Finantial Crisis

Sibylle Dehesdin:
Hello and welcome everyone to this new edition of ECO TV, the monthly program of BNP Paribas' economists.

Today's edition is dedicated to the global financial crisis.

With Philippe d'Arvisenet's editorial on the crisis consequences on emerging countries.

Then, Eric Vergnaud will explain the Federal Reserve and the European central Bank's reaction to the present crisis.

And finally, François Faure will focus on the South Korea's situation.

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Sibylle Dehesdin: First, let's welcome Philippe d'Arvisenet, BNP Paribas global chief economist. Hello Philippe...

Philippe d'Arvisenet: Hello

Sibylle Dehesdin: Many were hoping that emerging countries would avoid the crisis. Does it still make sense, in our days?

Philippe d'Arvisenet: Generally not. We expect growth in these countries to be further down next year. Probably in the province of 4.5 – 5%. They used to do something like 7.5%.

Sibylle Dehesdin: Yet there was no distribution of subprime loans. Howeve, several of these countries are very much affected by the crisis. Why?

Philippe d'Arvisenet: Sure. You have several mechanisms. First of all, if you take the big OECD countries, which have been impacted by the so-called subprime crisis, I mean the US, Euroland, UK, Japan, you have half of the planet, which is slowing down and of course you have consequences on the rest. Emerging countries export less, obviously. Some of them, which are specialised in exporting commodities, oil and so on, are affected not only because they export less, but at a lower price. So you have this traditional mechanism. Now, there are other things. Many of these countries experienced big capital inflows in the last few years. These inflows are now reversing; going back home if I can put it that way. Several reasons; first, we have a strategy which was called the “carry-trade”, i.e. you borrow in a low yield currency and you invest in a higher yield currency, though this is unwinding. Now you have a second thing: there was the idea that there was a future in emerging markets. So you had a lot of investment, for example in the stock exchange. That has burst now, and you have a movement of repatriation of capital towards the US and other places like this. Just because you have investors, hedge funds etc, which have to cover losses so they sell what they have in order to cover these losses. So you have a repatriation of funds.

One of the consequences of that of course is that you have a negative wealth effect in these countries with the stock down. Second you have a depreciation of many of their currencies. And third, because of this repatriation, when they need US dollars for instance and there is a lack of dollars of course obviously throughout the world... All this of course is impacting negatively.

These funds also were used in order to finance a boom in credit in several countries. And of course that has to come to an end. And together with another risk which is, you have especially in Eastern Europe or Central Europe countries in which people borrowed in foreign currencies, especially euro or Swiss francs, to buy homes in the Ukraine, in Hungary and in places like that if you will. And now with the depreciation of their currency; that is the appreciation of the foreign currency in which they borrowed, I mean the burden is much higher for them. So you have a lot of ingredients which add together.

Sibylle Dehesdin: Thank you, Philippe. And your editorials are online each week on the economy department's website.

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Sibylle Dehesdin: And we are now with Eric Vergnaud to talk about the Fed and the ECB's reaction to the actual financial turmoil.

Hello Éric.

Éric Vergnaud : Hello.

Sibylle Dehesdin: Can you tell us what are the main distinctive problems the crisis created?

Éric Vergnaud : Since the outbreak of the current financial crisis, the Fed and the ECB have taken numerous initiatives to guarantee a smooth functioning of the payment system. They have managed the liquidity crisis in order to enable banks to be refinanced in spite of nearly frozen money markets especially after the collapse of Lehman Brothers

Sibylle Dehesdin: Can you be more precise on the banks reactions and measures they adopted?

Éric Vergnaud : The Fed and the ECB have modified their refinancing operations. They have increased their amounts and lengthened their duration. They have also widened the range of eligible collaterals.

The Fed has created new instruments to provide liquidity, event to non financial companies. In addition, the ECB was also very active in providing dollars to European banks thanks to bilateral swap lines set up with the Fed. Lastly, policy rates were cut at both sides of the Atlantic.

Sibylle Dehesdin: Are the results already effective?

Éric Vergnaud : market interest rate spreads have been starting to narrow thanks to central banks' decisions combined with national plans aiming to support the banking system. Nevertheless, money market tensions remain high and it will take some time before returning to a normal situation.

Sibylle Dehesdin: Thank you Eric.

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Sibylle Dehesdin: Let's now welcome François Faure.

Hello François.

François Faure : Hello Sibylle.

Sibylle Dehesdin: As we were saying earlier with Philippe d'Arvisenet, the global financial crisis has started to destabilise emerging countries. In Asia, South Korea seems to be most affected. What's going on exactly in this country?

François Faure : Like most of emerging countries, especially Asian countries, the Korean stock exchange has followed the plunge of major equity markets. Actually, there are two main differences. First, the depreciation of the won - that began since the beginning of the year - has been much more pronounced than for other Asian currencies (about 25% against 5% on average since early September). Second, US dollar onshore interest rate has surged compared with US dollar offshore interest, I mean USD interest rate either in the US market or in international markets.

Sibylle Dehesdin: Do you think that such developments are justified by macroeconomic or microeconomic fundamentals?

François Faure : Globally yes. At the macro level, the economy has been decelerating since the beginning of the year mainly because of a cyclical reversal in the construction sector. Besides, the current account balance will post a deficit this year for the first time since 1997, net FDI flows including capital transfers are negative and equity portfolio investments left the country since mid-2007. As a result, external debt has ballooned and official fx reserves have been depleted since the beginning of the year. At the micro level, credit to households and especially housing credit has grown strongly so that Korean households as a whole are as indebted than American households. Lastly, SME are not in a good shape.

Sibylle Dehesdin: On October 19th, the government unveiled a package of measures to support the banking sector. What risks this plan is deemed to prevent?

François Faure : The risk of an external liquidity crisis actually. On the one side, the government will provide if necessary up to USD 30 bn to banks (but also to exporters) by using its foreign exchange reserve. On the other, the government will guarantee until June 2009 all external borrowings by Korean banks up to USD 100 bn. This latter measure is aimed at helping banks to roll over their short term external debt and to extend the maturity of the debt. Besides, recently, Korean will benefit from a USD 30 bn swap line with the US federal reserve.

Sibylle Dehesdin: Is there a real risk of external liquidity crisis like in 1998 or even a risk of systemic banking crisis?

François Faure : In a context of USD liquidity scarcity and given the substantial external financing needs of Korean banks, an external liquidity crisis is still an eventuality but we don't think that it will happen. First, because of measures I have just mentioned, second because of the still huge amount official fx reserves. On the systemic banking crisis issue, the present situation is quite different and in fact less alarming than in 1998. In 1997, a major part of the short term external debt was owed by Korean banks and they used it to finance short abut also medium and long term won-denominated loans to large corporates. At present, a large part of the short term external bank debt is owed by branches of foreign banks and is related to pure fx-hedging activities with counterparties which have resources in USD. As a consequence, external indebtedness is at present less risky than in 1997.

Sibylle Dehesdin: Thank you François.

We've come to the end of this programme. We'll see you next month for a new edition of Eco TV, the monthly programme of BNP Paribas' economists.

Posted by: Espinosa Ortíz Guadalupe (Copyright BNP Paribas)