic downturn could lead to the ratios rising from
already elevated levels in a number of economies," the bank warned.
Much of the cash that arrived in 2006 is believed to have found its way into
foreign reserves, but how much went back out to hedge funds or other volatile
financial instruments is unclear. Hence the uncertain mood in Asian equity
markets - and among monetary chiefs.
What we do know is that banks are not at any great risk. Rating agencies
Moody's and Standard & Poor's (S&P) both stated on Friday that Asian
banks had not lent money directly to US subprime borrowers.
The more likely exposure is from holdings of mortgage-backed securities (MBS)
and collateralized debt obligations (CDOs) by banks and insurance brokers:
Japan's banks alone have about $8 billion of declared subprime-related
securities.
In Beijing, the Bank of China, the second-largest lender, is believed to have
some subprime-mortgage-backed securities in its US portfolio, as do banks and
insurers in Singapore and Hong Kong and several Taiwanese financial-services
firms.
S&P said subprime-mortgage-related losses are likely to be "either minimal
or manageable", pointing to a $13 million loss by Taiwan Life Insurance, a
medium-sized financial-services group that had a stake in a collapsed hedge
fund operated by Bear Stearns.
DBS Group, the largest bank in Southeast Asia, has told shareholders that it
has an investment of $850 million in CDOs, with 22% holding varying exposures
to US subprime mortgages.
Malaysia's largest lender, Maybank, has $60 million of credit-linked notes that
were issued by financial institutions with what was termed a "significant"
subprime exposure. There is no substantive bank exposure in India, Indonesia,
Thailand or the Philippines.
All of these positions appear to be fully covered by risk reserves and account
for only a tiny ratio of capital provisions. There is also no evidence that
hedge funds have gone out on a limb, though it will be some time before we know
for sure.
Market analysts say Asian funds mostly have little appetite for CDO tranches
based on subprime instruments that are below investment grade, despite their
extremely attractive rates of return.
The US mortgage and financing markets themselves are in no danger of collapse.
American International Group, one of the lenders with the biggest exposure, has
calculated that the housing market would have to decline by 30-40%, a level
last seen in the Great Depression, before it would suffer extensive losses.
Let's remember that subprimes account for only a small portion of overall
lending activity in the United States and have a negligible imprint in the
stock market, which is backed by an imposing capitalization of more than $16
trillion.
So why the panic?
Securities brokers put it down to a fear of the unknown: Who is absorbing the
losses and how much are they? What impact will the cleanup have on global
interest rates? And how will monetary chiefs react, given that they are already
dampening down liquidity at every opportunity?
Then there is the confidence factor. A mysterious herd mentality emerges during
trading volatility that encourages investors to view all markets as suspect,
curbing lending and eroding consumption to the point where the economic outlook
is affected and even good loans begin to turn bad.
This isn't going to be a long process: reports from the US housing belt suggest
that subprime pressures will peak in October and the whole mess will probably
be cleared away by the end of the year.
But in the meantime, some equity markets will suffer more than others,
especially if structural stresses emerge. Economies most at risk are those with
large external debts, especially current-account deficits, and that have only
modest foreign reserves to cover this exposure.
That immediately excludes India and most of East Asia. Among the few Asian
countries rated as vulnerable are the Philippines and - to a lesser extent -
Indonesia, which have already taken big hits in equity trading.
South Korea, caught in a policy conundrum after an ill-timed monetary
tightening cut credit flows, may also be caught off guard. Household debt
remains high by regional standards, though it has fallen from a peak of 70% of
gross domestic product in 2002.
Japan is suffering from low liquidity after a spate of poor corporate earnings,
forcing an injection of $8.4 billion into money markets by the country's
central bank. Investors were already getting the jitters because of sluggish
growth: Japanese funds lost 0.55% in July and are ahead only 0.72% for the
year.
An exodus is likely from Japanese funds until the dust clears and the
interest-rate trend becomes a little clearer in the US, with investors opting
to park their money in safe government bonds.
And the winners? Countries that have adequate liquidity, a low reliance on
external funding, and strong external balances will fare best. Singapore and
Hong Kong can satisfy most of their financing needs from their own capital
markets and have prudent fiscal planning.
Malaysia will benefit from the capital controls it has retained since 1997
specifically to regulate funding flows and is a market favorite for its strong
government economic policies. Then there is China, which investors simply can't
resist.
The accumulated foreign reserves of China have risen by 130% in the past
decade, to $1.1 trillion, offering a sturdy defense against outside pressures.
The 63 regional China investment funds posted growth of 7.44% in July - the
best performance of any equities worldwide - and 33.86% for the year to date.
That's not a subprime performance by any standards.
Alan Boyd, now based in Sydney, has reported on Asia for more than two
decades.
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