can asia overcome its vulnerability to the european crisis?

• With the exception of Japan, the rest of Asia came through the 2008 financial crisis with relatively little damage. But for the second time in less than four years, the region now faces another major external demand shock, which could turn a mild recession into something far worse.
• Asian authorities were understandably smug in the aftermath of the financial crisis of 2008-2009. Growth in the region slowed sharply, as might be expected of export-led economies confronted with the sharpest collapse in global trade since the 1930’s. But, with the notable exception of Japan, which suffered its deepest recession of the modern era, Asia came through an extraordinarily tough period in excellent shape.
• That was then. For the second time in less than four years, Asia is being hit with a major external demand shock. This time it is from Europe, where a raging sovereign-debt crisis threatens to turn a mild recession into something far worse: a possible Greek exit from the euro, which could trigger contagion across the eurozone. This is a big deal for Asia.
• Financial and trade linkages make Asia highly vulnerable to Europe’s malaise. Owing to the former, the risks to Asia from a European banking crisis cannot be taken lightly. Lacking well-developed capital markets as an alternative source of credit, bank-funding channels are especially vital in Asia.
• Indeed, the Asian Development Bank estimates that European banks fund about 9 percent of total domestic credit in developing Asia – three times the share of financing provided by banks based in the United States. The role of European banks is especially significant in Singapore and Hong Kong – the region’s two major financial centres. That means that Asia is far more exposed to an offshore banking crisis today than it was in the aftermath of Lehman Brothers’ collapse in 2008, which led to a near-meltdown of the US banking system.
• The transmission effects through trade linkages are just as worrying. Historically, the US was modern Asia’s largest source of external demand. But that appears to have changed over the past decade. Seduced by China’s spectacular growth, the region shifted from US- to China-centric export growth.
• That seemed like a good move. Combined shipments to the US and Europe fell to 24 percent of developing Asia’s total exports in 2010 – down sharply from 34 percent in 1998-1999.  Meanwhile, over the same period, Asia’s dependence on intraregional exports – trade flows within the region – expanded sharply, from 36 percent of total exports in 1998 to 44 percent in 2010.
• These numbers seem to paint a comforting picture of an increasingly autonomous Asia that can better withstand the blows from the West’s recurring crises. But research by the International Monetary Fund shows that, beneath the veneer, 60-65 percent of all trade flows in the region can be classified as “intermediate goods” – components that are made in countries like Korea and Taiwan, assembled in China, and ultimately shipped out as finished goods to the West.
• With Europe and the US still accounting for the largest shares of China’s end-market exports, there can be no escaping the tight linkages of Asia’s China-centric supply chain to the ups and downs of demand in the major developed economies. Moreover, there is an important and worrisome twist to those linkages: China itself has tilted increasingly toward Europe as its major source of external demand. In 2007, the European Union surpassed the US as China’s largest export market. By 2010, the EU accounted for 20 percent of total Chinese exports, while the US share was just 18 percent.
• In other words, a China-centric Asian supply chain has made a big bet on the grand European experiment – a bet that now appears to be backfiring. Indeed, in China, a now-familiar pattern is playing out yet again – another slowdown in domestic growth stemming from a crisis in the advanced economies of the West. And, as goes China, so will go the rest of an increasingly integrated Asia.
• The good news is that, so far, the downside has been much better contained than was the case in late 2008 and early 2009. Back then, Chinese exports went from boom to bust in just seven months – from 26 percent annual growth in July 2008 to a 27 percent decline in February 2009. This time, the annual export gain has slowed from 20 percent in 2011 to 5 percent in April 2012 – a significant deceleration, to be sure, but one that stops well short of the previous outright collapse. That could change in the event of a disorderly euro breakup, but, barring that outcome, there is reason to be more sanguine this time around.
• The bad news is that Asia seems to be learning little from repeated external demand shocks. In the end, internal demand is the only effective defense against external vulnerability. Yet the region has failed to construct that firewall.
• On the contrary, private consumption fell to a record-low 45 percent of developing Asia’s GDP in 2010 – down ten percentage points from 2002. In these circumstances, immunity from external shocks – or “decoupling,” as it is often called – seems fanciful.
• As with most things in Asia nowadays, China holds the key to supplying Asia’s missing consumer demand. The recently enacted 12th Five-Year Plan (2011-15) has all the right ingredients to produce the ultimate buffer between the dynamism of the East and the perils of a crisis-battered West. But, as the euro crisis causes China’s economy to slow for the second time in three and a half years, there can be little doubt that implementation of the Plan’s pro-consumption rebalancing is lagging.
• There are no oases of prosperity in a crisis-prone globalized world. That is equally true for Asia, the world’s fastest-growing region. As Europe’s crisis deepens, the twin channels of financial and trade linkages have placed Asia’s economies in a vice. Rebalancing is the only way out for China and its partners in the Asian supply chain. Until that occurs, the vice now gripping Asia will only continue to tighten.

