In the late 1980s and early 1990s, little attention was being paid to the run-up of foreign debt in Asia’s emerging markets. The willingness and ability of these countries to meet their foreign-debt obligations as scheduled was largely unquestioned, given their rapid economic and export growth rates and widespread adoption of market-based reforms. The Asian financial meltdown of 1997, and more recently, a global economic slowdown and other, negative economic news, is causing many observers to intensify their focus on Asia’s economic and financial situation.
This article examines some of the major factors that might affect Asia’s future debt-servicing capacity, and highlights some economic and financial implications for Canada. (In this article, the Asia region comprises the People’s Republic of China (China), Indonesia, Malaysia, Myanmar (Burma), the Philippines, Singapore, South Korea, Thailand and Vietnam.)
ASIA’S FUTURE DEBT-SERVICING CAPACITY
Asia’s ability to service its debt in the months and years ahead will be affected by a number of factors: slower growth, rising oil prices, higher interest rates, financial sector fragility, infrastructure constraints and increased protectionist pressures.
slower growth
Recent data from the International Monetary Fund (IMF) show that the Asia region will grow, on an inflation-adjusted basis, by 6.6 percent in 2001, down from 6.7 percent over the previous year. Even though still high by international standards, these growth rates are much lower than the average annual real rate of almost seven percent and more than nine percent, respectively, registered during the 1982-1991 period, and during the first half of the 1990s. If it is to be sustained, Asia’s future growth will need to be financed by both domestic and international credit. Foreign debt accumulation and increased debt-servicing costs will follow. Within Asia, economic growth will continue to differ widely, contributing to worsening income and wealth differences, and rising poverty levels.
The removal of excess industrial and manufacturing capacity and the inventory adjustment process are moving slower than anticipated. The region’s real estate sector, property markets and construction industry still suffer from excess capacity brought about by years of over-investment and wasteful spending on prestige projects such as hotels, office towers and golf courses. In fact, the Far Eastern Economic Review observed that office occupancy rates were stuck at 38 percent in Bangkok in early 2000, and that over 300,000 apartments were unsold. As well, property values have yet to recover from their precrisis 1997 levels in Hong Kong, Special Administrative Region (SAR) and Singapore. Reportedly, it could take as long as another five years to clear up the current excess supply of office buildings, shopping malls and expensive housing throughout Asia.
In the coming years, stepped-up efforts to remove excess capacity and reduce surplus inventories in many industrial sectors will contribute to growing worker dissatisfaction and militancy. The recent violent confrontations at Daewoo Motor’s Pupyong facility over job cutbacks and inventory reductions are a clear indication of what might follow as financial and corporate restructuring efforts deepen. Incidentally, according to one estimate, South Korean taxpayers are injecting some $2.4 million into Daewoo daily to keep it from going belly up (all currency in U.S. dollars). Continued aggressive lobbying by powerful business and labour unions will continue to influence the pace and extent of future economic reforms, delaying Asia’s transition.
Asia’s heavy dependence on the manufacturing and export of electronic products and components makes the region very susceptible to unfavourable international economic conditions. By one estimate, exports of electronic products account for over one-third (35 percent) of total exports for Indonesia, Malaysia, South Korea and Thailand. Meanwhile, electronics output represents roughly one-half of Singapore’s manufacturing production.
To remain profitable, major global electronics manufacturers, including U.S., Japanese, South Korean and Taiwanese firms, might be forced to relocate more and more of their production capacity to China in the short to medium term, where wages and land costs are much cheaper. Longer term, the emergence of China as a major global player in both technically sophisticated, higher-value-added technology production and the low-technology, labour-intensive electronics assembly operations poses a serious challenge for the region’s other makers and exporters of electronics products.
As Asia becomes increasingly reliant on export-led growth, it will become more and more vulnerable to economic downturns in major industrialized export markets and rising global interest rates.
rising oil prices
According to the BPAmoco Statistical Review of World Energy, Asia’s energy consumption, including gasolines, distillates and oil, soared to almost 895 million tonnes (almost 26.4 percent of the world total) in 1998, from more than 583 million tonnes in 1988. This was an increase of more than 53 percent. This is not surprising given the rapid industrialization and modernization in most Asian countries over the last decade or so. The region’s ongoing high dependence on imported oil, the more than threefold per-barrel price increase, and devalued currencies led to rising bills and gradually depleting foreign exchange reserves. As more and more foreign exchange reserves go to pay for oil imports, fewer resources will be left for other uses, including the servicing of foreign debts.
