Information about Asia and the Pacific Asia y el Pacífico

Chapter 5. Is Asia Still Resilient?

Ratna Sahay, Cheng Lim, Chikahisa Sumi, James Walsh, and Jerald Schiff
Published Date:
August 2015
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Information about Asia and the Pacific Asia y el Pacífico
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Phakawa Jeasakul, Cheng Hoon Lim and Erik Lundback 

Main Points of this Chapter

  • Asia was less affected by the global financial crisis than were other regions because of its lower external and financial vulnerabilities. Asia had learned an important lesson during its own financial crisis in the late 1990s: good economic management is necessary, but not sufficient, to prevent a financial crisis.

  • The market turmoil surrounding the U.S. Federal Reserve’s tapering announcements in mid-2013 led to a repricing of global risk premiums. This episode provided the first test case of whether Asia could remain resilient in the face of more volatile external conditions following the global financial crisis.

  • For the most part, Asian economies that did not binge on the easy global financing conditions after the global financial crisis were relatively unscathed by the “taper tantrum.” By contrast, countries that did releverage and had higher domestic imbalances were hit by sudden stops and sharp asset price corrections.

  • Nevertheless, underlying financial and economic fundamentals have shifted since the global financial crisis. A quantitative analysis comparing more recent conditions with those before the global financial crisis suggests that Asia has become less resilient. Causes include growing domestic imbalances from rapid credit growth and elevated house prices, higher leverage in the household and corporate sectors, and deteriorating external positions.

  • To maintain its standing in the world as an engine of growth, Asia must proactively implement policies to guard against vulnerabilities while pushing ahead with structural reforms.

Resilience During the Global Financial Crisis

Asia proved to be remarkably resilient in the face of the global financial crisis. The scale of capital outflows and the collapse in real activity in late 2008 were of the same magnitude as those experienced during the height of the Asian financial crisis in the late 1990s. This time, however, the outcome for Asia was markedly different. No full-blown financial crisis or sharp destructive external adjustments occurred. Asia was relatively resilient and able to preserve economic and financial stability even as the euro area encountered its worst economic and financial crisis in history and other major advanced economies, including the United Kingdom and the United States, struggled to regain their footing. The economies of several Asian countries, such as China and Indonesia, continued growing throughout the global financial crisis. And the economies of those Asian countries that experienced an initial steep decline in output, such as Korea, Malaysia, and Singapore, posted swift and robust recoveries.

Asia was resilient because of relatively low financial and external vulnerabilities, the result of a decade of financial and structural reform following the Asian financial crisis (Annex Table 5.1.1). In particular, the Asian financial crisis experience prompted many countries in Asia, including those less directly affected by the crisis, to embark on ambitious financial sector reform agendas. New laws and institutions were introduced to fill identified gaps in the regulatory and supervisory framework. Failed institutions were closed, while the remaining viable banks were recapitalized and their legacy nonperforming loans removed and sold to restore profitability. Risk-management policies, including rules on corporate governance and disclosure, were revamped with stiffer penalties set for unsafe and unsound banking practices, and supervisory authorities were given expanded powers to intervene and conduct regular examinations. Policymakers in Asia were also early adopters of what is now referred to as “macroprudential instruments.” These include loan-to-value and debt-service-to-income restrictions, as well as limits on credit growth and on currency and maturity mismatches, all of which are aimed at mitigating systemic risk from excessive financial imbalances.1

At the same time, the private sector, including banks and firms, deleveraged and strengthened their balance sheets.2 Rapid balance sheet restructuring was reflected in sharp declines in banks’ provision of credit to the private sector, particularly in Indonesia, Malaysia, and Thailand. Financial institutions gradually cleaned up their balance sheets, improved risk management, and became more prudent in their risk taking and lending. Likewise, private firms undertook substantial deleveraging, enhanced corporate governance, and became more conservative in undertaking investment, which eventually restored corporate profitability, and strengthened transparency and competitiveness.

Another important reform was a shift toward policies to contain external vulnerabilities. Before the Asian financial crisis, currency pegs encouraged one-way bets that favored foreign currency borrowing, especially in Korea and some Association of Southeast Asian Nations (ASEAN) countries. When it became clear that the pegs were no longer sustainable as capital flowed rapidly out of the region, substantial balance sheet mismatches at banks and firms made the fallout from the devaluation that followed especially severe. In the aftermath of the Asian financial crisis, Asia reduced its vulnerability to contagion and sudden stops of capital flows by more closely monitoring external borrowing and net open foreign exchange positions while accumulating foreign reserves.3 These efforts allowed greater exchange rate flexibility.

