Regional Outlook, Global Perspective




By Martin Khor*

The Star-Feb 12

The global stock market turmoil last week has sparked concerns that the relatively good economic times of the past couple of years could be ending.

It is too early to understand what has just taken place or to predict what comes next. It is widely agreed though that the US stock market experienced a “correction” last week. But whether this is just a blip or will worsen to a crash remains to be seen.

Some analysts say there is nothing to worry about as corrections are normal, while others are more pessimistic, with a few predicting it is the start of the worst bear market ever. What happens this week will be crucial.

The primacy of Wall Street in setting the global trend has been confirmed. European equity markets followed the US correction. The Asian stock markets also followed suit, with big plunges almost daily.

The immediate trigger was the positive news on US jobs, prompting fears of wage increases and inflation that would pressurise the Federal Reserve to raise interest rates more rapidly.

Higher interest rates have a negative effect on stock markets as they give an incentive to investors to put their money in alternatives, especially bonds.

But the larger reason is that equity prices had jumped to record levels, due to speculation not backed by fundamentals and fuelled by the easy money policy that the US government pursued in the hope of stimulating economic growth. Some of the trillions of dollars pushed into the banking system by the “quantitative easing” contributed to the stock market bubble.

Even though quantitative easing has ended and is being reversed, US stock prices continued to rise rapidly in January. It was a matter of time before a downturn occurred.

If it continues, the stock market sell-off can have large repercussions on developing countries like Malaysia.

There is the domestic effect. Feeling they have less wealth, affected investors will decrease their spending, thus reducing GDP growth. Those that borrowed to speculate in the stock market may have debt repayment problems.

Companies may see their market capitalisation and asset values sag as the prices of their shares go down.

If the sell-off becomes more prolonged, banks may start worrying about non-performing loans.

Then there is a complex of issues related to the interaction with the global financial markets. The stock market turbulence could affect global investor confidence in emerging economies, which are seen as riskier than the US.

In good times, a lot of speculative funds in search of higher yields flow from the West to the developing countries. But amid global uncertainty, the funds can rapidly flow in the opposite direction, often causing significant damage.

This boom-bust cycle of capital flows has been played out several times over the years. The boom in funds going to developing countries in the 1970s ended in 1982 with the Latin American debt crisis. The boom in the early 1990s ended in crises in East Asia, Brazil, Russia and Argentina.

The boom in the early 2000s stopped with the 2008 global financial crisis, but resumed and has continued to now, with some sharp outflows in 2015 and a return of inflows in 2016 and last year.

We do not know yet what effect the current stock market turmoil will have on capital flows.

A quite balanced view was given by Tokyo-based Mitsubishi UFJ Kokusai Asset Management, which oversees US$119bil in assets.

“We’re not going to see the type of euphoria we saw in emerging markets anymore,” said its chief fund manager Hideo Shimomura in an interview with Bloomberg.

“We’re in a phase where investors are being given a reality check after a great run. That’s not to say inflows to emerging markets will reverse completely.”

In recent years, the developing economies have become more open to external capital flows. This has resulted in new vulnerabilities and has heightened their exposure to external financial shocks, as pointed out in South Centre papers by its chief economist Yilmaz Akyuz.

There has been a massive debt build-up by their non-financial corporations since the 2008 crisis, reaching US$25 trillion or 95% of their GDP.

The dollar-denominated debt securities issued by emerging economies increased from some US$500bil in 2008 to US$1.25 trillion in 2016, according to the Bank of International Settlements.

Moreover, the foreign presence in local financial markets has reached unprecedented levels, increasing their susceptibility to global financial boom-bust cycles.

Foreigners now own a much larger share of government bonds and the equities in the stock market of many developing economies. In Malaysia, foreigners account for about a quarter to a third of the value of government bonds and about a quarter of the value of shares in the stock exchange.

Should there be net capital outflows from developing economies, their currencies may depreciate. And in a vicious cycle, this leads to more capital outflows.

It will also be more costly to service debt and inflationary pressures will mount.

While their vulnerabilities have grown, the countries have less resilience to prevent or counter a crisis. The current account balances and net foreign asset positions of many developing countries have deteriorated in the past decade.

In most countries, international reserves built up in recent years came from capital inflows rather than current account surpluses.

The reserves could decrease if foreigners decide to take their funds back, and these reserves may not be enough to meet large and sustained outflows of capital.

Thus the ongoing stock market turbulence could only be the tip of an iceberg of financial instability and vulnerability.

Ironically, this instability increased in recent years due to efforts to counter the effects of the 2008 crisis. These initiatives may have brought the unintended consequence of building up a new crisis.

*Martin Khor is executive director of the South Centre. The views expressed here are entirely his own.

(First published in The Star –



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