By our metrics, which are encapsulated by ratings, the credit standings of Asian sovereigns have fared better than those of the rest of the world's governments. They have fared better because the governments took difficult measures in past crises to reduce their economies' vulnerabilities. Standard & Poor's recently reviewed the region's progress at a meeting of 11 central bank deputy governors in Kuala Lumpur and this is what we told these representatives from Australia, China, Hong Kong, Indonesia, Japan, Korea, New Zealand, Malaysia, Philippines, Singapore and Thailand (the East Asia-Pacific countries, EAP 11).
The EAP 11's credit standing has been on an upward trend since the Asian financial crisis a decade ago. The ratings on Australia, China, Hong Kong, Japan, New Zealand and Singapore were largely unaffected by the Asian crisis and -- except for Japan -- have largely trended upward for the past couple of decades (see chart 1). Indonesia, Korea, Malaysia, Philippines, and Thailand were more affected by the Asian financial crisis; most of these ratings have bounced back, although not completely to previous levels. We believe that the measures these governments took after the Asian crisis to gird their economies to future external shocks helped insulate them from current economic travails.
After the Asian financial crisis, the EAP 11 members' ratings improved but not because there was a cyclical recovery. Rather, the governments undertook micro reforms that boosted medium-term growth prospects; fiscal debt levels were gradually reduced; and the countries' external positions were improved. These measures took fortitude. Policymakers expended political capital to carry them out. Australia and New Zealand had enacted similar steps five years before, when they underwent a similar downturn. In these ways, we believe this group of 11 serves as a good model for many Western governments that are now undergoing a test of similar proportions.
Here, we are also looking at why the EAP 11's credit standing fared so well through the recent global recession, and what its ratings future looks like. We haven't lowered any of the ratings for the EAP 11 members in the past five years, not even during the global recession from which we are now emerging. However, we have assigned negative outlooks on two: Japan and Thailand. The other eight have stable outlooks, indicating that we believe they are likely to hold up well in current conditions -- remember that ratings are forward-looking opinions on the likelihood of an issuer paying its debt in accordance with its terms. Ratings are not opinions on whether an issuer's security is costly or cheap, or whether or not it is appropriate for a portfolio.
A range of credit fundamentals helped brace the EAP 11 for a global recession. Indeed, we believe that most of the EAP 11 entered the recession from a position of strength. Apart from Australia and New Zealand, savings rates are high and afford countries more flexibility in adjusting to downturns. It is usually easier to cut government capital spending than current expenditures. Companies with strong cash flows need to worry less about sudden stops in financing. Households that don't consume all of their earnings have less difficulty managing when household income falls. Similarly, household credit is moderate in the Asian members of the EAP 11.
Partly as a result of the high savings rate, most of the EAP 11 also entered the global recession with a strong international investment position. China, Hong Kong, Japan, Malaysia, and Singapore are net external creditors. Korea's and Thailand's external assets exceed their external debt. On the other hand, external debt is quite high in both Australia and New Zealand.
The conditions of the political economy have been supportive, too, for the most part. By this, we mean the strength of the social contract; the ability of policymakers to respond quickly to changing developments; and the institutional arrangements that provide checks and balances between different branches of government. The markedly improved political settings in Indonesia since the end of Suharto's rule for example, have contributed to a series of upgrades, while political troubles in Thailand contributed to our assigning a negative outlook in December 2008.
The banking systems of the EAP 11 held up well during the global crisis. Most of the banks had little allocation to structured finance products in their liquidity portfolios. Loan underwriting standards had been tightened since the Asian crisis and since the deep economic downturn of the early 1990s in Australia and New Zealand. Deposit-to-loan ratios were conservative, except in Korea, Australia, and New Zealand.
So, what lies ahead for this resilient and dynamic group? Although real economic output for all the EAP 11 declined during the recent global downturn, we forecast a solid recovery across the board. In part because of the favourable initial conditions just cited, domestic demand has proved resilient, except in Japan where deflationary pressures, an aging labour market, and consumer caution have sapped the domestic economy's vitality.