These structural reforms reduced Asia’s financial and external vulnerabilities and enabled the region to quickly recover and sustain strong output performance during the global financial crisis. On a weighted average basis, Jeasakul, Lim, and Lundback (2014) find that the drop in output in Asia in the immediate period after the global financial crisis was 3.8 and 1.4 percentage points less than it was in Europe and the Western Hemisphere, respectively; they also find that the recovery period was shorter by about 5.4 and 5 quarters, respectively. As a result, the cumulative output loss in Asia was 21 and 16 percent of annualized 2008:Q3 GDP less than it was in the other two regions, respectively. The study showed that initial financial and external conditions at the time of the global financial crisis were critical to explaining differences in the resilience of economies. In particular, indicators used to capture the degree of financial and external vulner-abilities were statistically and economically significant when tested against output performance.4

The results indicate that the combination of financial factors (modest credit growth, limited reliance on noncore funding, and improved bank asset quality and capitalization) and external factors (reduced external debt, strengthened current account balances, and significant accumulation of foreign reserves) could explain 60 to 84 percent of the difference in the cumulative output loss between Asia and Europe, and 49 to 65 percent of the difference between Asia and the Western Hemisphere (Figure 5.1). Standard macroeconomic variables such as inflation, public debt, and the fiscal balance were also included in the analysis, but were not found to be significant in explaining cross-country differences. This is not to say that macroeconomic fundamentals did not matter in explaining output performance.5 Macroeconomic fundamentals in Asia were sound going into the global financial crisis, but this was also true for many of the countries at the epicenter of the crisis. Asia and many of the advanced economies shared common attributes: low inflation, fiscal surpluses or small deficits, and public debt that was generally below 60 percent of GDP (with the exception of Japan). These indicators were not exceptionally more favorable in Asia compared with the rest of the world. Thus, while credible and consistent macroeconomic policies were necessary to support a stable economy, they alone are not sufficient to explain cross-country differences in resilience during the global financial crisis.

Figure 5.1The Relative Importance of Financial and External Vulnerabilities in Explaining Differences in Output Performance between Asia and Other Regions

(Share of cumulative output loss explained by initial conditions)

Source: IMF staff estimates.

Note: For each region, the share of cumulative output loss (relative to Asia) explained by a particular initial condition is calculated as its estimated output loss (relative to Asia) divided by its actual output loss (relative to Asia). Then, the shares of individual regions are aggregated and weighted by regional GDP. The estimated output loss is based on the bivariate regression analysis.

Another important factor contributing to Asia’s resilience was its regional dynamism and, in particular, China’s strong economic performance. Asia is one of the most dynamic and fastest growing regions in the world, with trade and supply chains that help individual economies sustain each other’s growth momentum. China’s robust growth and appetite for commodities was a boon to regional growth and to commodity exporters such as Australia, Indonesia, and Malaysia. Rough estimates suggest that Asian economies on average gained 1.2 percentage points for each additional percentage point increase in the growth of its partners.

Emerging Market Stress in 2013 and Early 2014

After several years of easy monetary and financial conditions following the global financial crisis, emerging markets came under stress again between mid-2013 and early 2014 (Figure 5.2). In testifying to Congress in May 2013, Federal Reserve Chairman Bernanke raised the possibility of the Federal Reserve tapering its purchases of Treasury and agency bonds. The announcement sent financial shock waves to many emerging markets and triggered sharp corrections in emerging market asset prices and exchange rates, as well as a reversal in capital flows (Sahay and others 2014).6 Market reaction was indiscriminate in the first few weeks of volatility as investors abruptly revised their expectations of future interest rate hikes in anticipation of an earlier-than-expected tightening of monetary policy by the Federal Reserve.7 Subsequent market reaction was more differentiated, and countries with larger external financing needs and macro-financial imbalances—such as Brazil, India, Indonesia, South Africa, and Turkey—came under greater pressure. For example, India and Indonesia, respectively, saw a 140 and 280 basis point increase in their bond yields and 15 percent depreciation in their exchange rates between May and September 2013. Indonesia also suffered significant reserve losses because it initially used foreign exchange interventions (partly directed toward meeting the foreign currency needs of the oil and gas state-owned-enterprise) to limit the rupiah’s depreciation. Emerging Asia as a whole, however, was less affected than were other emerging markets, and the rise in long-term rates and decline in equity prices were somewhat smaller. Markets calmed after the Federal Reserve announced a delay in tapering in September 2013 and provided assurances that tapering would be conditional on the recovery of the U.S. economy.

Figure 5.2Selected Economies: Divergent Developments in Financial Markets

Sources: Bloomberg, L.P.; and IMF staff calculations.

However, during January and February of 2014, global market volatility reemerged. The main contributing factors were lingering concerns about tapering; country-specific imbalances; and idiosyncratic factors, such as Argentina’s debt litigation proceedings and signs of slowing growth in China. This time, market reaction was quick to differentiate, and India and Indonesia, which were seen to have taken more comprehensive policy actions to address domestic imbalances since the 2013 taper tantrum, were relatively unscathed compared with other emerging markets. India’s and Indonesia’s long-term bond yields stabilized, their exchange rates strengthened, and stock prices recovered strongly. By comparison, some other emerging markets, including Argentina, Kazakhstan, and Ukraine, experienced relatively large declines in reserves and sizable exchange rate pressures. Brazil, Turkey, and South Africa, which had tightened monetary policy in response to the earlier bout of volatility, saw bond yields increase but not to the degree seen in the earlier bout. Market turbulence subsided after advanced economies—especially the United Kingdom and the United States—showed signs of economic recovery. Credit risks declined and risk appetite returned. Financial markets in advanced economies rallied, which increased asset prices and compressed spreads relative to emerging market high-yield bonds and equities. Capital inflows to emerging markets resumed in April 2014.

