Global financial turmoil is not only having an impact on markets, it could also affect the political and security climate.
Ian Bremmer, Eurasia Group president and widely known in the field of political risk, answers Reuters' questions in an e-mail interview on the impact the financial crisis might have in Asia.
Q. Which Asian countries are most at risk from the impact of the financial crisis and economic slowdown in the OECD world and why?
Countries with large current account deficits and over-leveraged banks like South Korea and Pakistan have already experienced quite a bit of fallout from the Western financial crisis and will likely suffer some more. But there is no sense in Asia that the region as a whole faces an imminent financial crisis. The bad effects are more for the medium term, as investment- and export-driven economies suffer from the growth slowdown in the United States and the European Union. The larger Asian economies like China and India are unlikely to experience the kind of turmoil we're seeing in South Korea and Pakistan.
Q. Are Asian banks as vulnerable to distress as their counterparts in Europe and the United States, despite the structural clean-up that followed the 1997/98 crisis? Is there a risk that a lack of regional coordination could allow cracks to widen?
No. Asian banks as a whole are less vulnerable now than they were in 1997. Banks and regulators became more risk-averse after the crisis, instituting stricter rules on loans that have helped prevent the large debt bubble that led to the Asian financial crisis. Of course, there are some individual banks and countries — those in South Korea come to mind — that may face some risk. But even South Korea does not seem as vulnerable as it was in 1997, and its leaders and regulators are better prepared today. But the fact that a crisis is now less likely to occur doesn't imply that Asia would fare better if one did occur. In fact, financial turmoil would still hit Asia hard. The regional understanding of crises and contagions is much improved. But unlike Europe, there is very little regional infrastructure in place to design, much less coordinate, a crisis response. That's their continued vulnerability.
Q. What are the political and social dangers for Asian countries in the face of a rapid economic slowdown?
The primary danger for many countries is that the growth of the past few years has raised public expectations that may be impossible to fulfil going forward. Still, while dissatisfaction is growing, large-scale unrest is still a relatively low risk. The crisis will therefore be more a minor contributor than a major cause of any regional instability. The countries that are most vulnerable are those where there are existing internal political conflicts — like Pakistan, Thailand, and Malaysia. In these places, the economic slowdown is likely to exacerbate existing social and political tensions.
Q. Can Asia rely on China and Japan, with their combined reserves of $2.8 trillion, as a safety net, or are they heading for problems of their own?
China and Japan's foreign currency reserves are not safety nets for Asia's regional economy. But the outlook for long-term economic growth in China is good, and this will certainly benefit Asian neighbours, especially Japan. In the near term, both countries face their own domestic economic difficulties and are preoccupied with ensuring growth as this slowdown settles in. GDP growth in China has slowed, but remained at 9 percent for the third quarter of this year. And in response, Beijing and Tokyo are rolling out a host of expansionary policies focused on preventing more significant fallout. In Japan, the 3Q GDP number was -0.7 percent. The government has passed a limited stimulus package and looks set to move forward on a broader plan that includes significant near-term tax cuts.
Q. Will China try to spend its way out of the slowdown that will result from a drop in demand for its exports, and if so what difficulties and risks will come with this?
Yes. Beijing has clearly signaled a preference for using spending to promote domestic demand and to make up for a drop-off in exports. Beijing may also introduce a broader fiscal stimulus package in addition to spending more on infrastructure projects. There is a limit to what it can do, because the growth in the government's revenue has slowed considerably from about 30 percent in the first half of this year to just 3.1 percent in September. Declining exports are a problem for several reasons, particularly rising unemployment. We've seen as many as 10,000 Chinese manufacturers forced to stop production this year. But massive lay-offs do not appear to be happening yet. That's important.
Q. How far will Asian governments be tempted to intervene in markets and corporations as economies slow sharply, and what risks would this carry for investors and social stability?
Many countries are following Washington's lead. Market intervention and some fiscal and monetary loosening are understandable in dealing with a crisis situation … The longer term effects are likely to be more pronounced. Having seen the crisis, governments will try to be more active in evaluating the level of risk in their financial systems. In some cases, they will institute tougher standards to prevent firms or financial institutions from taking risks that endanger the broader system. Investors may, therefore, find less volatile, but more regulated sectors in Asian countries. This could slow the flow of capital to some economies, hampering their longer-term ability to attract investment.
Q. Would a slowdown in trade growth raise the risk of a protectionist spiral?
We are already seeing signs of protectionism, and it would be fair to say that globalization will be treated with a little more scepticism. Governments could start to shelter their domestic industries under pressure from local interests. On the other hand, if these economies are unable to increase domestic demand, they may be forced to look elsewhere in the region for growth, especially if demand rises in China and India.
Q. China was already America's biggest creditor before the meltdown. What leverage/conditionalities will China exact in exchange for holding onto or even buying more U.S. paper?
China is unlikely to exact much leverage from the United States in taking on more U.S. debt. In deciding how to manage its U.S. holdings, Beijing has to balance an aversion to taking on more dollar-denominated assets with a desire to maintain stability in the yuan/dollar exchange rate. For now, stability in this exchange rate is more important to Beijing as Chinese exporters suffer from a global slowdown. If China diversifies away from the dollar, it would make the yuan relatively more valuable against the dollar. Therefore, China has little choice but to hold onto its existing U.S. Treasury holdings and may even take on more debt, as upward pressure on the yuan/dollar reappears. That's especially true since economists are telling us that the difference in growth rates between the U.S. and China will likely increase.
Q. The wars in Iraq and Afghanistan had already exposed the limits of U.S. military power, while helping to quadruple its national debt over the past decade. Could the financial crisis cause the U.S. to scale back its military commitments in the Asia-Pacific? What are the regional implications of that? Would we see a renewal of the Japan-China rivalry and an arms race?
There will be significant domestic pressure on the coming US administration to reduce foreign expenditure, and that will undoubtedly include military obligations with American allies. That's going to put Japan in a quandary, increasingly needing to decide between closer regional integration with China and remilitarisation. Japan's choice will depend in part on China's trajectory (and Japanese perception that the Chinese market continues to afford a significant investment opportunity). It will also depend on whether the Democratic Party of Japan (DPJ) comes to power, which would lead to a greater Japanese prioritisation of relations with China over relations with America.
