by Tion Kwa, Asia Society Bernard Schwartz Fellow
Originally presented in the Straits Times, April 30, 2008
America's subprime crisis has circled the world, taking a toll on banks, on stock markets struggling to find a footing, on jobs as companies hunker down, and on economic growth as consumers pull back on spending. Another way it has left its mark is on Asia's corporate bond market.
In regional banks and ratings agencies, the word is that corporate bond issuance in Asia has fallen off the past six months. The reason is obvious when you think of it: an aversion among investors to holding any kind of debt instrument, including bonds.
What has taken its place is just as obvious—bank loans. Put the two together and you get a worrying reminder of a decade ago, when corporate Asia's over-dependence on bank financing brought down what was supposed to have been the "Asian Miracle." People are still trying to figure out how big is the new bank lending trend. It's still very new, and what we have right now is just anecdotal evidence—and a growing unease among those who've seen it all before.
Here's how it goes. Regional banks are swimming in US dollars. Although export growth has eased recently, export earnings are still significant. Manufacturers that earn US dollars exchange these for local currencies as quickly as they can because the American currency is rapidly declining.
The more US dollars they hold on to, and the longer they do so, the less they end up with in local currencies. So banks are obliged to buy the currency from clients and hold it themselves. But with US interest rates low and sliding, there's no joy in owning dollars.
So why not lend it out? Seems like a good idea. But we've been down this road before. In the late 1990s, the sky fell when Asian central banks finally couldn't support currencies that were essentially proxies to the dollar. As values collapsed, dollar-denominated loans became hugely expensive for a broad sweep of companies making money in local currencies.
The difference today is that Asian currencies float more freely. And from borrowers' perspective, this is even better: As the dollar dips and dives, loans get cheaper by the day.
The caveat is that the dollar isn't going to slide into oblivion. Moreover, though the signs say the dollar should remain weak for the medium term at least, over a shorter period markets don't always behave in ways people think they should. Other things being equal—such as the US trade and fiscal deficits—even if the Federal Reserve, for example, were to pause its rate-cutting regime after today's Federal Open Market Committee meeting and eventually start to reverse gear, this doesn't mean the end of the weak dollar. Nevertheless, in this and other situations, the dollar can rally in ways out of proportion to the facts. Then, those dollar loans would become less of a bargain to hold and service, with the possibility of knock-on effects.
One thing those who've lived through a couple of crises can tell you is that there's nothing predictable in market upheavals. Except that they always seem set off by a brigade of bright sparks with the next great idea for making pots of money.
Not incidentally, these smart things are unfailingly twenty-somethings with no memory of the last great idea that wasn't. People blame the subprime crisis on a failure in surveillance, overly elaborate and exotic investment instruments, greed, and so on. But maybe, just maybe, blame also goes to the dependence of financial institutions on new ideas—and old new ideas—from just-minted MBAs with more theory under their belt than experience.
A positive outcome from the Asian crisis was a commitment all around to a more robust and diversified financial infrastructure in the region, one centred on a deeper and broader local-currency corporate bond market. A reversion to old norms is a distraction from this goal at the very least, and at worst increases the risk to markets and economies.
So maybe someone should remind Asian bankers of a little history. In particular, the 25-year-olds and others too young to remember 1997.