NOTE NUMBER 353 viewpoint DECEMBER 2018 Global Financial Market Turmoil Ndiamé Diop Why is South East Asia Exposed but Resilient? macroeconomics, trade & investment Global Practice Ndiamé Diop (Ndiop@ South East Asia’s largest middle-income economies are highly integrated into worldbank.org) is Practice Manager for the East Asia global financial markets. While this provides considerable benefits, it also and Pacific Region in the exposes them to sudden retrenchments of portfolio flows from emerging Macroeconomics, Trade & Investment (MTI) global market economies. This note shows that Indonesia, Malaysia, the Philippines, practice of the World Bank and Thailand are nevertheless resilient because they have learned and applied Group. key lessons from the 1997 Asian financial crisis. One key lesson is that adoption Useful comments on this of a flexible exchange rate should go hand in hand with keeping foreign cur- note were received from rency exposure in the balance sheets of the public sector, the financial sector, Frederico Sander, Rong Qian, Richard Record, and the corporate sector low or hedged. Indira Hapsari, and South East Asia’s (SEA’s) large economies are public sector, the financial sector, and the corpo- Kiatipong Ariyapruchya under some stress from trade tensions and rising rate sector low or hedged. Another lesson is the (all MTI, East Asia and Pacific). U.S. interest rates. This reflects these economies’ importance of large foreign reserve holdings to sensitivity to the U.S. Federal Reserve monetary insure against sudden reversals in capital inflows. policy, their high degree of global trade integra- Going forward, while contagion from tion, and their strong production network links Argentina and Turkey seems contained, sustain- with China. In sharp contrast to the situation in ing resilience will not be automatic. It will hinge 2017, in Indonesia, Malaysia, the Philippines, and on macro-fiscal measures to reduce inflation (the Thailand, the currencies depreciated against the Philippines), prevent the current account deficit THE WORLD BANK GROUP U.S. dollar, bond yields rose, and stock markets from widening (Indonesia), and reduce external have declined to date in 2018. debt (Malaysia). Structural measures to encour- However, these countries have managed to age foreign direct investments and deepening hold up relatively well because they have learned the financial sector are also crucial to strengthen and applied key lessons from the 1997 Asian Indonesia’s resilience. financial crisis and have maintained strong fun- This note: (i) discusses the contrasting states damentals. One key lesson from the 1997 crisis of equity, bond, and currency markets in SEA is that adoption of a flexible exchange rate is between 2017 and 2018; (ii) explains why some crucial to amortize capital flow shocks, but it currencies in the sub-region are more sensitive should go hand in hand with keeping foreign to sudden changes in portfolio capital flows currency exposure in the balance sheets of the than others; (iii) discusses the sources of SEA’s G lobal F lobal A ttract i ng nD i nanc naF a c Ii al Hl arket o wM M aurckhe D toT esurmo u r In e si tlm W mv o Wh enht y C is So lim au te aa t hME st tt ?sia Exposed but Resilient? e rA resilience, and (iv) identifies priority policies to first 10 months of 2017, SEA countries received sustain the sub-region’s resilience. The analysis a total net portfolio flow (equity and debt) of focuses on Indonesia, Malaysia, the Philippines, US$20.8 billion (Table 1). Reflecting these large and Thailand. These countries were chosen inflows and high investor confidence, bond yields because they are the largest in SEA, have flex- dropped sharply, and stock markets rose (Table ible exchange-rate regimes and are strongly inte- 2). This is in sharp contrast with January–October grated into global financial markets. 2018, during which net portfolio flows to SEA dropped by close to US$9 billion, leading to Asset markets in flux currency depreciations, rising bond yields, and 2 The contrast in the state of asset markets in depressed stock markets (Table 2). While capital SEA between 2017 and 2018 is striking. In the outflows in the bond markets seem to have stabi- lized (thanks to debt issuances at higher yields), the pressure on stock markets continued through Table Equity and debt portfolio flows to South East Asia October 2018, explaining the continuous weak- 1 Jan–Oct 2017 Jan–Oct 2018 October 2018 ening of currencies in the sub-region. Equity portfolio flows (US$, millions) Two key factors help explain the contrasting Indonesia –1,372 –4,059 –372 developments in SEA capital flows and asset mar- Philippinesa 1,071 –1,752 –182 kets between 2017 and 2018: (i) changes in U.S. Malaysiab 2,205 –2,505 –375 monetary policy and (ii) trade tensions between Thailand 168 –8,386 –1,868 