Quantitative Easing

End of easy money won't lead to repeat of 1997 crash in Asia

Erik Lueth sees little sign of excessive inflows due to quantitative easing

PUBLISHED : Monday, 17 June, 2013, 12:00am
UPDATED : Monday, 30 May, 2016, 2:05pm

US Federal Reserve chairman Ben Bernanke has sparked significant nervousness in the markets with recent hints of an end to the third round of quantitative easing.

In Asia, which has benefited from the global liquidity resulting from the Fed's policy, there are fears that various asset bubbles may be about to burst in a repeat of the regional financial crisis of 1997.

However, there is no evidence that we are heading for another crash should the Fed stop its programme of buying US$85 billion worth of Treasuries and mortgage bonds every month to keep long-term interest rates low and encourage lending.

One of the best ways to illustrate this is to look at whether capital flows into Asia from foreign investors have been out of the ordinary. Looking at data going back to 1975 on cross-border capital movements in the shape of foreign direct investment, portfolio flows and loans, the pace of foreign investment under quantitative easing has not been that different from before the global financial crisis.

Specifically, Asia's foreign liabilities increased at a steady pace of 5 percentage points of gross domestic product per year from 2004 and continued at the same pace under quantitative easing.

This stands in marked contrast to the lead-up to the Asian financial crisis, when countries' net foreign liabilities increased by 20 percentage points of GDP per year, on average.

The post-Asian crisis build-up in foreign liabilities looks more like a steady trend, reflecting greater financial integration globally, than a cyclical aberration.

Portfolio flows have been the dominant form of foreign investment for the typical Asian country over the past 15 years. Other investment flows, mostly bank loans, were moderate, while the amount of FDI has declined as a percentage of GDP, but this figure is mainly swayed by the drop in foreign investment in Malaysia and Indonesia after the Asian crisis and in China over the past 10 years.

Does the sanguine assessment also hold for countries of the Association of Southeast Asian Nations? Growth, including credit growth, has been particularly brisk, fuelling fears of an asset bubble. Foreign investment into Asean picked up once the worst of the global financial crisis was over. But, the pace of inflows was not extreme - 10 percentage points of GDP per year - particularly when compared with the run-up to the Asian financial crisis, when foreign liabilities increased by 36 percentage points per year. In addition, the pick-up in capital flows came after 10 years of outflows.

So, there is little evidence of excessive capital flows into Asia in recent years. As a result, a massive and rapid capital flight when quantitative easing comes to an end is unlikely.

There is, of course, the chance of a more orderly wind-down in Asia trades. The likelihood of this depends largely on whether Asia is going to recover alongside the US. If it doesn't, then higher interest rates in the US will lure capital away from the region and Asian equities, bonds of longer maturity and currencies will lose value. But even then, monetary conditions would remain broadly stable, with weaker currencies offsetting the higher cost of capital.

On the other hand, if Asia does recover alongside the US, profits and policy rates will rise and prevent a capital exodus abroad.

For Asia to remain unaffected by the US recovery, one would have to assume that any improvement in the US would be offset by a deterioration in China or Europe (or both). While the outlook for these two economies remains uncertain, most observers believe they have reached the bottom.

Erik Lueth is senior regional economist at RBS and a former IMF economist