Asia 1997 Retrospective: Repeat Of 1997 Crisis Unlikely, But High Leverage A Worry

Standard & PoorÆs Ratings Services believes that a crisis similar to the financial crisis in 1997 is unlikely to recur in Asia. Key factors enabling the 1997 crisis are no longer as prevalent now as they were in 1997. Ten years ago, high foreign currency indebtedness by companies and external liquidity vulnerability of sovereigns, in part due to current account deficits, provided the backdrop to the crisis.

Today, companies have reduced their foreign currency debt exposure or adopted hedging policies against foreign exchange risk, while sovereigns have bolstered their external positions with stronger reserves. In addition, many banking systems have fully regained the economic role they played before the crisis. Nevertheless, the overall increase in the debt of sovereigns and, to a lesser extent, corporates remains a concern. Our study covers 10 financial systems in AsiaùChina, Hong Kong, Indonesia, India, Korea, Malaysia, the Philippines, Singapore, Taiwan, and Thailand.

This article is part of three æAsia 1997 RetrospectiveÆ articles by Standard & Poor's Ratings Services that reviews the region's banking and financial systems a decade after the financial crisis occurred. The factors behind the crisis are discussed in ôCredit FAQ: Asia 1997 Retrospective,ö published September 5, 2006. The third article, "Asia 1997 Retrospective: TodayÆs Banks Likely To Survive Stress Scenarios," published September 5, 2006, examines the impact of probable crisis scenarios on the region's banking systems.

Growing Government Debt
As a share of GDP, general government indebtedness of all 10 sovereigns is higher than it was a decade ago. Weaker sovereign credit profiles raise concerns that these sovereigns have reduced financial flexibility should a financial or banking crisis, however unlikely, eventuate.

The reasons for greater indebtedness are varied. In Indonesia, the higher debt is mainly due to debt taken on by the government to help rescue its banking sector following the 1997 crisis. Singapore's increased debt, in contrast, is wholly denominated in local currency, and is not driven by any borrowing needs. Instead, the increased borrowing reflects efforts to establish pricing benchmarks for the bond yield curve.

Consequently, six of the 10 sovereigns have weaker credit profiles in 2006 than in 1996. This is reflected in Standard & PoorÆs ratings on these sovereigns (see table 1). On the other hand, the credit profiles of China, Hong Kong, India, and Singapore are stronger. ChinaÆs economic growth has propelled its sovereign credit ratings higher, and lifted those on Hong Kong. The Singapore government's continuing astute management of the economy and finances has enabled it to retain the æAAAÆ sovereign credit rating throughout the past decade.

Corporate Borrowing Climbs In China And India
In addition to higher government borrowing, private sector indebtedness as measured against GDP is greater in four systems in 2006 than it was in 1996 (see table 2). These are China, India, Korea, and Singapore. Strong economic growth has fueled the increased corporate borrowing in China and India, while growing debt in Singapore reflects its role as a key financial market centre amid healthy growth in the region. Unlike the other countries affected by the 1997 crisisùIndonesia, Malaysia, the Philippines, and ThailandùKoreaÆs ratio of private sector debt to GDP is perhaps uncomfortably similar to its ratio at the peak of the Asian crisis. Nevertheless, Korea's proportion of foreign currency debt to GDP is lower than its pre-crisis level. Taiwan's private sector has maintained its leverage roughly at the same level through the decade.

Lower Foreign Currency Debt Burden
Fortunately, the foreign currency debt of both government and private sectors, measured against GDP, is lower or remains manageable for most of the 10 systems (see table 3). Hong Kong's high ratio of foreign currency borrowing is mainly due to its role as a key financial centre.

The reduced exposure to foreign currency borrowing is partly due to the relatively lower cost attractiveness of foreign currency borrowings compared with the pre-crisis period. This favourable position reduces the risk of the sudden withdrawal of foreign currency funds leading to pressure on domestic exchange rates as in the case of the 1997 crisis. In addition, the international reserve positions for all 10 sovereigns are higher on an absolute US-dollar equivalent basis compared with 1996.

Smaller Interest Rate Differentials With The US
Unlike the situation in 1996, interest rates in the region are largely lower or similar to US interest rates, thus lowering the attraction of foreign currency borrowings. Prior to the 1997 crisis, US borrowing rates were more attractive to Asian borrowers because of the larger differential with local interest rates (see table 4). This situation encouraged Asian corporates to increase their borrowings in foreign currencies, particularly the US dollar. When the exchange rates of various countries in the region were pressured during the crisis, borrowers whose earnings were substantially in local currency were severely distressed and unable to repay their foreign currency borrowings.