Debt portfolio flows (US$, millions) the United States and its major trading partners— Indonesia 10,501 1,918 809 particularly China. Like other emerging market Philippines — — — economies such as Argentina, Brazil, India, and Malaysia b n.a. n.a. n.a. Turkey, SEA is highly sensitive to changes in U.S. Thailand 8,237 7,909 899 monetary policy because global portfolio investors Source: CEIC Data (database), New York, NY (accessed November 5, 2018), www.ceicdata.com. constantly undertake “arbitrages” on the risks and Note: — = not available; n.a. = not applicable. returns on investments in SEA’s liquid markets  a. equity only; b. equity and debt data not broken down; since equity flows are much greater, all flows are “assigned” in table to equity; portfolio flows through 9/15/18. relative to markets in the United States. Typically, capital flows to emerging markets increase when U.S. interest rates are low, and the global finan- Table Changes in bond yields, stock markets, and exchange rates in South East Asia cial markets are calm. Such a situation in 2017 2 Jan–Oct 2017 Jan–Oct 2018 October 2018 led to large net portfolio capital inflows to SEA. Bond yield: change in basis points of the monthly average yields Conversely, global investors tend to withdraw between the end and beginning of the period capital from emerging market economies when Indonesia –113 198 16 U.S. interest rates rise. In March 2018, the U.S. Philippinesa –21 144 — Malaysia –29 18 2 economy’s tight labor market and rising infla- Thailand –38 27 4 tion led the U.S. Federal Reserve to reaffirm its Stock market: change in monthly index average adherence to a tightening cycle. Since then the between the end and beginning of period federal funds rate has been increased three times Indonesia 13.9 –5.3 –1.2 (in March, June, and September) with possible Philippines 22.7 –15.0 –5.1 further hikes in December and in 2019 (Figures Malaysia 7.2 –0.5 –3.6 1 and 2). Thailand 12.2 –2.2 –2.1 Thus, going forward, risks of further portfo- Currency: change in the LCY/USD exchange rate, monthly lio capital retrenchment from emerging mar- average, between the end and beginning on the period kets remain. Based on the Federal Open Market Indonesia 0.8 12.0 2.1 Committee (FOMC) members’ judgment about Philippines 3.1 7.2 0.1 the path of federal funds rates during their Malaysia –5.2 2.0 0.5 Thailand –7.1 0.3 0.4 September 28th meeting this year, it is possible Source: CEIC Data (database), New York, NY (accessed November 5, 2018), www.ceicdata.com. that U.S. interest rates may rise higher and faster Note: — = not available; LCY = local currency. than initially expected by the market (Figure 2). a. Using September data; Philippines bond yield data is available only up to September. If this occurs, portfolio capital retrenchment from I nflation and unemployment rate in the United States  Policy   I nflation rate and unemployment and rate in the United States market expectations Figure (inflation: percent; year on year and unemployment: percent of labor force) (year on year and percent of labor growth) Figure (percent) Figure 1 3 6 2 4 3 FOMC median 2 5 2 Percent Percent 1 1 4 3 0 0 3 –1 2015 2016 2017 2018 2010 2013 2016 2019 2022 Year Year Inflation Unemployment rate (RHS) United States Euro Area Japan Source: Global Economic Prospects (database), World Bank, Washington, DC,  Source: Global Economic Prospects (database), World Bank, Washington, DC,  http://www.worldbank.org/en/publication/global-economic-prospects. http://www.worldbank.org/en/publication/global-economic-prospects. Note: Inflation is measured by year-on-year change in the personal consumption expenditures (PCE) price index. Both Note: Policy rates are for the effective federal funds (United States), EONIA (Euro Area), and overnight call rate (Japan). PCE price index and unemployment rate are seasonally adjusted. Dotted lines refer to projections over longer run in Blue dots (FOMC median) are medians of individual FOMC participant’s judgment of the appropriate target level for the the latest Federal Open Market Committee (FOMC) meeting (in September 2018), based on the central tendency. Last federal funds rate at the end of 2018 to 2021, in the September 2018 FOMC meeting. Shaded area indicates market observation is August 2018. RHS = righthand side. expectations derived from overnight swap rates (as of September 28, 2018). emerging markets may increase, leading to sharp exports is small, representing 0.7 percent, 0.8 per- asset prices movement in emerging market devel- cent, 0.1 percent, and 0.5 percent of Indonesian, oping economies. A similar scenario happened in Malaysian, Philippine, and Thai exports, respec- mid-2013 when an announcement by then Federal tively. A further slowdown in Turkey’s gross Reserve Chairman Ben Bernanke that quantitative domestic product (GDP) growth is