In Asia, South Korea, Japan, Singapore, the Philippines, Indonesia and Malaysia have the region’s highest exposure to rising oil prices, with oil-import bills ranging anywhere from nine percent to 17 percent of total imports. Likewise, Hong Kong, SAR, China, Thailand and Taiwan have the region’s lowest exposures to higher oil prices, with oil import bills ranging between some two percent to more than eight percent of total imports.
For Asia’s oil exporters, including Indonesia and Malaysia, recent oil-price hikes have generated windfall foreign-exchange earnings, profits and higher tax revenues. On the negative side, these countries, like the region’s oil importing countries, heavily subsidize domestic gasoline and kerosene consumption. For example, Indonesia’s fuel-subsidization program has recently swelled to roughly $4.5 billion, or 20 percent of the central government’s budget. As oil subsidy burdens rise, Asian governments will have fewer financial resources to recapitalize their respective shaky banking and financial systems, and to repay foreign loans on schedule.
Continued weakness in dollar-based, non-fuel commodity prices will aggravate funding and payment problems for many Asian producers and exporters of non-fuel commodities. Asia, excluding Hong Kong, SAR, Japan, Singapore and Taiwan, had amassed almost $359 billion in foreign exchange reserves in 2000; this compared to some $338 billion in 1999, $290 billion in 1998 and $234 billion in 1997. China’s foreign exchange reserves reached almost $163 billion in 2000, with South Korea ($96 billion), Thailand ($32 billion), Malaysia ($31 billion) and Indonesia ($23 billion) far behind. Decreasing foreign exchange reserves and higher foreign debt burdens may potentially erode sovereign credit quality, contributing to higher fundraising costs. Cash-strapped Asian countries are more likely to resort to non-debt-creating mechanisms to finance ambitious infrastructure development, industrial upgrading, import consumption and the conservation of scarce foreign exchange reserves.
higher interest rates
The higher the foreign debt load, the more susceptible heavily indebted borrowers are to economic downturns and even to modest interest rate changes. Many Asian countries have large shares of their foreign debts denominated in U.S. dollars, making them highly vulnerable to sudden interest and exchange rate swings, and abrupt changes in investor-risk perceptions.
Despite recent interest rate cuts, the U.S. Federal Reserve may be forced to raise interest rates in the near future to dampen inflationary pressures on the U.S. economy, and address ballooning trade and current-account deficits. Higher U.S. interest rates will persuade investors to switch out of Asian stock markets, into American dollar assets and other higher-yielding, safer assets. The cost of borrowing and debt servicing will rise for individual, corporate and sovereign Asian borrowers.
Higher future U.S. dollar interest rates will lead to higher debt-servicing burdens, making general debt defaults among Asia’s most heavily U.S. dollar-indebted countries more likely. Recent data from the World Bank show that a large portion of foreign debts held by Asian countries is denominated in U.S. dollars. In 1998, for instance, South Korea, at almost three-quarters (74 percent), had the largest portion of its long-term debt denominated in U.S. dollars, followed closely by China (72 percent). Malaysia (59 percent), Thailand (49 percent), Indonesia (47 percent) and the Philippines (34 percent), also had high shares of their long-term foreign debt denominated in U.S. dollars. At the same time, Vietnam and Myanmar had in excess of one-quarter of their foreign debt denominated in U.S. dollars, 29 percent and 28 percent, respectively.
Similarly, the purchase of U.S. dollars by heavily dollar-indebted Asian borrowers to pay off their U.S. dollar-denominated debt will lower the value of their respective currencies. Making matters worse, lower future U.S. disposable incomes and profits, and heavy consumer and corporate debt loads, could cause American consumers and businesses to buy fewer foreign goods and services, including Asian products. By one estimate, the U.S. accounts for more than one-fifth (21 percent) of the total exports from Indonesia, Malaysia, the Philippines, Singapore and Thailand. This compares to 12 percent and 13 percent for the EU and Japan, respectively.
In Japan last August, ending the near zero-interest-rate policy raised concerns that this action might lead to higher future debt-servicing burdens for heavily indebted Asian countries with large portions of their foreign debts denominated in Japanese yen. These concerns were allayed somewhat in late February 2001. At that time, the Bank of Japan backtracked and subsequently decreased the overnight and discount rates to 0.15 percent and 0.25 percent, respectively. The bank’s actions came amidst persistent domestic economic and financial problems, the plummeting Nikkei 225-share index and a global economic slowdown.