Fundamentals do Matter

The 2013–14 stress episodes show, once again, that economic and financial fundamentals matter in ensuring countries’ resilience to shocks. No single fundamental matters for all countries at all times, given that markets appear to focus on different fundamentals at different times (Sahay and others 2014). Typically, however, countries with large external financing needs, low growth prospects, financial vulnerabilities, and rising public deficit or high inflation become easy targets (Figure 5.3).8 In Asia, both India and Indonesia were struggling with current account deficits, relatively low reserves, and persistent inflation in the period leading up to the tapering announcement. Indonesia had also seen a period of accelerating credit growth and rising credit-to-deposit ratios. In India, credit growth had been weak, but the overhang of corporate debt, rising nonperforming and restructured loans, and persistent large fiscal deficits raised concerns—and at a time when potential growth appeared to be slowing because of structural bottlenecks.

Figure 5.3Emerging Market Economies: Market Reactions and Macroeconomic Fundamentals

Sources: IMF, Information Notice System and World Economic Outlook database; and IMf staff calculations.

Note: BRA = Brazil; BGR = Bulgaria; CHL = Chile; CHN = China; COL = Colombia; HRV = Croatia; HUN = Hungary; IND = India; IDN = Indonesia; MYS = Malaysia; MEX = Mexico; PER = Peru; PHL = Philippines; POL = Poland; RUS = Russia; ZAF = South Africa; THA = Thailand; TUR = Turkey; UKR = Ukraine; VNM = Vietnam; NEER = nominal effective exchange rate.

Both countries took measures starting in the summer of 2013 to address domestic imbalances. Indonesia raised interest rates, scaled back its intervention, and allowed the rupiah to adjust to market conditions. It also implemented measures to increase liquidity and ease pressures on the exchange rate, including the following:

  • Holding biweekly auctions of foreign exchange swaps with resident banks, and allowing derivatives positions held by banks to be passed on to the central bank through the swap auctions

  • Extending the maturities of U.S. dollar term deposits offered by the central bank

  • Relaxing the rules on foreign exchange purchases by exporters to encourage repatriation

  • Shortening the minimum holding period of central bank bills to increase market liquidity

Indonesia also strengthened macroprudential measures and embarked on fiscal consolidation, including cutting energy subsidies. India raised interest rates and took additional actions by relaxing the limits on foreign direct investment and external borrowing, introducing capital flow measures, increasing gold import duties, and tightening fiscal policy.

These efforts paid off, and as the policies started to take effect and gain credibility, the Indian rupee and the Indonesia rupiah recovered, and the Indian stock market reached an all-time high in late 2013. That upward trend continued in 2014. Indeed, capital flows to emerging Asia as a whole were, as noted by the Institute of International Finance (2015), well sustained in 2014, helped by strengthened fundamentals, although the region experienced a phase of volatility late in the year triggered by changes in global risk appetite and the oil price slump. These sustained capital flows were due to generally strong regional growth, corrective policies, the election of pro-reform governments in India and Indonesia, and a return to a functioning administration in Thailand—all of which supported market sentiment.9 Still, the favorable sentiment toward Asia was to some extent a reflection of the region’s relative position rather than of the absolute strength of underlying fundamentals and policies.

Rising Vulnerabilities and New Challenges

Although Asia easily withstood the market turmoil in 2013–14, the experience nevertheless revealed that vulnerabilities have been rising. A bird’s-eye view provided by the Global Financial Stability Report’s global financial stability map (Figure 5.4) shows that, although credit risks in advanced economies have declined since 2008, emerging market risks have risen in step with global risk appetite. Monetary and financial conditions were loose in 2014 compared with conditions in 2008, but they became tighter than in 2013. This is consistent with a closer look at Asia, where financial, external, and macroeconomic developments since 2008 appear to have moved the region to a more vulnerable position.

Figure 5.4Global Financial Stability Map, 2008–14

Sources: IMF, Global Financial Stability Reports (2008, 2013a, 2014a).

Note: Away from center signifies higher risks, easier monetary and financial conditions, or higher risk appetite.

Financial Developments

  • Credit growth—Credit growth has accelerated significantly since 2008 compared with the period before the global financial crisis, when the ratio of outstanding credit to GDP actually declined in several countries (Figure 5.5). In particular, China, Hong Kong SAR, Malaysia, Singapore, and Thailand have gone from moderate to strong credit growth. To some extent, this robust credit growth reflects desirable financial deepening and market development in these economies. However, rapid credit growth also raises concerns—especially for low-income households and small and mediumsized enterprises—if most of the credit is channeled to the property sector and household and corporate balance sheets are stretched.

Figure 5.5Asia: Financial Developments, 2002–13

Sources: Bank for International Settlements, Credit to Private Sector data; IMF, International Financial Statistics, Financial Soundness Indicators database, and World Economic Outlook database; and IMF staff calculations.

  • Household debt—Household debt has increased sharply in China, Indonesia, Singapore, and Thailand, where the household-debt-to-GDP ratio has jumped by 50 percent or more since 2008. Debt levels in Malaysia and Thailand are above 60 percent of GDP. Although some of the risk is mitigated by increased household wealth, leveraged households are likely to be more susceptible than are nonleveraged households to an unexpected or faster tightening of global monetary and financial conditions, sharp corrections in house prices, or a slowdown in domestic growth.