For the EAP 11, the sharp recovery in global inventories is helping export demand. The quick return of capital inflows, in part motivated by very low interest rates in the West, has helped too, as has the West's own fiscal stimulus, some of which leaked to the West's trading partners. We see trough-to-peak jumps in real economic growth of more than 4% of GDP for Japan, Korea, Malaysia, Singapore, and Thailand.
We also forecast that almost all of the EAP 11 will consolidate their fiscal positions in the next two-and-a-half years. The impact of the global recession on the group varied according to the governments' ability or desire to run countercyclical fiscal policies, the composition of government revenues, and the tightness of the social safety net. On the revenue side, higher reliance on more variable taxes depressed revenues in Hong Kong, Singapore, New Zealand, Philippines and Indonesia compared with the other EAP 11 members. Automatic stabilisers on the expenditure side were also allowed to operate in Australia, Japan, New Zealand, Singapore, and Thailand. The result was a deterioration of the general government fiscal balance of more than 3% of GDP in the EAP 11 between 2008 and 2010, except for Hong Kong, Indonesia and Malaysia.
The global recession caused net government debt positions to worsen by 10% of GDP or more for Australia, New Zealand, Japan, Malaysia and Singapore from 2008 to 2010 (or the net asset position in the case of Singapore). We see the ratio of net government debt levels to GDP declining or holding steady from now until 2012 for most of the EAP 11. Japan, New Zealand, Australia, and Malaysia are exceptions. With growth prospects improving -- and little pressure on currencies or interest rates-- these debt dynamics look much more favourable than what we observe in the West, where we have lowered many ratings and assigned many negative outlooks.
We also believe there will be further macroprudential tightening. For example, New Zealand is implementing a core liquidity ratio, which will oblige the banks to term out wholesale funding and rely more on retail deposits. Korea and Singapore have taken steps to slow mortgage credit growth. A potential exception is China, where the government has used its banking sector as a channel to stimulate the economy. Although highly effective in the short term, only time will tell if the 30% increase in domestic credit last year has financed productive projects.
After a period of monetary accommodation, policy is beginning to tighten and we see core consumer price inflation contained in the group. Australia and Malaysia have begun to raise policy rates and Singapore has widened its band to allow more nominal appreciation of the Singapore dollar. China has repeatedly raised reserve requirements on banks. We do see risks of food inflation, however, as productivity gains in the agricultural sector have been low, and the free flow of trade of staples, such as rice, could be disrupted again to accommodate domestic food price pressure. We also see pockets of asset price inflation.
Apart from Australia and New Zealand, all are projected to remain in a current account surplus, which cannot be explained by exchange rates alone. Rather, it is the great disparity of productivity gains in the tradable versus non-tradable sectors of most the Asian EAP 11 members; the less-extensive social safety nets, which motivate precautionary household savings; and the tendency of profitable public enterprises to retain earnings to finance activities either within or outside their core competencies. As a result of these current and capital inflows, external financing requirements are moderate for most of the Asian EAP 11, and reserve levels are high.
So, having emerged from the global recession with credit metrics intact -- and with prospects of future solid growth -- where does this leave us in terms of the EAP 11's sovereign ratings? Regarding Indonesia's positive outlook, we've said that the rating could rise if the government presses on with its reform agenda and other key credit indicators continue to improve. For Japan, whose rating carries a negative outlook, we will examine the government's updated medium-term fiscal plan and its resolve on economic reform, particularly after the upper house elections. For Thailand, also with a negative outlook, an escalation of the political turmoil that spills over to the country's economic performance or the government's fiscal accounts could result in a downgrade.
Eight of the 11 have ratings with stable outlooks, indicating that upward and downward pressures on the ratings are balanced. The trajectories of these ratings are in the hands of policymakers and society at large. As reforms raise economic productivity, keep fiscal and external accounts in check, and maintain price stability, ratings will rise. Conversely, policy mistakes could result in ratings falling. At a time when several European policymakers face making tough economic decisions we believe the EAP 11 makes an instructive case study. The group has shown how to use a previous crisis to forestall a future one.
The author of this article, John Chambers, is a managing director in Standard & Poor's credit market services division.
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