therefore easing would be “tapered” later that year triggered unlikely to have a significant direct impact on capital outflows from emerging markets. SEA. Markets in SEA would be affected only if Global trade tensions constitute the second events in Turkey disrupted the global financial main factor behind the pressure on SEA markets. markets, which seems unlikely. The sensitivity of SEA economies to trade tensions stems from the high degree of global trade inte- When shifts in capital flows affect currencies gration and their strong trade links with China. Three main factors explain the difference in the The direct spillover impact of higher U.S. tariffs sensitivity of SEA currencies to volatility in capital on China’s goods (via lower Chinese demand for flows. The first factor is the size of stable foreign SEA’s inputs) is difficult to estimate in the short financing inflows relative to the current account term as business players are weighing whether the balance. Because foreign direct investments are “shock” is temporary or permanent. However, the most stable capital inflows to developing threats of trade wars generate uncertainty in global countries, the “basic balance,” that is, the dif- markets and threaten to disrupt regional supply ference between foreign direct investment (FDI) chains if they materialize—a risk enhanced by the flows and the current account balance is often tightening cycle of current U.S. monetary policy. used to measure this gap. When the basic balance There was a strong spike in SEA currencies (that is negative (that is, FDI inflows are insufficient is, depreciation) in July 2018 when the United to fully cover a current account deficit), volatile States and China first raised their tariffs.1 portfolio flows are relied upon to fill external While the situation in distressed emerging funding gaps, and this exposes countries to sud- market economies may have adverse, indirect den changes in portfolio investor sentiment. If “sentiment” effect on SEA, direct contagion risks the negative basic balance is driven by a large are likely to be contained. For instance, SEA’s current account deficit, a foreign financing exposure to Turkey’s financial sector is negli- gap opens, which needs to be closed through gible, and Turkey’s share in most SEA countries’ a currency depreciation and reduced domestic Global Financial Market Turmoil Why is South East Asia Exposed but Resilient? demand (for example, lower GDP growth) or a surplus is about 50 percent lower than that of sharp depletion of foreign reserves. Thailand. Malaysia’s deep financial sector is, how- The second factor is the share of non-resident ever, a buffer that helps amortize the potential investors’ holdings of domestic portfolio assets. impact of sudden sell-offs on the currency. For When this share is large, the market is more sensi- both Thailand and Malaysia, capital outflows tive to risks, and there is a higher chance of capi- from residents (not captured by the basic bal- tal flight when global investor sentiment toward ance) may be as important as non-resident flows emerging markets suddenly changes. The third in moving domestic currency markets. factor is the depth of the financial sector. There At the end of the spectrum, Indonesia’s rupiah 4 is empirical evidence that deep financial markets is more sensitive to changes in portfolio capital (proxied by the level of private credit extended by flows. In Indonesia, this sensitivity is heightened banks and other institutions as a share of GDP) by a combination of a low basic balance (near serve as a shock absorber, mitigating the negative zero in 2017 and slightly negative in 2018), a high effects of external shocks on exchange rate vola- share in the foreign holding of domestic currency tility.2 In the case of sudden portfolio outflows, bonds (38 percent), and a shallow financial mar- financial sector depth enhances the ability of the ket (the shallowest in SEA). In the Philippines, domestic financial sector to purchase the assets equity flows and resident outflows are the main sold by foreign investors without large swings in “mover” of the peso, as the bond market is small asset prices and exchange rates. and largely domestic (non-residents hold only 5 Table 3 and Figure 3 show how the four percent of government bonds). The peso is less major SEA economies fare relative to these sensitive to sudden capital outflows because the three factors. In Thailand, a large basic balance scope of bond sell-offs is reduced by the small surplus (reflecting a large current account sur- share of non-resident holding and a still posi- plus) combined with a deep financial market tive basic balance (despite a widening current significantly reduces the sensitivity of the Thai account deficit). baht to portfolio reversals of moderate scale. For instance, with Thailand’s basic