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Asian Investors Wrestle With US Crisis Risk

If Asia’s equity and bond markets are any guide, then investors seem pretty sanguine about the risks of the US Treasury running out of cash or the eurozone debt crisis spinning out of control.

Traders sit at their desks at the Stock Exchange in Hong Kong.
Mike Clarke | AFP | Getty Images
Traders sit at their desks at the Stock Exchange in Hong Kong.

The deadlocked talks on raising the US debt ceiling have yet to affect seriously the region’s financial markets. Indeed, Asian stocks have been rising in recent weeks, with the FTSE All-World Asia Pacific excluding Japan index 3 per cent higher than at the start of the year.

And although the cost of insuring against corporate defaults in Asia has become more volatile and expensive over the past two months, the iTraxx Asia ex-Japan index – a measure of credit risk – remains well below its average levels of 2010.

But what if the US has a debt crisis or a probable Greek default adds to Europe’s woes? Is Asia more or less vulnerable to contagion than in 2008, when the global financial crisis swept across western economies?

“Certainly we’re not priced for a full-blown default or credit downgrade by the US,” says Shane Oliver of Sydney-based AMP Capital Investors.

Like most market participants, Mr Oliver is confident US politicians will come up with a solution to lift the borrowing limit before time runs out early next week.

Yet he reckons a serious crisis in the US or Europe would hit Asian financial markets just as hard as three years ago. Others are more bearish, judging the region to be more vulnerable to contagion this time round because governments have less capacity to apply another round of stimulus measures.

In 2008 and 2009, as Lehman Brothers failed, global funding markets seized up and international trade collapsed, Asian stocks and bonds plunged even further than those at the center of the storm in the US.

Those savage declines were all the more galling for investors because in the preceding years the popular view was that Asia was “decoupling” from the west.

“If the US crashes, you’re going to have everything going down with it,” says Fawaz Habel, who runs an Asian bond fund for Value Partners, the Hong Kong-listed asset management group.

Asia remains deeply reliant on Europe and the US, most obviously through exports of goods and services to western consumers but increasingly through the financial system and capital flows.

Viktor Hjort, credit analyst at Morgan Stanley in Hong Kong, says the “fastest and most dangerous source of contagion” for Asian bond markets is the seizing up of global funding markets. In the 2008 financial crisis, European banks cut lending to Asia by 20 per cent, leading to widespread contagion and preventing some companies from rolling over their debt.

Mr Hjort argues that Asian economies are better positioned to face a global liquidity squeeze now compared with 2008 as foreign exchange reserves have grown and banking systems are less reliant on foreign or wholesale funding.

Bond yields are now higher, too, as investors have taken a more cautious approach to default and inflation risks. Similarly, equities in the region are less expensive than three years ago on a range of valuation metrics, suggesting they may have less far to fall in a crisis scenario.

But, despite all that, analysts say there is an important difference between 2008 and today that threatens to make any new crisis much more dangerous: after unleashing unprecedented amounts of money to fight the last financial meltdown, governments and central banks have used up much of their crisis-fighting firepower.

The US Federal Reserve, for example, has cut interest rates to close to zero and the indebted US government is likely to face fierce opposition to any further stimulus spending.

While Asian governments have more room than those in the west to embark on a round of debt-fuelled stimulus spending or to cut interest rates in the face of any new global financial crisis, their capacity to do so has been greatly diminished.

“What got us through the last crisis to where we are now was confidence that the governments and the central banks could do things to settle the markets,” says Owen Gallimore, Asia credit strategist at ANZ. “If we went back into a rocky patch, that plank has been taken away.”

Indeed, the stimulus measures that helped Asian nations recover quickly from the last crisis are now causing uncomfortable side effects. China unleashed the world’s largest stimulus package after the global financial crisis, ordering its banks to lend hundreds of billions of dollars to state-sponsored investment projects. Bad debts are now mounting.

Core inflation, which excludes food and energy prices, is accelerating across much of Asia, even though growth has started to slow due to a weakening in the global economy. In China, consumer price inflation hit a three-year high in June, with prices rising 6.4 per cent from the previous year – well above Beijing’s target at the start of the year of 4 per cent.

Outside China and India, credit growth is still picking up speed.

Ominously, the ratio of credit to gross domestic product across Asia has surged close to levels last seen just before the 1997 Asian financial crisis, according to HSBC. Few expect Asia will run into trouble for the foreseeable future, particularly as dollars still pour into the region in search of higher growth and in the expectation that Asian currencies will continue to strengthen.

But if the US or Europe did plunge into crisis, few would assume that Asian nations would bounce back with the same vigor of three years ago.