  • Corporate debt—Corporate debt has increased by more than 40 percent in China, Hong Kong SAR, Indonesia, and Singapore since 2008. This rise is modest in comparison with the spike in leverage observed in the mid-1990s. Nevertheless, there is reason to be concerned about already highly leveraged and weaker companies being increasingly exposed to shocks, in, for example, India and Indonesia (IMF 2014c, 2014d). In China, the buildup of debt is concentrated in a “fat tail” of highly leveraged large firms, mostly in real estate and construction. State-owned enterprises’ leverage ratios also have edged up. In Korea, risks are concentrated in a few vulnerable industries including construction, shipbuilding, and transportation, as a result of profitability pressures, liquidity risks, and high leverage.

  • Bank balance sheets—One bright spot is Asian banks, which tend to be well capitalized and liquid, and where supervision is broadly strong (see Chapter 11). Total capital levels have increased across many countries although they remain below those in other regions. Banks are mostly funded by retail deposits, and the ratio of loans to deposits has actually declined slightly since the period before the global financial crisis, limiting concerns about dependence on potentially destabilizing noncore funding. Overall, the ratio of nonperforming loans to total loans has declined, though not by nearly as much as during the period before the global financial crisis, when many Asian countries were repairing bank balance sheets. Banks’ profitability has improved as growth has boosted non-interest revenues, but the acceleration in credit growth of the past few years could pose asset quality issues down the road.

  • Nonbank lending—Across Asia, nonbank lending, which is lightly regulated, has increased substantially. This activity is most evident in China, where nonbank financial intermediation doubled between 2010 and 2013, fueling a real estate market boom in major cities (see Chapter 2). Nonbank lending has also increased in other countries, such as Korea, Malaysia, and Thailand, where lending by specialized and nonbank financial institutions has contributed a large portion to the rise in household debt.

External Developments

  • Current account—Current account surpluses have narrowed since the global financial crisis, and some countries are in deficit (Figure 5.6). Indonesia has gone from surplus to deficit partly because of a significant terms-of-trade shock, notwithstanding some improvement due to weaker domestic demand and a more competitive exchange rate. In India the current account deficit has narrowed thanks to direct measures aimed at curbing gold imports, weak domestic demand, and some revival in exports, but is still in deficit. Current accounts in other Asian countries are still fairly strong overall. Lower surpluses partly reflect the relative strength of the region’s economies, as well as its progress in shifting away from an export-driven to a consumption-based growth model.

  • External debt—The decline in current account surpluses, however, has been accompanied by an increase in external debt, especially in China, India, and Malaysia. In addition, some of the increased borrowing, notably in China, Indonesia, and the Philippines, has been of shorter maturities, making the countries more vulnerable to sudden stops. India also appears to be increasingly financing its current account deficit with debt flows, including in the form of nonresident Indian deposits and external commercial borrowing by leveraged Indian firms. In Indonesia, firms are resorting to external borrowing because domestic lending rates have increased and external spreads have declined, leading to rapidly rising private external debt (including by stateowned enterprises).

Figure 5.6Asia: External Developments, 2007–14

Sources: IMF, International Financial Statistics and World Economic Outlook database; and IMF staff calculations.

  • Reserves—Asian countries still have large foreign reserves as buffers against capital flow volatility. Thanks to recent policy actions to address vulnerabilities, India, Indonesia, and other Asian emerging markets were able to weather the bout of global financial volatility in January 2014 with only limited use of their reserves to counter currency pressures. Indeed, for most Asian countries, reserves ended up higher in 2014 than they had been a year earlier, with the main exceptions being Indonesia and Thailand (IMF 2014d). Still, the foreign reserves coverage of short-term external debt is below levels in effect before the global financial crisis.

Macroeconomic Developments

  • Fiscal positions—With a few exceptions, fiscal positions in the region have weakened relative to historical benchmarks because the fiscal policy responses in the wake of the global financial crisis have not been fully unwound (Figure 5.7). Medium-term fiscal risks could be large because of federal contingent liabilities in the form of loan guarantees, insured deposits, and other obligations. Although fiscal deficits in India and Vietnam are fairly sizable, for emerging Asia as a whole, fiscal balances are strong and debt levels appear manageable, and not a cause for near-term concern.

  • Inflation—Inflation is generally low, and contained inflation expectations provide welcome monetary policy space. The exceptions are India and, to a lesser extent, Indonesia. India’s high and persistent inflation remains a policy concern and is projected to decline only gradually. In Indonesia, inflation expectations appear well anchored despite a recent uptick in prices following a subsidized fuel price hike.