According to World Bank data, the following countries had the largest portions of their foreign debts denominated in Japanese yen in 1998: Myanmar (49 percent), Thailand (40 percent), the Philippines (39 percent), Indonesia (33 percent) and Malaysia (30 percent). As a result, these countries are the most vulnerable to future Japanese interest rate hikes. A stronger yen will also increase the dollar cost of repaying yen-denominated loans. South Korea and Vietnam held the smallest portions of their foreign debts denominated in Japanese yen, 17 percent and 9 percent, respectively. The region’s heavily yen-indebted countries might intensify demands for debt relief to free up resources to support economic growth, social development and poverty reduction.
As interest rate outflows rise, fewer financial resources will be left to tackle pressing domestic infrastructure development requirements, environmental cleanup and rising social needs. Escalating interest commitments might convince international credit agencies to downgrade the debt ratings of debt-burdened Asian countries, increasing borrowing costs. Weaker regional currencies will only aggravate the region’s debt repayment difficulties.
financial sector fragility
While banks’ non-performing loans (NPLs) have declined region-wide, they are still large and problematic. In a recent report on the region’s 500 largest banks, Asiaweek estimated that the NPLs as a share of total loans reached 28 percent in China in 2000. Coincidentally, China’s banking system is believed to be technically insolvent, with the NPL situation worsening as state-owned enterprises refuse to service old and new loans. Indonesia, closely behind at 26 percent, had the region’s second-largest NPL ratio, followed by South Korea and Thailand, both at 18 percent. Meanwhile, the NPL ratio reached 16 percent in the Philippines and 12 percent in Malaysia last year.
To put the region’s NPL situation into perspective, it is generally viewed that two percent of the outstanding loans at a financially sound bank will be non-performing. Below five percent is regarded as satisfactory, more than 10 percent is a problem and over 20 percent a crisis. Recent data suggest that the cost of re-capitalizing Indonesia’s banking system, for example, has already cost Indonesian taxpayers $66 billion and will require approximately $60 billion more. Meanwhile, South Korea has already spent over $97 billion on recapitalizing the country’s financially troubled banking industry, and it is projected to spend another $45 billion.
As a share of national income, the cost of recapitalizing the region’s banking systems may reach 60 percent of GDP for Indonesia, 40 percent of GDP for Thailand, and 15 percent of GDP for South Korea. In many Asian countries, state-owned asset management corporations (SAMCs) were established to purchase NPLs from their respective banks. Not surprisingly, most banks’ balance sheets have improved drastically since problem loans have been shifted onto the books of these SAMCs. According to a recent Asia Development Bank report, South Korea’s Korea Asset Management Corporation had bought over one-half of the NPLs of the country’s banking system by mid-2000; it has already sold some 40 percent of these loans. At the same time, Malaysia’s asset management agency (Danaharta) had purchased in excess of 40 percent of the NPLs in the nation’s banking system by mid-2000 and has already disposed over 60 percent of the NPLs. Meanwhile, the Indonesian Bank Restructuring Agency (IBRA) also bought over three-quarters of the NPLs in Indonesia’s banking system, but it has disposed of less than half of one percent of the NPLs under its control.
The same report also noted that the discount rates on purchases of NPLs by SAMCs ranged between 30 percent and 60 percent. In turn, the SAMCs have had recovery rates on the sale of these loans of between 40 and 70 percent of their face values. While this strategy has bought the region’s wobbly banks much-needed time, it has also exposed Asian taxpayers to potentially massive future tax burdens. As joblessness rises and demands for increased spending on social programs increase, public support will wane for using taxpayer money to bail out the region’s ailing banking system and financial sector. In coming years, greater private-sector involvement in preventing and resolving international financial crises can be expected.
In spite of the introduction of new bankruptcy and foreclosure laws, the region’s legal and regulatory systems still remain relatively underdeveloped and ineffective. That continues to make the loan recovery process long and costly. It has also frustrated debt restructuring and arbitration between creditors and debtors throughout Asia. Rampant corruption and mismanagement also continue to hinder the formal resolution of delinquent debts, delaying financial sector reform. Continued banking and financial sector rationalization, deregulation and increased foreign competition will create fewer, but larger, banks, securities houses and insurance companies across Asia in the longer term.
infrastructure constraints
Before the outbreak of the Asian currency and banking crisis in mid-1997, the World Bank estimated that Asia’s requirements for infrastructure investments would total some $1.5 trillion during the 1995-2004 period, and roughly $7 trillion by 2020. The crisis forced many countries in the region to postpone, downsize or cancel many infrastructure projects. The current economic downturn and exchange and interest rate uncertainties will further delay investment in the region’s infrastructure.