balance of How resilient are SEA economies to capital 8.5 percent of GDP, it would take portfolio capital outflows? outflows equivalent to more than this amount to The initial impact and policy response to a weaken the baht (assuming all else are equal). In retrenchment in capital flows depends on the addition, Thailand’s deep financial markets can degree of flexibility of the exchange rate. SEA help minimize the impact of sudden sell-offs by economies have all adopted flexible exchange non-residents, as there are large domestic finan- rate regimes since the 1997 crisis to avoid unsus- cial institutions to purchase the assets. Malaysia tainable misalignments and currency crashes shows similar characteristics except that foreign and allow flexible adjustment to shocks. Thus, investors hold a higher share of domestic bonds a depreciation of the exchange rate should be (32 percent) and the size of the basic balance expected when portfolio flows retrench, espe- cially where stable financing (for example, FDI) is low compared to the size of the current account Table Basic balance, share of foreign holding, credit to GDP deficit. This depreciation would help amortize 3 Basic balancea Share of foreign holdingsb Credit-to-GDPc the shock and minimize reserve depletion, but (% of GDP) (% of total government (% of GDP) sharp depreciations may be a concern if foreign local currency debt issuance) currency exposure in the balance sheets of the Indonesia 0.2 37.6 47.0 public sector, the financial sector, and the corpo- Thailand 8.5 14.1 164.7 rate sector is large, and household debt sizeable. Malaysia 4.2 32.2 145.3 Philippines 2.4 5 66.3 Sharp depreciation may also fuel inflation, forc- ing the central bank to increase interest rates. Sources: World Development Indicators (WDI, database), World Bank, Washington, DC, datatopics.worldbank.org/world-development- indicators/user-guide.html; AsianBondsOnline (database), Asian Bonds Market Initiative, Manila, Philippines (accessed November 5, 2018). Thus, the “vulnerability” of countries to sharp www.asianbondsonine.adb.org Note: a. WDI; b. As of end Q4, 2017(AsianBondsOnline); c. domestic credit provided by the financial sector (% of GDP); data for 2017 depreciation depends primarily on the follow- except Malaysia, 2016 (WDI). ing key factors: ■■ Public sector imbalances: such as high fiscal Figure Depth of the financial sectors in South East Asia deficit, external public debt, and large con- 3 tingent liabilities 120 ■■ Financial sector imbalances: such as banks’ high leverage and risk taking, liquidity, and Bonds Market Capitalization (per GDP) 100 Thailand currency mismatches ■■ Non-financial sector imbalances: such as Malaysia 80 excessive corporates and household debts Bubble size: domestic credit by GDP ■■ Foreign reserves adequacy: foreign reserves 60 5 compared to total imports, for example Philippines ■■ The initial level of inflation. 40 Against these factors, SEA displays a strong resilience base and fundamentals (Table 4). 20 Indonesia On the fiscal side, primary balances are in small deficit (Indonesia, Malaysia, and Thailand) or in 0 0 50 100 150 200 surplus (the Philippines). In addition, the real Stock Market Capitalization (by listed companies per GDP) GDP growth is higher than the real interest rate Source: World Development Indicators (database), World Bank, Washington, DC, in all countries, auguring well for the trajectory datatopics.worldbank.org/world-development-indicators/user-guide.html of public debt, which remains relatively low across the region (except in Malaysia). In the financial have ample foreign exchange buffers relative to sector, the leverage and risk taking by commer- imports. Finally, inflation has remained low in cial banks is low: their capital adequacy ratios 2018 for the region, except for the Philippines are all above Bank for International Settlement (5.1 percent on average in the January–October prudential requirements and non-performing 2018 period, against 3.2 percent for Indonesia, loans are below 3 percent (except in Thailand). 1.2 percent for Malaysia, and 1.1 percent for However, household and corporate debt remain Thailand). Inflation in the Philippines acceler- high in Thailand and Malaysia, partly reflecting ated over the past year due mainly to food supply the depth and sophistication of the financial mar- bottlenecks and cost-push factors, and demand- kets in these countries. All the countries in SEA pull factors. Table Selected indicators of resilience in key areas 4 Indonesia Malaysia Philippines Thailand Financial sector Net open position in foreign exchange to capital (%) 1.7 9.2 3.6 — Non-performing loans to toal gross loans (%) 2.7 1.6 1.7 3.1 Regulatory tier 1 capital to risk-weighted assets (%) 22.2 14.0 12.7 14.9 Regulatory capital to risk-weighted assets (%) 22.5 17.5 14.5 17.8 Fiscal sector Real 