  • Growth outlook—The growth outlook for Asia is solid, but with clear downside risks, and supply-side constraints appear to have reduced potential output. The October 2014 World Economic Outlook (IMF 2014b) and Regional Economic Outlook: Asia and Pacific (IMF 2014d) pointed to financial dislocations associated with higher global interest rates and protracted weak growth in advanced and emerging market economies as the main downside risks to the outlook. Advanced economies, in particular, may face low potential output growth and “secular stagnation,” given that robust demand growth has not yet emerged despite a prolonged period of very low interest rates and increased risk appetite in financial markets. Geopolitical tensions, including turmoil in the Middle East and international tensions surrounding the situation in Russia and Ukraine, could also disrupt trade and financial flows. These tensions could take a toll on market confidence, with adverse effects on growth. In the near term, slower growth in China is seen as a healthy development, but the region could be adversely affected if the slowdown is more acute than expected, or if growth-supporting policies in Japan are not as effective as envisaged. Overall, Asia is expected to continue to drive the global economic engine, but it may do so at a slower pace. World Economic Outlook forecasts for real GDP growth in emerging Asia have been gradually pared down since 2011 even though potential growth in Asia is still higher than it is in other regions.10 The reasons behind the lower growth prospects vary across economies, and include deceleration or a leveling off of total factor productivity growth in key Asian economies (ASEAN, with an exception of the Philippines); a rebalancing of growth away from investment; less dependence of the economy on credit (China); and supply bottlenecks in infrastructure, power, and mining (India).

Figure 5.7Asia: Macroeconomic Vulnerabilities, 2006–18

Sources: IMF, World Economic Outlook database; and IMF staff calculations.

Note: Each vintage graph shows actual numbers up to the previous year and projections thereafter.

These developments suggest that Asia has become less resilient to shocks than it was before the global financial crisis. On the financial front, although bank balance sheets appear strong, risks have increased because of accelerated credit growth. This growth has come through nonbank lending and through substantially higher levels of household and corporate debt. External positions still appear to be relatively strong, and large reserves are providing buffers. However, current accounts have deteriorated and external debt, including shorter-maturity debt, has increased in several countries. Also, macroeconomic vulnerabilities have increased because fiscal positions have weakened and growth prospects have been revised down, even though the growth outlook is still solid.

Resilience: How Would Asia Fare Today Given a Global-Financial-Crisis-Sized Shock?

Given these developments, how resilient is Asia today, compared with its resilience during the global financial crisis period? In other words, what would be the impact on output performance today if Asia were hit by shocks similar in size to the shocks during the global financial crisis? Applying the methodology used by Jeasakul, Lim, and Lundback (2014) to financial and external conditions at end-2013, the analysis finds that Asia looks less resilient today compared with during the global financial crisis period (Table 5.1). There would be a larger output loss of some 6½ to 8½ percent of GDP compared with the loss witnessed following the global financial crisis if Asia were to be hit by similar shocks (Table 5.1).

Table 5.1.Estimated Impact on Output Performance Using End-2013 Initial Conditions and Shock Equivalent to Global Financial Crisis
Initial ConditionsEstimated Impact

on Output

Asian financial

crisis countries
All AsiaCumulative

output gain

(percent of GDP)
Before Asian

financial crisis
Before Asian

financial crisis
Before global

financial crisis
Change in ratio of credit to GDP4.61.9−1.64.4−7.0
Increase in bank nonperforming loans to total loans−7.0−0.6−1.3
Banking system’s net foreign assets−7.3−−0.6
Increase in ratio of bank capital to total assets1.10.8−0.1
Credit-to-deposit ratio142.5105.588.286.00.3
Cumulative net nondirect investment inflows4.−2.7
Gross external debt40.823.316.223.3−2.5
Net external debt−5.45.5−2.0
Current account deficit4.50.4−5.4−1.3−1.5
Ratio of foreign reserves to short-term debt72.6109.4440.9385.7−1.0
Preferred multivariate specifications:2
Net external debt−8.3
Ratio of foreign reserves to short-term debt−7.4
Gross external debt−6.7
Source: IMF staff estimates.

The difference in estimated cumulative output gain following a global shock between the global financial crisis and end-2013.

Multivariate regressions are based on change in the ratio of credit to GDP, increase in bank nonperforming loans to total loans, credit-to-deposit ratio, and one of the following external vulnerability indicators: gross external debt, net external debt, and ratio of foreign reserves to short-term external debt.

Source: IMF staff estimates.

The difference in estimated cumulative output gain following a global shock between the global financial crisis and end-2013.

Multivariate regressions are based on change in the ratio of credit to GDP, increase in bank nonperforming loans to total loans, credit-to-deposit ratio, and one of the following external vulnerability indicators: gross external debt, net external debt, and ratio of foreign reserves to short-term external debt.

The rise in both financial and external vulnerabilities has contributed to this estimated reduced resilience to shocks comparable to those of the global financial crisis. The rapid expansion in private sector credit explains the bulk of the cumulative decline in output loss, roughly an estimated 7 percentage points of GDP.11 The estimated cumulative effects of higher external debt and lower current account surpluses (or higher deficits) explain about 1 to 2½ percentage points of GDP. Nevertheless, the current deterioration in macro-financial conditions in Asia is nowhere near the scale seen in the period leading up to the 1997–98 Asian financial crisis for the crisis countries. Moreover, current conditions in Asian countries would still lead to a better outcome for Asia today compared with other regions during the global financial crisis. The results of this analysis suggest that Asia is still in a strong position, but that emerging vulnerabilities, fueled by cheap and plentiful money since the global financial crisis, have made it more susceptible to shocks. The 2013–14 episodes were a first test of Asia’s resilience since the global financial crisis.