Better Quality Of Banking Systems
Qualitatively, many banking sectors in Asia are less fragmented, while some boast foreign shareholder expertise. This has helped improve the depth of management and development of risk management systems. These observations recognize that there is a limited pool of capable senior bankers that any one banking sector may have, and the economies of scale needed for IT-based risk management systems. In addition, financial disclosure from the banking sector has generally improved.

The intermediary function of the banking sector has also evolved, as the development of domestic capital markets picked up over the past five years. One positive implication is that banks have increased their focus on the consumer and small and midsize enterprise (SME) markets. This has led to an increased granularity of lending portfolios, as the corporate sector increasingly accessed the capital markets for funding. Nevertheless, there still exists the risk of concentration if banks were to focus excessively on a particular sub-segment of the consumer lending market.

Some of the leading Asian banks that had their credit ratings lowered by Standard & PoorÆs during the 1997 crisis have yet to recover their full credit strength. Nevertheless, their prospects are good. A few banks, including DBS Bank and the larger Korean banks, have regained their pre-crisis credit strength. In addition, the leading banks in China and Hong Kong now have slightly higher ratings; Chinese banks have benefited from extensive government capital injections, while the latter reflects the innate strength of Hongkong and Shanghai Banking Corp.

Recovery In Indonesian, Thai Banking Still Some Way To Go
Most Asian banking systems have recovered from the 1997 crisis, when the worst affected systems were Indonesia, Korea, Malaysia, the Philippines, and Thailand. Nevertheless, some systems, notably Indonesia and Thailand, have yet to fully regain the economic role they played before the crisis. This can be measured by the level of domestic credit to private sector and nonfinancial public entities in US dollar equivalent terms (see table 5). The domestic credit level can indicate the extent to which the banking sector is fulfilling its intermediary function.

The absolute US dollar equivalent domestic credit for Korea (187% of the 1996 level) and Malaysia (120%) now exceed levels before the 1997 crisis, while that of the Philippines, at 94%, is nearly back to its pre-crisis level. However, domestic credit in Thailand (65%) and Indonesia (56%) still falls short of pre-crisis levels. In Thailand's case, its relatively weak 2005 GDP, which is similar to its 1996 GDP, could have hampered the build up of its domestic credit. This is unlike the situation in the other four countries, where 2005 GDP surpasses 1996 GDP.

Although Indonesia's 2005 GDP is above the level in 1996, the recovery in domestic credit has been very much slower as bankers have been more cautious in extending loans than before the crisis. The Indonesian banking sector had been on track for a full recovery by year-end 2009, with credit growth of 17.5% in 2005. Nevertheless, this now appears unlikely, given a substantial slowing in real credit growth in 2006. Domestic credit would have to register a real compounded annual growth rate of 15.5% over 2006-2009 to regain the US dollar equivalent of its 1996 level.

Previously, Standard & Poor's estimated that the upfront fiscal cost, or funds required by the government to initially recapitalise or pay creditors of distressed banks, was equivalent to $87 billion, inclusive of three years of interest-servicing costs (see ôIndonesian Banking: World's Worst Crisis Since 1970s,ö published June 9, 1999, on RatingsDirect). An IMF paper in late 1999 (Occasional Paper No. 188, ôFinancial Sector Crisis and Restructuring: Lessons from Asia,ö Carl-Johan Lindgren, Tomßs J.T. Bali±o, Charles Enoch, Anne-Marie Gulde, Marc Quintyn, and Leslie Teo) subsequently estimated the public cost for IndonesiaÆs financial sector restructuring at $85 billion.

Domestic credit, as a percentage of GDP, can also partly reflect the level of bank intermediation. Using this measure, the ratios for Korea and Malaysia have returned to their pre-crisis levels (see chart 1). Nevertheless, it should be noted that domestic credit is not expected to mirror the GDP growth rate during the post-crisis years. This is particularly given that there was an over-extension of credit before the crisis. As a result, some subsequent softening of domestic credit against GDP is to be expected.

Study Examines Nine System Risk Factors
For this study, Standard & PoorÆs analysed nine system risk factors in 1996 and 2005-2006. These are:
ò Banking system structures,
ò Financial disclosure by banking systems,
ò Corporate indebtedness,
ò Government indebtedness,
ò Foreign exchange rate mechanism,
ò Foreign currency indebtedness,
ò Current account balance,
ò International reserve positions, and
ò Interest rate differentials with the U.S.

These factors were selected after taking into account the drivers for the 1997 crisis. Individual tables for each system are provided below.

The article is an extract from RatingsDirect, Standard & Poor's Ratings web-based credit research and analysis system ( To learn more, please click on About RatingsDirect.
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