Global Financial Turmoil Tests Asia

• Author: Kenneth Kang/Jacques Miniane
• Position: Deputy Division Chief/Economist in the IMF's Asia and Pacific Department
• Pages: 34-36

As the global financial crisis spreads, how will Asia weather the storm?

Page 34

Compared with other regions, Asia appeared at first better positioned to weather the storm created by the global fiancial crisis, thanks to its substantial official reserves cushion, improved policy frameworks, and generally robust corporate balance sheets and banking sectors.

However, after the collapse of Lehman Brothers in mid-September and the ensuing rise in global risk aversion, the crisis spread to Asia and rattled many of its markets. Any hope that the region would escape the crisis unscathed has by now evaporated.

With global growth expected to slow markedly next year and deleveraging to continue, Asia will likely face a difficult period ahead. How Asia withstands the shock of both slower global growth and a spreading financial crisis is critical not only for the region, but for the world as a whole.

[ GRAPHICS ARE NOT INCLUDED ]

Page 35

Asia's financial systems

Some important characteristics of Asia's financial systems protected them early on from the worst of the crisis. These systems tend to be bank dominated and generally have not engaged in the off-balance-sheet activities or invested in the illiquid securitized assets at the heart of the current crisis in advanced economies.

Asian financial institutions overall have limited exposure to U.S. subprime mortgages and structured credit products from overseas, attributable in part to the more cautious risk management and the strengthening of the regulatory structure that resulted both from Japan's banking crisis in the late 1990s and the 1997 financial crisis in emerging Asia.

Moreover, the region's derivative and structured products remain for the most part in relative infancy.

But given the region's large trade and financial integration with the rest of the world, investors' views of Asia soured as the global turmoil intensified and perceptions grew that the global economy was in for a major slowdown. Large net equity outflows have driven down stock prices sharply (see Chart 1). Asia-focused hedge funds have been among the worst performers worldwide, with their returns consistently below those of other emerging market funds.

Capital outflows have also significantly weakened currencies in some countries, notably India, Korea, New Zealand, and Vietnam. And several countries...