Asia proved to be remarkably resilient during the global financial crisis when many advanced economies around the world succumbed to a financial and economic meltdown. This strength reflected the lessons learned from the Asian financial crisis of the late 1990s. That crisis triggered wide-ranging financial and structural reforms that led to stronger banks, improved corporate governance, more sustainable current account balances, and a stockpile of foreign reserves to cushion a sudden reversal of capital inflows. The active use of macroprudential policies well before they were recognized as an essential component of the financial stability toolkit, and the overhaul of Asia’s financial regulation and oversight framework, forced positive changes in risk taking by households and firms. In addition, Asian economies benefited from being part of a fast-growing region with momentum from trading partner growth. These conditions helped the region recover quickly from the global crisis after an initial decline in output.

The financial market turmoil in 2013–14 was the first test of Asia’s resilience since the global financial crisis. Although the turmoil was not caused by the kind of broad and massive global shocks that triggered the global financial crisis, the experience of Asian economies demonstrated once again that economic and financial fundamentals matter, and that strong policies—both preventive and remedial—pay off. Across the world, countries with larger external financing needs and macro-financial imbalances came under greater pressure. Asia with-stood the test well, but it was clear that, for the first time since 2008, rising vulnerabilities weighed on market sentiment. This chapter’s quantitative comparison of current macro-financial conditions with those prevailing before the global financial crisis suggests that Asia’s domestic imbalances have grown. The influx of cheap money from abroad has encouraged rapid credit growth, which has, in turn, resulted in more leveraged household and corporate sectors, elevated house prices, and higher external debt. Supply-side constraints, including those caused by infrastructure bottlenecks, have also dampened growth prospects.

Asia remains the world’s engine of growth, but in the future, it may well have to adjust to rates of economic growth lower than those reached during the boom before the global financial crisis. Making the transition to this “new normal” will be a challenge that policymakers in Asia will no doubt rise to meet. However, policymakers will need to summon the political will to push ahead with structural reforms to deliver sustainable growth while at the same time strengthening fiscal and macroprudential policies to contain systemic risks, and provide the room to take countercyclical measures, should the need arise.

Annex 5.1
Annex Table 5.1.1Financial Sector Reforms Following the Asian Financial Crisis
Amendments to the banking law
  • Modified requirements regarding bank secrecy

  • Ended restrictions on foreign ownership of banks

  • Enabled the Indonesian Bank Restructuring Agency to transfer assets and to foreclose on a nonperforming debtor

Strengthening the prudential and regulatory framework
  • New regulations regarding loan classification, loan provisioning, and the treatment of debt restructuring operations

  • New liquidity management reporting requirements: Banks required to submit liquidity reports twice monthly for their global consolidated operations, including the foreign currency liquidity profile and actions that the bank intends to take to cover any liquidity shortfall or absorb any liquidity surplus

  • New regulations to tighten rules for connected lending

  • Disclosure of financial statements: Banks required to publish their financial statements quarterly, beginning April 1999

Banks resolution framework
The Deposit Insurance Corporation (Lembaga Penjamin Simpanan) Law of 2004 established a coordination committee comprising the Ministry of Finance, the Bank of Indonesia, and the Lembaga Penjamin Simpanan to determine the policy for the resolution and handling of a failing bank that is expected to have a systemic effect
Reforms of institutional arrangements, based on Presidential Commission on Financial Reform in 1997
  • Significantly strengthened the independence of the Bank of Korea

  • Consolidated financial sector supervision in a single Financial Supervisory Commission and unified supervisory authority (the Financial Supervisory Service), separate from the government

  • Legislation to grant the Financial Supervisory Commission power to license and delicense financial institutions, as well as to supervise specialized and development banks

  • Merged deposit insurance protection agencies into the new Korea Deposit Insurance Corporation, which was provided with powers and funds to pay back deposits in failed institutions and, if necessary, to provide recapitalization funds to banks

  • Established a Financial Restructuring Unit within the Financial Supervisory Commission to oversee and coordinate the restructuring of the financial sector

Strengthened prudential standards and supervision procedures
  • New loan classification standards and provisioning rules under which loans more than three months overdue are classified as substandard; general provisioning requirement increased.

  • Regulations to require provisioning for securities losses and to discontinue the inclusion in Tier 2 capital of all provisions for nonperforming loans

  • Loan classification and provisioning guidelines to take into account a borrower’s future capacity to repay in classifying and provisioning loans

  • Strengthened prudential supervision and regulation of foreign exchange operations by commercial and merchant banks, including requiring short-term assets to cover at least 70 percent of short-term liabilities, and long-term borrowing to cover more than 50 percent of long-term assets

  • Banks to maintain overall foreign currency exposure limits per counterparty, including foreign currency loans, guarantees, security investments, and offshore finance

  • A maturity ladder approach requiring banks to report maturity mismatches for different time brackets, and with limits on mismatches

  • Limits on exposures to single borrowers and groups, and tightened regulations for connected lending

  • Full foreign ownership of merchant banks allowed

Measures to strengthen the financial sector introduced in 1998
  • Stricter loan classification and provisioning standards: Classification standards to be brought to best practice standards; 20 percent provisioning requirement against uncollateralized portions of substandard loans; off-balance-sheet items incorporated in the loan classification and provisioning system

