This op-ed was originally published by East Asia Forum.
A surge of financial crises across emerging economies has already begun. Ecuador and Zambia have been the first to default. Argentina has postponed negotiations with creditors, Turkey looks more and more vulnerable, and the International Institute of Finance warns that South Africa is next. Collapses in exchange rates are an indication of who might follow. Brazil, Russia, and Mexico are at the top of the list.
In Asia, Indonesia is the frontline of defense against financial contagion. The Indonesian rupiah has lost almost 20 percent of its value since January, with Thailand and Malaysia not far behind. Emerging economies are under unprecedented financial pressure. Crises will spread throughout our region unless action is taken to steady financial systems against the rising tide of capital outflow. Financial contagion is even faster than viral contagion.
Emerging economies have seen the largest capital outflows in history, multiples of what was experienced during the global financial crisis. They face a perfect storm of events which threatens cascading crises. The collapse of their exchange rates against the U.S. dollar has seen the $5.8 trillion of their dollar-denominated debt inflate. Indonesian foreign debt rose 7.5 percent in January year on year. The collapse in oil and commodity prices and tourism has shut off vital sources of the income and foreign exchange they would otherwise use to repay those debts. Rising bond yields has increased borrowing costs and the sudden stop in capital flows makes refinancing existing debt almost impossible.
Financial contagion is even faster than viral contagion
Asian financial systems are managing risk much more effectively than they were in the 1990s. Banks are well capitalized. Supervisory frameworks are stronger. Exchange rates are more market determined and better able to absorb shocks. Large current account imbalances have narrowed considerably. The absence of high inflation and increased macroeconomic credibility has given Asian economies more monetary and fiscal policy freedom and independence. But the sheer size of this crisis means that even countries that are in good shape will take a hit.
In responding to financial crises, speed is everything. Southeast Asian countries are at the epicenter of the gathering storm in Asia. They need lines of credit and support to stave off deep, long-lasting crises that will reverberate across the whole region. Financial markets will freeze and risk premiums will skyrocket as investors scramble to determine the exposure of government, banks, insurers, and companies to the shock. There’s no time to “wait and see.” The longer you wait, the bigger the ultimate cost.
The problem is, as policymakers have been warned for years, the global financial safety net to deal with these imminent problems in the region and around the world is dangerously inadequate. The resources available to countries when they face a financial crisis are highly fragmented across many different, uncoordinated bodies that are not resourced to provide even the same level of support that was needed in lesser crises in the past. The International Monetary Fund‘s inadequate resources forced it to be a minority lender for the first time in its history in response to the Greek bailout in Europe after the global financial crisis. Greek unemployment is still at 17 percent.
No Southeast Asian leader could credibly call in IMF support after the debacle of the Fund’s mismanagement of the bailouts during the Asian financial crisis—even if IMF funding were sufficient to the task. IMF staff have recommended a new Short-term Liquidity Swap facility to avoid this, providing members with strong policy regimes with liquidity support against short-term shocks. The Fund’s advanced-economy shareholders have refused to approve it.
Asia’s regional financial backstop, the Chiang Mai Initiative Multilateralization (CMIM) has just $240 billion available to help countries in need. But the fund is yet untested and not yet fully operational. Its processes for approving resources are slow, cumbersome, untested, and politically complex, producing widespread skepticism in its ability to provide assistance. And Australia is not yet a party to CMIM.
The Fed’s recent announcement of a repo facility for central banks—where central banks can borrow U.S. dollars from the Fed after providing their U.S. Treasuries as collateral—is of little help to most emerging economies.
The United States has been prepared to provide bilateral credit swap lines to select countries in crises past. A swap line with the U.S. Fed allows partner countries to access U.S. dollars directly from Fed. Australia was extended a swap in recent weeks and that saw the Australian dollar stabilize almost immediately. But the only emerging economies to have received a U.S. swap line are Mexico and Brazil. As the Americans retreat further, most countries will turn to China.
There’s no time or chance to upgrade regional and multilateral institutions to meet the threat of financial contagion that Asia faces right now. Rolling out bilateral swap lines within the region to economies at risk is a top priority. These temporary loans will stabilize the region and protect the millions of Australians who rely on Asia for their business and prosperity.
China’s support in this time of need will understandably be welcomed throughout the region. But it will be welcomed more if it’s part of a combined, cooperative effort at regional financial stabilization.
Certainly, countries like Australia and Japan need to step up quickly too. The central banks in Australia and Japan both have currency swap lines with Indonesia worth $10 billion and $23 billion, respectively. They’ll need ramping up. The RBA and Bank of Japan must clarify that these facilities are available to Indonesia in the event of a crisis (and are not merely for trade finance in noncrisis times), with finance ministry or treasury backing as necessary.
Japan and China are the two lead creditors in CMIM. It provides one useful institutional anchor around which to coordinate the extension of additional regional financial support. But central bankers (and finance ministries) in Australia, Japan, China, Indonesia, and around the region can sensibly collaborate on immunizing the Asian economy against being laid waste, and help to provide the basis for stability both through and after the COVID-19 shock.