10-year bond yield minus GDP growth (%) –0.8 –1.0 –5.3 –3.2 Primary balance (% GDP) –0.9 –1.1 1.4 –0.1 Government gross debt (% GDP) 28.9 54.2 37.8 41.9 External sector Reserves excluding gold as % of imports of goods, services, and income 45 45 52 74 Current account balance as a % of GDP –2.7 3.3 –1.5 8.1 External debt as a % of GDP 34 56 24 32 Non-financial sector Household debta (% GDP) 17.0 67.0 16.0 68.0 Sources: World Development Indicators (database), World Bank, Washington, DC. datatopics.worldbank.org/world-development-indicators/user-guide.html; CEIC Data (database), New York, NY (accessed November 5, 2018), www. ceicdata.com; Institute of International Finance (IIF, database), Washington, DC (accessed November 5, 2018), www.iif.com. Note: Based on 2017 data; — = not available. a. IIF. Global Financial Market Turmoil Why is South East Asia Exposed but Resilient? SEA’s strong macro-fiscal indicators reflect key Going forward however, good macro and reforms implemented following the East Asian macro-prudential policies may not be enough to financial crisis of 1997–98. Key lessons learned guarantee resilience. Deep structural reforms are from the 1997–98 crisis include the importance of also needed. Indonesia’s exposure to the vaga- flexible exchange rates, the need to accumulate ries of portfolio flows reflects the fact that the large foreign reserve holdings (to insure against country exports less than it could and attracts sudden reversals in capital inflows), the advan- less FDI than its good macro policies and large tages of low public debt (to sustainably conduct domestic market warrant. Structural reforms that countercyclical fiscal policies as needed), and the aim to increase private investment including FDI, 6 importance of oversight institutions and pruden- boost exports, and deepen the financial sector tial regulations (to keep bank, corporate, and are crucial. Authorities could remove restrictions household leverages in check). SEA has learned faced by investors to attract higher levels of FDI by these lessons and has applied them in macroeco- reducing restrictions in the government’s nega- nomic policies over the past two decades. Perhaps tive investment list. World Bank studies show that more importantly, SEA’s governments have Indonesia’s low level of FDI is linked to a high moved to a more flexible policy setting, using level of restrictiveness on foreign investment, flexible exchange rates and prompt monetary including the limits to foreign ownership detailed and fiscal policy responses to shocks. This has in the negative investment list. Indonesia could generally helped SEA as a sub-region maintain also increase competition in financial services to resilience. However, to sustain resilience, each develop its domestic banking sector. The sector is SEA country needs to pay attention to and act currently suffering from limited competition due in a few specific policy areas. to the dominance of state-owned banks and the presence of various barriers to increased prod- Policy priorities for sustaining the economic uct offerings (for example, long-term credit and resilience of SEA hedging instruments). Capital markets, which do not currently offer sufficient funding to the pri- Indonesia: Structural reforms needed to vate sector, are not yet a competitive alternative reduce vulnerability to episodic portfolio to the banking sector.4 retrenchments Indonesian authorities have long internalized the The Philippines: Managing inflation and rupiah’s sensitivity to sudden capital outflows by avoiding a fast widening of the current implementing prudent macroeconomic policies. account deficit Fiscal policy is prudent, with a strict adherence In the short-term, reducing inflation is the to the 3.0 percent of GDP legal deficit limit every Philippines’ main policy challenge. Inflation rose year, leading to low levels of public debt (29 to an average of 5.1 percent in the first 10 months percent of GDP) and reasonable fiscal buffers. of 2018, against 2.8 percent in the same period in Typically, fiscal policy has had a strong impact on 2017. This was driven in large part by food supply the current account deficit through capital goods constraints (weak agricultural and fisheries pro- imports. In response to recent global financial duction and rice import bottlenecks), cost-push market volatility and weak FDI inflows, the gov- factors (higher global oil prices and depreciation ernment has postponed some large infrastructure of the peso), and strong domestic demand (GDP projects to prevent the current account deficit growth has remained above 6 percent over the from widening further.3 Monetary policy has also past three years). Indeed, core inflation rose to prioritized macro stability in recent years, and a 4.9 percent in October 2018, from 2.6 percent in large real interest rate gap