  • Tightened rules for accounting interest in suspense, such that banks would be required to reverse unpaid interest out of income and record it in the interest-in-suspense account

  • Tighter capital adequacy framework: Increased risk-weighted capital adequacy requirements of finance companies from 8 percent to 10 percent; minimum capital for finance companies increased from 5 million ringgit to 300 million ringgit; compliance with capital adequacy requirement required each financial quarter

  • Single borrower limit reduced from 30 percent to 25 percent of capital funds

  • Aggregate statistics on nonperforming loans, provisions, and capital positions for all financial institutions to be published monthly by the Bank Negara Malaysia

  • All institutions to report and publish key indicators of financial soundness on a quarterly basis; banks required to report on the ratio of nonperforming loans broken down into substandard, doubtful, and loss; loans by sectors on a quarterly basis

  • More intensive and rigorous supervision of banks through monthly stress tests by Bank Negara Malaysia and a requirement for similar exercises by individual institutions on the basis of parameters set by Bank Negara Malaysia

  • A prudentially based framework for assessing bank liquidity risks was introduced, effective August 2, 1998

  • Bank Negara Malaysia facilitated the merger program of finance companies on market-based criteria

Ten-Year Financial Sector Masterplan for 2001–10
  • Bank merger program designed to take advantage of economies of scale and to determine an exit strategy for the weakest banks; domestic banks given broad flexibility to form their own merger groups

  • Changes to regulation and supervision in line with best practices, including implementing risk-based supervision with more focused supervisory attention for weak institutions, refined calculation of risk weightings for capital adequacy, implementation of a system of incremental enforcement action, and early warning system

Broad financial sector reform program
  • Raised minimum capital requirements for banks, and phased out lower capital requirements for certain universal banks

  • Banks required to make a general loan-loss provision of 2 percent and specific loan-loss provisions of 5 percent for loans specifically mentioned, and 25 percent for secured substandard loans

  • The Bangko Sentral ng Pilipinas required banks to start marking to market their trading securities portfolio

  • All banks listed on the Philippine Stock Exchange instructed to publicly disclose detailed information on a quarterly basis, including the level of nonperforming loans, and the ratio of nonperforming loans to the total loan portfolio

  • Consolidated supervision of financial conglomerates

  • Stricter licensing guidelines for establishing banks, focusing on the statement of income and expenses; evidence of asset ownership; and in the case of a foreign bank, certification by the home supervisory authority that it agrees with the proposed investment

  • Changed focus of supervision activities from compliance-based and checklist-driven assessments of banks’ condition to a forward-looking and risk-based framework

  • Improved rating methodologies. The capital adequacy, asset quality, management quality, earnings, sensitivity to market risk (CAMELS) rating system revised, including to ensure that the composite rating will never be better than the bank’s individual factor rating for capital adequacy

  • External auditors of banks required to report to the Bangko Sentral ng Pilipinas all matters that could adversely affect the financial condition of their clients, any serious irregularity that may jeopardize the interests of depositors and creditors, and any losses incurred that substantially reduce the bank’s capital

Addressing recognition and resolution of weak banks
  • Intensified bank monitoring of selected banks

  • Measures to improve the ability of the Philippine Deposit Insurance Corporation to act as the receiver of banks, including selling assets of distressed banks to pay for the administration costs related to receivership, and faster approval by the Monetary Board of a proposed liquidation

  • Prompt corrective action and explicit procedures for bank capital shortfalls

Later measures
  • Memorandum of Agreement between the Securities and Exchange Commission and the Bangko Sentral ng Pilipinas (2001)

  • Anti-Money Laundering Act (2001)

Revamping of the prudential framework
  • Tightening of loan classification, with loans being classified into five categories

  • Establishment of strict rules on interest accrual

  • Provisioning requirements gradually tightened to bring them in line with international best practice

  • Rules for classification and provisioning of restructured loans set clear incentives for banks and finance companies to actively initiate restructuring of nonperforming loans

  • New regulation requires collateral for loans larger than a certain size to be independently appraised

Strategy to restructure and rehabilitate the financial system
  • Established the Financial Sector Restructuring Agency to deal with suspended finance companies, replacing the Bank of Thailand and the Ministry of Finance temporarily as decision maker on all matters related to financial sector restructuring

  • Amended the Commercial Banking Act and the Finance Company Act to empower the Bank of Thailand to request capital reductions, capital increases, or changes in management in troubled commercial banks and finance companies

  • Established an asset management company to deal with assets of finance companies that had their operations suspended, or impaired assets in any financial institution in which the Financial Institutions Development Fund had acquired shares (intervened) and assumed management control

  • Amended the Bank of Thailand Act to empower the Financial Institutions Development Fund to lend to these institutions with or without collateral, raise the fee charged to financial institutions whose depositors and creditors were protected, and make explicit the government’s financial support of the Bank of Thailand

Sources: IMF (1999); and Financial Sector Stability Assessment reports for Financial Sector Assessment Programs undertaken in the countries.
Sources: IMF (1999); and Financial Sector Stability Assessment reports for Financial Sector Assessment Programs undertaken in the countries.