Nevertheless, extensive infrastructure upgrading and construction still needs to be carried out to support future economic growth, social development and poverty alleviation efforts. This means that most Asian countries will continue to depend heavily on continued foreign capital inflows, both directly and through portfolio investments. For most Asian countries, a failure to maintain or achieve investment-grade ratings will make it more costly to raise long-term financing for infrastructure development and social projects. Asia’s heavy reliance on foreign capital to finance current and future infrastructure requirements will lead to foreign debt accumulation and higher future debt-servicing burdens. Infrastructure projects have limited ability to earn foreign exchange, thereby compounding the region’s future foreign debt problems.
Longer term, many of Asia’s heavily indebted countries will find it harder to finance economic restructuring, ballooning import bills and rising military spending, while at the same time meeting growing obligations for social services spending and servicing foreign-debt commitments in full and on time. As Asia’s risk profile deteriorates, the costs of doing business in the region will escalate.
increased protectionist pressures
The recent failure of multilateral trade negotiations in Seattle, coupled with stalled efforts to establish freer and more open trade and investment among members of the Asia Pacific Economic Co-operation (APEC) forum by 2010/2020, may signal increased trade disputes and friction in the years ahead. The large and growing U.S. trade and current-account deficits will only complicate matters. As protectionism rises, Asian export-oriented countries will find it tougher to generate export receipts and attract foreign capital to finance economic and social development, and still pay off their foreign loans on a timely basis.
According to one study, China was subjected to 247 antidumping investigations during the 1987-1997 period, followed by South Korea (139 investigations), Japan (133), Taiwan (100), Thailand (62), Malaysia (37) and Singapore (31). The same study also found that the U.S. and the EU w e re the major initiators of these investigations. A slowing U.S. economy, a weaker euro, a moribund Japanese economy, persistent structural unemployment in most industrialized economies, and exchange and interest rate fluctuations suggest that the number and frequency of antidumping cases against Asian export-oriented economies will most likely continue to rise.
Reportedly, Chinese-made products are flooding into regional markets at the expense of other Asian-made products. In fact, The Wall Street Journal recently reported that the textile and farm lobbies in Japan were pressuring Japanese officials to stem the influx of cheap Chinese textile and agricultural products. Japan presently buys over 83 percent of its clothing imports from China, compared to 73 percent in 1997.
China’s imminent entry into the World Trade Organization (WTO) will quicken corporate liquidations and bankruptcies, increasing the burden on the country’s fragile banking system. One estimate suggests that 40 million Chinese jobs could be lost during the first five years following its entry into the WTO. To alleviate domestic social pressures, China may boost exports globally. A future devaluation of China’s currency—the yuan—will make Chinese products on world markets even more competitive against similar products from other regional and extra-regional exporters. This will only compound the foreign-exchange generating capacity of these countries, adversely affecting their ability to repay their foreign debts as contracted. Worse still, it could heighten protectionist pressures and possibly trade sanctions against Chinese-made products.
The withdrawal of preferential tariffs by the U.S., the EU and Japan for many Asian labour-intensive and low-technology export-oriented economies suggests a decline in their future international competitiveness and reduced foreign exchange earnings. Presently, Indonesia, the Philippines and Thailand are eligible under the U.S.’s Generalized System of Preferences. A slowdown in direct and portfolio investment flows, declining aid inflows, reduced worker remittances and smaller privatization revenues also suggest lower future foreign exchange earnings.
Not only will smaller holdings of foreign exchange reserves contribute to debt-servicing difficulties, it will also hinder Asian countries from importing much-needed modern and energy-saving Western plant, equipment, technologies and expertise. The region’s movement into higher value-added, more technologically sophisticated production will be slowed. That will frustrate export diversification ambitions, impeding future foreign exchange-generating capabilities. Foreign debt-servicing difficulties are a likely result.
IMPLICATIONS FOR CANADA
Unlike the days before the Asian financial meltdown in mid-1997, Canadian banks have become decidedly cautious toward Asian sovereign and corporate borrowers. Recent Bank of Canada data show that Canadian chartered banks’ exposure in Asia totalled over $27.1 billion during the first nine months of 2000 (all currency in this section in Canadian dollars). This represented nearly 6.2 percent of a total international exposure of almost $441 billion. By contrast, chartered banks’ exposure to Asian countries reached $28.3 billion (6.7 percent of total) during the same period in 1999, $36.1 billion (eight percent of total) in 1998, $33.9 billion (10.3 percent of total) in 1997, $27 billion (9.9 percent of total) in 1996 and almost $21.1 billion (9.6 percent of total) in 1995.