between the rupiah October 2017, breaching the central bank’s 2018 and the U.S. dollar has generally supported capi- target (2–4 percent). To contain inflation risks tal inflows. Between May and November 2018, and anchor expectations, the central bank has the central bank has increased its policy rate by raised the key policy rate by a cumulative 175 basis 225 basis points despite an inflation rate within points to 4.75 percent (5 increases from May 2018 the target range (3.5 percent). to mid-November). The central bank’s forward- looking statements of “strong commitment to should, however, be continued in the medium price stability” and “readiness to act” augurs well. term to bring down the deficit and rebuild fiscal The government’s decision to replace rice import buffers. As part of the 2019 Budget publication, quotas with a more open and transparent import the new government announced that fiscal con- tariff system is also important to fight inflation solidation measures will help reduce the fiscal going forward. deficit to 3.4 percent of GDP in 2019 (from 3.7 Sustaining the Philippines’ resilience will also percent in 2018), 3 percent by 2020, and 2.8 hinge on preventing the current account balance percent in 2021. Effective implementation of from widening too much too fast, which requires fiscal reforms will be crucial in sustaining the 7 calibrating the expansionary path of fiscal policy. country’s strong resilience to shocks. The country’s current account deficit increased Malaysia’s current account surplus may also rapidly in the first half of 2018 (1.9 percent of come under pressure from a possible global trade GDP), substantially higher than the 0.1 percent slowdown, but the cancellation of many govern- of GDP deficit in the first half of 2017. The rise ment mega-projects could offset that. Malaysian in the current account deficit has gone together exports represent 68 percent of the country’s with fiscal expansion. The fiscal deficit has indeed GDP. Trade protectionism and a slowdown in gradually increased to 2.3 in the first half of 2018, global demand are important downside risks to from 2 percent in 2017. The fiscal expansion is growth. While the robust growth of Malaysia’s driven partly by public capital spending on infra- exports is expected to continue in 2018, it is structure, which increased by 41.6 percent growth projected to decelerate gradually in the coming in the first half of 2018 consistent with the govern- years as the global environment becomes less ment policy to improve roads, control flooding, supportive. However, the new government has and maintain bridges and school facilities. Going cancelled many mega projects that could have led forward, a further fiscal expansion is likely to to significant capital imports and a rapid decline increase capital imports and the current account in the current account surplus, and this may help deficit as rising trade tensions reduce the likeli- Malaysia keep its external financing needs from hood of a compensatory rise in exports. Thus, for rising in the near term. the Philippines, while closing the infrastructure gap is crucial for inclusive growth, calibrating Thailand: reducing high household leverage and sequencing the fiscal expansion carefully Thailand remains well placed to manage any will be important if the external environment potential volatility arising from cross-border remains difficult. capital flows due to the large scale of its buffers. Thanks to a large current account surplus (8.1 Malaysia: Fiscal reforms needed to bend the percent of GDP), Thailand displays a very large curve of external debt basic balance surplus and the largest foreign While Malaysia’s economic fundamentals remain exchange buffer in the sub-region (74 percent sound, fiscal reforms will be crucial in sustain- of GDP). Moreover, at 42 percent of GDP, pub- ing the country’s resilience. Malaysia’s macro- lic debt remains low. Fiscal discipline and fiscal fiscal indicators are solid, but at 54 percent, rules are now enshrined in law under the recently the level of public debt is high, and pursuing passed State Financial and Fiscal Discipline Act of a fiscal consolidation trajectory is in order. The 2018. External debt is also relatively low (32 per- government repealed the goods and services cent of GDP) and mostly denominated in baht or tax on June 1, 2018 and unwound fuel subsidy hedged (Table 4). While the size of these buffers rationalization. According to the Ministry of reflects Thailand’s sluggish public investment Finance, these changes will cost 1.7 percent of and growth in recent years, there seems to also GDP in 2018, and they will be offset by spending be a clear bias toward stability in policy making. cuts, bigger oil revenues, larger dividends from The government’s past quasi-fiscal policies to government-linked companies, and