How badly will Singapore be creamed if we see a repeat of 2008/09?

RBS has some worrying views, time to hold on to your hats.

In a report, the bank discussed the strong linkages between developments in the Euro zone and its implications for the region in previous reports. Given the rising severity of problems in the Euro zone, we now consider the available policy options available to regional authorities. Policy responses during 2008/09 provide useful guidance although both the capacity to respond and underlying fundamentals of the region have changed over time.

To put the discussion in perspective, we have initially summarised the main channels of transmission from Europe. They include: (1) deterioration in external trade; (2) de- leveraging by EU banks and (3) outflow of portfolio capital. The first of these has already been in play since mid-2011, consistent with weaker spending and tighter lending standards in EU.

The new threat however, is a severe and prolonged risk contagion induced compression in EU demand. This will be difficult to manage. Though diminishing, the EU remains a formidable export market for the region and can not be easily replaced by other export markets at least in the short run.

As regards bank de-leveraging, the exposure of EU banks to the region has been declining in an orderly manner. The issue that deserves consideration now is the risk of a more rapid paring down of exposure that is accompanied by (1) is not confined to EU banks and (2) accompanied by credit retrenchment by domestic institutions. 

Our observation from the Lehman crisis is that deleveraging is contagious i.e. regardless of geography with even local institutions tightening lending standards. The IMF has estimated that a 1% decline in foreign bank liabilities resulted in a 0.6%-0.7% contraction in domestic credit during the Lehman crisis. European banks are also engaged in specialised activities including trade and project finance.

The impact of a withdrawal of portfolio flows is difficult to quantify. Based on the net international investment position (NIIP) data, the aggregate stock of portfolio flows into Asia were slightly over 14% of GDP (excluding Hong Kong and Singapore).

The domicile of these funds is not known but in a period of global risk aversion, outflows are likely to indiscreet. During the Lehman crisis, the drop in the stock of portfolio capital was almost 7% of GDP. The consequent impact on regional stock markets was formidable with declines in some markets like Hong Kong surpassing even during the 1997/98 Asian financial crisis. What that meant was a sizeable negative wealth effects and diminished corporate valuations – the end result being higher levels of precautionary savings and reduced investment activity.

For ensuring foreign currency liquidity, most central banks now have a higher level of foreign currency reserves than in 2008/09. Equally important are intra-regional defences including the Chiang Mai Initiative Multilateralisation (CIMM). The CIMM is a self-managed reserve pooling system of ASEAN + 3 with a total corpus of USD120bn (the corpus itself is set to be doubled). CIMM members are allowed to tap as much as 30% of their quota without attracting any form of IMF conditionality.

With this, even the region’s smaller economies like the Philippines can access USD2bn- 3bn without attracting any IMF supervision. We also believe that swap lines with the Fed could be reactivated which during the last crisis were established with Hong Kong,Korea and Singapore. Other countries including Korea and India have recently increased their bilateral swap facilities with Japan. 

Both economies are vulnerable to dollar shortages. However, the problem with both of these bilateral and multilateral swap facilities is that they have not been tested. Post the 1997/98 Asian financial crisis, the stigma of tapping swap lines is high. A change in policymaker mindset will be critical.

Finally, the issue of replacing weak exports with new growth drivers. Moderating trade/current account surpluses in most economies suggests that the region has had some success in strengthening domestic demand dynamics. This nascent shift in growth dynamics may however, not suffice in a deep downturn in external demand and a more expansionary fiscal policy may become essential. Public debt has remained within manageable limits in most countries despite the implementation of sizeable stimulus programmes.