Asia is unlikely to escape the consequences of its recent credit binge completely unscathed – although a full-blown crisis looks unlikely, Capital Economics has claimed.
Gareth Leather, Asia economist, said the group had long argued that emerging Asia’s credit behaviour was unsustainable and he expects several countries to see a rise in bad loans and a slowdown in credit growth in the coming years.
“Large parts of emerging Asia have experienced rapid credit growth since the global financial crisis as central banks have kept monetary policy loose to compensate for weak export demand,” he added.
“However, while strong credit growth has enabled the region to continue growing at a decent pace while the West has been stuck in a rut, risks in the financial sector are building.”
As a broad rule, an increase in the ratio of private sector debt to GDP of more than 30 per cent within a decade has tended to be a signal of problems further ahead.
On this measure, China, Thailand, Hong Kong, Vietnam, Singapore and Korea all look vulnerable, and even the Philippines, which appears fairly low risk, has seen rapid credit growth in recent years.
Against this backdrop, Capital Economics sees three possible scenarios for the region over the coming years.
According to Mr Leather, scenario one – with a 20 per cent probability – would be most damaging: another region-wide financial meltdown similar to the Asian financial crisis of the late 1990s, involving multiple bank failures, a big contraction in credit and a slump in GDP.
“Fortunately, there are good reasons to believe things will not end so messily, not least because foreign currency debt levels are now very low,” he said.
“This means countries are less vulnerable to a sudden loss in investor confidence and decline in their currencies than they were during the Asian financial crisis.”
As for scenario two, the most likely at a 50 per cent probability, a region-wide systemic financial crisis would be avoided but a number of countries would still be hit hard.
“Credit growth in the worst affected economies would drop significantly, some banks would either be closed or taken over by the government, and GDP growth would disappoint,” said Mr Leather.
“Korea and Vietnam have experienced something similar in the past few years, and in both cases, while a full-blown crisis was avoided, the government was called in to support the banking sector, while growth has also been very weak.”
Finally, scenario three, with a 30 per cent probability, would see most economies escape largely unscathed.
Credit growth would slow gradually, but other growth drivers (most likely exports) would take up the slack and banking sectors would come through relatively unharmed.