The same data illustrate that the banks’ financial exposure to Japan, at $13.4 billion, accounted for over three percent of total exposure. Meanwhile, banks’ exposure to Hong Kong, SAR, was about $4.8 billion (1.1 percent of total exposure ), followed by Singapore (0.6 percent) and South Korea (0.6 percent). Canadian chart e red banks also had large financial exposures to Malaysia, Taiwan, the Philippines, China and Thailand. Persistent economic and financial difficulties in most Asian countries suggest that Canadian bankers will remain less willing to extend new credit or roll over old loans to many Asian sovereigns and corporate borrowers, raising demand for officially supported credits.
The latest data show that the Export Development Corporation’s (EDC) exposure to major Asian countries reached almost $3.1 billion or some eight percent of its total exposure of $43.9 billion in 1999. China accounted for almost $2.1 billion (4.7 percent) of total exposure, where as exposure to Indonesia reached about $1.2 billion (2.4 per-cent). As EDC support for Canadian export sales and investments grows, so too will the need for higher allowances for loan losses. Commercial credits extended by the Canadian Wheat Board and aid credits extended by the Canadian International Development Agency (CIDA) to Asian borrowers and recipients also raise the future exposure of Canadian taxpayers to potential payments difficulties.
The current economic slowdown and the collapse and insolvency of many Chinese Itics, including the Guangdong, Hainan and Dalian International Trust and Investment Corporations, as well as worsening economic and financial problems for many other of the region’s major industrial and financial conglomerates, suggest repayment and collection difficulties will rise. In the event of default, Canadian lenders and creditors can, at the very best, expect to receive only cents on the dollar. At worst, these loans might never be fully recovered, resulting in higher loan write-downs and write-offs.
Were Asian debtors to demand and receive debt relief, either by rescheduling or refinancing, it would have to be done through either the Paris or London Clubs. Loans extended, guaranteed or insured by the Canadian government or its agencies would be rescheduled or refinanced through the Paris Club. Conversely, loans issued by Canadian banks or other commercial lenders, without official guarantees, would be rescheduled through the London Club. Canadian banks and official creditors would thus need to devote substantial time, financial and human resources to safeguard their interests. The need to establish larger provisions for potential losses on Asian loans will also adversely affect the wealth of bank shareholders through lower dividends and share prices. Heavily indebted Asian borrowers may increasingly resort to non-cash transactions to settle their payments arrears.
The inadequacies of the region’s judicial and regulatory systems, weak institutional capacities and widespread corruption encourage debt delinquencies among Asian debtors. Despite new fore closure and bankruptcy laws, breach of contract, non-payment problems and collection disputes with Asian borrowers will likely increase. As regional and international economic conditions weaken, securing payment from cash-strapped Asian customers or borrowers will become increasingly difficult, time-consuming and costly. It is highly likely that Canadian lenders and creditors might continue to refuse to roll over old loans or provide new credits to Asian borrowers to minimize their vulnerability.
Canada is a member of many international financial institutions and groups, including the IMF, the World Bank and the Group of 20. As a result, Canada’s contributions to international debt-relief schemes might rise. Currently, according to the Department of Finance, Canada’s total contributions to trust funds under the control of the IMF ($65 million) and the World Bank ($150 million) that are devoted to debt reduction for the world’s most heavily indebted countries (HIPCs) totalled some $215 million. Canada is presently owed some $1.1 billion by 17 of the 41 HIPCs. Myanmar and Vietnam are the only heavily indebted Asian countries listed as HIPCs.
Starting January 1, 2001, Canada announced a moratorium on debt-service payments from eligible HIPCs. Since 1978, according to the Department of Finance, Canada has forgiven $1.3 billion in official development assistance debt to 46 developing countries. Canada also offers some $2 billion yearly in aid to developing countries, largely through CIDA.
Governments will find it increasingly tougher to win public support for multibillion-dollar official assistance schemes or international bailouts of financially troubled markets, especially if domestic economic and financial conditions worsen. As public support wanes, the Canadian private sector’s exposure to financial losses on investments and loans in emerging markets will rise. That will raise the costs and risks of doing business in mature and emerging Asian markets.
Given the current volatile international environment, Canadian investors and lenders need to be prudent and realistic in their financial dealings with Asian borrowers. If Asian borrowers require prior approval by their respective central officials, then it would be prudent for Canadian lenders and creditors to get all official guarantees and rely less and less on personal connections. Without such prior approvals and appropriate guarantees, Asian central officials could refuse to accept responsibility for non-sovereign debt. Failure to do so means that Canadian lenders and creditors could suffer heavy financial losses.
Finally, as economic conditions further deteriorate and debt servicing becomes more onerous, more and more illegal Asian immigration to industrialized countries, including Canada, can be expected.