proceeds stimulate consumption, such as the tax rebate from the reinstatement on September 1, 2018 for housing and car purchases, rice pledging of a sales and services tax. Fiscal reform efforts scheme, and loose macro-prudential stance have G lobal F i nanc i al M arket T urmo i l Wh y i s S o u t h E a s t A s i a E x p o s e d b u t R e s i l i e n t ? contributed to a rapid rise in household debt 2. See, for instance, Dabla-Norris and Srivisal 2013. over the past 10 years. The latter stood at 52 3. The mid-2013 “taper tantrum” of the United States percent of GDP in 2008, and it has risen to 68 caused the Indonesian financial markets to come percent in 2017 and 78 percent to date. Given under pressure. The stabilizing actions taken immedi- the relatively high non-performance loan ratio ately—chiefly an increase in the price of fuel, which (3.1 percent) and a possible rise in the central reduced the fiscal deficit, combined with a tightening viewpoint bank policy rate for the first time in three years, of monetary policy—effectively brought the current- the high level of household debt represents a account deficits down and improved investor sentiment. is a note series to clear build-up of potential vulnerabilities. The Subsequent major fuel subsidy reform in late 2014 and encourage dissemination of Bank of Thailand has recently announced the early 2015 led The Economist magazine to “withdraw” public policy innovations. issuance of loan to value caps for high-end hous- Indonesia from the “Fragile Five” group of emerging It is published by the ing to address pockets of risks and preempt the market economies. Unfortunately, part of the fuel sub- Macroeconomics, Trade further build-up of vulnerabilities. In addition, sidy gain is lost due to a “pause” in adjustment of fuel & Investment global practice the prudential supervision of “policy banks”5 was prices over the past year. of the World Bank Group. transferred to the Bank of Thailand from the 4. See IMF-World Bank Indonesia Financial Sector As- The views published are Ministry of Finance in 2017 to mitigate conflict sessment Program (2018) for more details. those of the authors and of interest and increase transparency around the 5. “Policy banks” are state-controlled specialized finan- should not be attributed to cost of directed lending to the taxpayer. These cial institutions (SFIs) set up under specific legislation the World Bank or any other measures combined with the banking sector’s to fulfil government policy objectives (for example, affiliated organizations. Nor high capital adequacy ratio (17 percent, well agriculture, housing, and SME development). SFIs are do any of the conclusions above Basel 3 requirements) further strengthen an important part of the Thai financial system, account- represent official policy of the health of Thailand’s financial sector. ing for 25 percent of system deposits and providing 29 the World Bank or of its percent of household debt. Executive Directors or the Conclusion countries they represent. Going forward, the outlook for global growth, References To order additional copies trade, and investment is likely to be less favorable Dabla-Norris, Era, and Narapong Srivisal. 2013. “Revisit- contact Jenny Datoo, for developing countries. Furthermore, rising ing the Link Between Finance and Macroeconomic managing editor, trade tensions and interest rates will heighten Volatility.” IMF Working Paper, WP/13/29. Room F 5P-504, policy uncertainty and elevate financing risks. International Monetary Fund. 2018. Financial Sector The World Bank, In this context, continuous focus on macroeco- Assessment Program Detailed Assessment of Observance— 1818 H Street, NW, nomic stability will remain important for South Insurance Core Principles. March. Washington, DC 20433. East Asian economies. The application of the International Monetary Fund and World Bank. 2018. Telephone: lessons from the 1997 crisis has served them Indonesia Financial Sector Assessment Program. 001 202 473 6649 well so far. An effective implementation of the Röhn, Oliver, Aida Caldera Sánchez, Mikkel Hermansen, Email: recent “responses” to the global market volatil- and Morten Rasmussen. 2015. “Economic resilience: jdatoo@worldbank.org ity announced in the different countries over A new set of vulnerability indicators for OECD coun- the past few months will however be crucial to Produced by Carol Siegel tries.” Economics Department Working Paper n. 1249. sustain resilience. Printed on recycled paper Notes 1. Note that domestic country-specific factors also affected asset markets in Malaysia. For instance, the sharp one-time capital outflow in July was attributed to the surprise effect of the results of the May general elections. Net portfolio investment recovered rapidly in August as the new administration was established and its policy agenda announced.