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Islamic Finance news

Are Asian banks and financial institutions more resilient to shocks in the global financial markets, having endured one of the worst historical regional crashes in 1997? NAZNEEN HALIM gains expert opinion.

Lest we forget, Asia has taken it on the chin once before. The financial crash in July 1997 saw the Southeast Asian economy tailspin into financial chaos and create large-scale socioeconomic shifts. At the time, it seemed nobody was spared. Countries such as Indonesia and Thailand - some of the worst hit economies - were plunged into an abyss of debt and despair, leaving politicians and industry leaders stumped for a solution while the people rioted in the streets; protesting the fate of their nations and inevitably disrupted livelihoods.

Having enjoyed gratuitous economic highs in the decade leading up to the crash of ’97, the markets of Indonesia, Malaysia, Singapore, Hong Kong and South Korea were on a spending spree. With infrastructure and development projects booming - including the RM20 billion (US$6.3 billion) Malaysian government administrative center ‘Putrajaya’ construction, a building and housing frenzy in Bangkok and South Korea’s semiconductor craze - there was no stopping the development spending of the Southeast Asian economies. Indonesia, which at the time was under the Suharto regime, capitalized on the economic boom, funding investments of up to 300 businesses dominated mostly by those closest to the President, and perpetuating the culture of ‘crony-capitalism’.

Fuelled by double-digit gross domestic investment growth - at 16.3% a year in Indonesia, 16% in Malaysia, 15.3% in Thailand and 7.2% in South Korea between 1990 to 1996 - the Southeast Asian economies seemed unstoppable.

Then suddenly, without warning, it all went up in flames just like the 1937 Hindenburg endeavor. However, instead of an ill-informed use of hydrogen igniting the crash, the economic disaster was fuelled by the flagrant utilization of debt. Following the devaluation of the Thai baht, Malaysia, Indonesia and Singapore all saw their local currencies decline sharply: by more than 50% for Malaysia and 75% for Indonesia by December 1998. The South Korean and Japanese manufacturing sectors also took a big hit, causing mega-manufacturers such as Sanyo and steel manufacturers Hanbo, among others, to file for bankruptcy. Indonesia’s bonds were downgraded to junk bond status, while other countries experienced significant sovereign downgrades. This, coupled with thousands of job cuts, caused nothing less than chaos in the markets.

Christine Kuo, a vice-president and senior credit officer at Moody’s, explains: “At the time, Asian corporates, mainly in Indonesia and Thailand, borrowed foreign currency loans which were also pegged, so the currency regime was very different from how it is now. Then, when the local currencies began to depreciate sharply against the US dollar, suddenly the companies in those markets found it very difficult to service their borrowing currencies back.”

Market reforms
Struggling to get back on its feet, the affected Southeast Asian economies (except for Malaysia) received aid from the International Monetary Fund (IMF) to repay their debt, and took drastic steps to reform the market: including the easing of foreign entry barriers, developing domestic capital markets via the diversification of firms’ funding sources and increased government efforts to develop the domestic bond and equity markets. In Malaysia,  Bank Negara Malaysia in 2001 released the Financial Sector Masterplan with the objective of building an efficient and effective financial sector, focusing on domestic institutions to fuel the financial system.

More than ten years on, industry players believe that the Asian markets, having learnt from their prior hardship, are better equipped to ride out the current global market consternation.

“The main difference today is that most corporates actually have very strong liquidity. We at Moody’s have a monthly Asian Liquidity Stress Index that we publish, and Asian liquidity is at its highest levels since we started publishing this in 2007. It doesn’t go as far back as 1997 because we had fewer rated companies then, whereas now we have a much larger peer group which we can compare.

“I think the liquidity situation is a very strong argument. Companies have been building up cash balances, they have been pre-funding their capital expenditures during the good times, and with a handful of exceptions, the corporates throughout Asia today are in a much stronger position than they were at the time,” Philipp Lotter, the senior vice president at Moody’s Singapore, elucidated.

“The other thing is that most corporates that we rate in Asia are also directed at the domestic economy, so there is not a great deal of export exposure to Europe or the US. Those companies that do export, like the coal and energy companies, export mainly within Asia: to China and to a lesser extent India, which are both power-hungry economies, so that again helps isolate them to a degree to the woes in the US and Europe at the moment,” he added.

Kuo also affirmed this, stating: “If we look at the Asian banks in general, so far most of them have been little affected by the recent global financial crisis; this is mainly because the problem is mainly in the US or European markets. Despite some degree of exposure to these markets, the impact has certainly been quite manageable thus far. Nonetheless, if the US and European economies experience a sharp slowdown or run into protracted recession, the Asian economies would be impacted, which could result in slower loan growth and some increase in problem loans later on.”

Not isolated from the group, Islamic banks within Asia, which are subject to similar regulatory and capital requirements as other banks in the jurisdiction, on top of Shariah requirements for transparency and a fair amount of liquidity, are also expected to fare well.

This is particularly due to a focus on domestic markets such as in Indonesia, where Islamic retail banking and microfinance sectors are expected to fuel the proliferation of the sector; and in Malaysia, where the domestic corporate Islamic bond market is seeing strong support from issuers and equal demand from investors.

Maintaining the edge
With industry analysts confident of Asia to lead the next wave of economic growth, and to some degree maintain the balance in the force, there is much hope resting on these emerging markets. So far, the numbers have been promising. Despite the global economic slowdown, domestic Asian markets have shown consistent growth, and are expected to attract more international funding as the world turns towards the east.

However, although things are relatively robust in the region, industry analysts are still concerned of a spillover effect from the western markets into the east. China, a growing economic superpower and also one of the most active investors in the world at present, is also under the microscope; with market players fearing a possible soft-landing for the republic which could ultimately hurt the global economy and the Asian economy in one fell swoop.

“At the same time, it is important to not be too complacent. If there is a wider economic meltdown in the developed world, then Asia will not be isolated. That will have repercussions in China, and once China slows down, it has repercussions for the entire Asian corporate landscape.

The last couple of months, the global macro-environment has deteriorated, so I think a further slowdown should certainly be expected. And the more intense that slowdown is, the more likely it will also ultimately affect Asia,” Lotter revealed. However, he adds, that would be the worst-case scenario.

Another danger could be Asia’s robust appetite for US dollar loans, causing an imbalance in the investment and funding scale. “On the fixed-income side, we see that a lot of domestic markets are still doing fine. Many of the banks and corporates have been able to raise debt in the domestic market, without too many problems. But if we talk about US dollar funds, it would seem that definitely liquidity is tighter.

“On one hand, we are seeing US dollar loan demand increase. Among the Asian banks, we found that US dollar loans move faster than their local currency loans, because in a few markets there is a substantial interest rate differential. For example in India, the local currency interest rate is much higher than the US dollar interest rate.

Another reason is because the Asian corporates have been relatively active in investing overseas and making acquisitions, fuelling the US dollar loan demand. However, we don’t see the same growth on the funding side,” Christine stated.

Still on the positive side of growth despite the IMF’s recent cut on growth forecasts for some regions (by 0.5% for Indonesia to 4% in 2012), and concerns over Europe’s inability to contain its debt crisis, Asia has so far shown resilience to global financial conditions. And with prudent regulations and effective use of liquidity, another Asian financial crisis could still be avoided.  

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