    AizenmanJoshuaBrianPinto and VladyslavSushko. 2012. “Financial Sector Ups and Downs and the Real Sector: Up by the Stairs and Down by the Parachute.University of California Santa Cruz Department of Economics Working Paper 689 Santa Cruz California.

    GourinchasPierre-Olivier and MauriceObstfeld. 2012. “Stories of the Twentieth Century for the Twenty First.American Economic Journal: Macroeconomics4 (1): 22665.

    Institute of International Finance. 2015. Capital Flows to Emerging Markets ReportThe Institute of International FinanceWashington.

    International Monetary Fund (IMF). 1999. Financial Sector Crisis and Restructuring: Lessons from Asia. Occasional Paper 188. Washington: International Monetary Fund.

    International Monetary Fund (IMF). 2008. Global Financial Stability Report: Assessing Risks to Global Financial StabilityWashingtonOctober.

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    International Monetary Fund (IMF). 2014b. World Economic Outlook: Legacies Clouds Uncertainties.WashingtonOctober.

    International Monetary Fund (IMF). 2014cIndia: 2014 Article IV Consultation.IMF Country Report No. 14/57.Washington.

    International Monetary Fund (IMF). 2014d. Regional Economic Outlook: Asia and Pacific.WashingtonApril.

    JeasakulPhakawaCheng HoonLim and ErikLundback. 2014. “Why Was Asia Resilient? Lessons from the Past and for the Future.Journal of International Commerce Economics and Policy5(2).

    LimCheng HoonFrancescoColumbaAlejoCostaPiyabhaKongsamutAkiraOtaniMustafaSaiyidTorstenWezel and XiaoyongWu. 2011. “Macroprudential Policy: What Instruments and How to Use Them? Lessons from Country Experiences.IMF Working Paper No. 11/238International Monetary FundWashington.

    MishraPrachiKenjiMoriyama and PapaN’Diaye. 2014. “Impact of Fed Tapering Announcements on Emerging Markets.IMF Working Paper No. 14/109International Monetary FundWashington.

    ParkDonghyunAriefRamayandi and KwanhoShin. 2013. “Why Did Asian Countries Fare Better during the Global Financial Crisis than during the Asian Financial Crisis?” In Responding to Financial Crisis: Lessons from Asia Then the United States and Europe Now edited by ChangyongRhee and Adam S.Posen. Washington: Asian Development Bank and Peterson Institute for International Economics.

    SahayRatnaVivekAroraThanosArvanitisHamidFaruqeePapaN’Diaye and TommasoMancini-Griffoli. 2014. “Emerging Market Volatility: Lessons from the Taper Tantrum.IMF Staff Discussion Note No. 14/09International Monetary FundWashington.

For an analysis of macroprudential tools and usage, see IMF (2013b). Lim and others (2011) provide a comprehensive overview of global country experiences, including Asian countries.

Gourinchas and Obstfeld (2012) identify the rapid buildup of leverage as a key precursor to financial crises in emerging market and advanced economies.

Aizenman, Pinto, and Sushko (2012) examine episodes of financial sector booms and contractions, and conclude that the effects on the real economy from abrupt financial contractions are mitigated by buffers of foreign reserves.

Output performance is defined as the cumulative real GDP loss or gain from the 2013:Q3 level through 2010:Q4. Economic resilience minimizes the output loss for each country as estimated in a series of bivariate regressions yi = α + βxi + ∊i, in which yi is output performance in country i and xi is an indicator capturing the degree of financial or external vulnerabilities in country i before the global financial crisis. Other definitions, measuring the depth of the output decline from precrisis peak to trough, or the length of time it takes for output to recover to the 2008:Q3 level, were also used with qualitatively similar results.

In a related study, Park, Ramayandi, and Shin (2013) analyze factors explaining output performance in countries that have experienced a currency crisis. They find that basic macroeconomic conditions such as inflation and GDP growth before a crisis can explain output performance. However, their focus is on comparing the experiences during the Asian and global financial crises of the five Asian economies that were hit the hardest during the Asian financial crisis, and not on the differences in output performance between Asia and other countries and regions.

See IMF (2014c) and Sahay and others (2014) for an analysis of the impact of the Federal Reserve’s tapering announcements on emerging market asset prices and capital flows, and the different reactions across countries.

Systemic liquidity mismatches appeared to have amplified the price reactions. Large increases in nonresident holdings of local currency debt coincided with a decline in liquidity conditions in secondary markets, which can create larger market price fluctuations during periods of outflows even if the outflows are small. See the IMF’s October 2014 Global Financial Stability Report (IMF 2014a).

The analysis of factors explaining cross-country experiences during 2013 and early 2014 is very much ongoing, but there is agreement that external vulnerabilities and macro imbalances (in particular, current account deficits, high inflation, and fiscal imbalances) have been key in setting countries apart. See, for example, IMF (2014b) and Mishra, Moriyama, and N’Diaye (2014).

See Institute of International Finance (2015). The conclusions are based on estimates for the whole of 2014.

Based on comparison of outer year forecasts in the World Economic Outlook database for April 2009 and 2014.

Estimated effect from bivariate regression, 2008:Q3 annualized real GDP (Table 5.1).

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