Academic journal article Journal of Southeast Asian Economies

Impact of Eurozone Financial Shocks on Southeast Asian Economies

Academic journal article Journal of Southeast Asian Economies

Impact of Eurozone Financial Shocks on Southeast Asian Economies

Article excerpt

I. Introduction

Five years after the Global Financial Crisis (GFC), the economies of the United States and the eurozone continue to struggle, with the eurozone recovery lagging behind that of the United States. The financial crisis wreaked havoc on the balance sheets of households and banks. Faced with large losses and a weak capital base, American and European banks have been deleveraging. This has considerably reduced lending growth and slowed the process of recovery in their respective economies.

European banks' funding conditions have been worsening as evinced by slower bond issuance (Bank for International Settlements 2012). Worries about the health of the banking system have also led to a rash of withdrawals by bank depositors. The recent events in Cyprus, where some depositors stand to lose a significant share of their savings, could potentially heighten concerns in countries where banks are facing similar losses. The banking system in the United States is relatively healthier as losses have been recognized and banks have undertaken recapitalization. Nevertheless, the troubles facing European banks could also affect the liquidity situation in the United States. After all, the major European banks are also big lenders in the U.S. interbank markets (Shin 2012).

Monetary authorities have responded by sharply easing monetary policy. This has brought policy interest rates down to close to zero. Having quickly reached the interest rate floor, both the Federal Reserve and the European Central Bank (ECB) have resorted to unconventional monetary policy through episodes of quantitative easing. The Bank of Japan, under new leadership, has also followed suit more recently. This has further increased liquidity in the banking system.

However, these policy moves have yet to produce the desired effect in the home countries, as private lending has failed to increase as expected. Banks are still hesitant to lend given lingering uncertainty about future economic prospects. Consumers and businesses are also reluctant to borrow as uncertainty remains high and confidence in the recovery remains low. As a result, increased liquidity from the asset purchase programmes of the central banks has only increased the banking system's holding of reserves. That most of the funds have been placed in very low yielding reserves at the central banks shows a continued lack of confidence in the economic recovery. (1) All of this suggests that the problems in the eurozone are unlikely to end anytime soon. It also points to the very real possibility that the situation could indeed worsen.

It is with this global backdrop that we turn our attention to the situation in Southeast Asia. What has the impact been of the global financial turmoil on the Asian economies? Is there a real risk that a similar crisis could hit the region? Given the fragility of the financial system, what are the possible impacts of a shock to the financial system in the eurozone on the economies of Southeast Asia? This is a real possibility given that vulnerability in the region has increased following massive inflows of capital and build-up of debt related to successive bouts of quantitative easing in the United States initially, and now Japan. Furthermore, should East Asia succumb, is it ready to deal with the fallout, or will it again have to seek support from the IMF as it did during the Asian Financial Crisis (AFC), but at a time when global resources are even more stretched?

The paper is in six parts. Section II of the paper focuses on the impact of monetary policy easing in advanced economies on capital flows in Southeast Asia. It will also examine the trend in bank lending in Southeast Asia, as governments in the region attempt to stabilize growth through various stimulus measures. Section III will examine the possible implications of a crisis in the financial system in Europe. During the 2007/08 GFC, the region's financial systems were hit hard but showed their resilience with a strong rebound. …

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