the future of the european union

• What will become of the European Union? One road leads to the full break-up of the euro, with all its economic and political repercussions. The other involves an unprecedented transfer of wealth across Europe’s borders and, in return, a corresponding surrender of sovereignty. Separate or superstate: those seem to be the alternatives now.
• For two crisis-plagued years Europe’s leaders have run away from this choice. They say that they want to keep the euro intact—except, perhaps, for Greece. But northern European creditors, led by Germany, will not pay out enough to assure the euro’s survival, and southern European debtors increasingly resent foreigners telling them how to run their lives.
• This has become a test of over 60 years of European integration. Only if Europeans share a sense of common purpose will a grand deal to save the single currency be seen as legitimate. Only if it is legitimate can it last. Most of all, it is a test of Germany. Chancellor Angela Merkel maintains that the threat of the euro’s failure is needed to keep wayward governments on the path of reform. But German brinkmanship is corroding the belief that the euro has a future, which raises the cost of a rescue and hastens the very collapse she says she wants to avoid. Ultimately, Europe’s choice will be made in Berlin.
• Last summer this newspaper argued that to break the euro zone’s downward spiral required banks to be recapitalised, the European Central Bank (ECB) to stand behind solvent countries with unlimited support, and the curbing of the Teutonic obsession with austerity. Unfortunately, successive European rescue plans fell short and, though the ECB bought temporary relief by supplying banks with cheap, long-term cash in December and February, the crisis has festered and deepened.
• In recent months we have concluded that, whether or not Greece stays in the euro, a rescue demands more. If it is to banish the spectre of a full break-up, the euro zone must draw on its joint resources by collectively standing behind its big banks and by issuing Eurobonds to share the burden of its debt. We set out the scheme’s nuts and bolts below. It is unashamedly technocratic and limited, designed not to create the full superstate that critics (and we) fear. But it is plainly a move towards federalism—something that troubles many Europeans. It is a gamble, but time is running short. Rumours of bank runs around Europe’s periphery have put savers and investors on alert. The euro zone needs a plan.
• Is the euro really worth saving? Even the single currency’s diehard backers now acknowledge that it was put together badly and run worse. Greece should never have been let in. France and Germany rode a coach and horses through the rules designed to prevent government borrowing getting out of hand. The high priests of euro-orthodoxy failed to grasp that, though Ireland and Spain kept to the euro’s fiscal rules, they were vulnerable to a property bust or that Portugal and Italy were trapped by slow growth and declining competitiveness.
• A break-up, many argue, would allow individual countries to restore control over monetary policy. A cheaper currency would help match wages with workers’ productivity, for a while at least. Advocates of a break-up imagine an amicable split. Each government would decree that all domestic contracts—deposits and loans, prices and pay—should switch into a new currency. To prevent runs, banks, especially in weak economies, would shut over a weekend or limit withdrawals. To stop capital flight, governments would impose controls.
• All good, except that the people who believe that countries would be better off without the euro gloss over the huge cost of getting there. Even if this break-up were somehow executed flawlessly, banks and firms across the continent would topple because their domestic and foreign assets and liabilities would no longer match. A cascade of defaults and lawsuits would follow. Governments that run deficits would be forced to cut spending brutally or print cash.
• And that is the optimistic scenario. More likely, a break-up would take place amid plunging global share prices, a flight to quality, runs on banks, and a collapse in output. Devaluation in weak economies and currency appreciation in strong ones would devastate rich-country producers. Capital controls are illegal in the EU and the break-up of the euro is outside the law, so the whole union would be cast into legal limbo. Some rich countries might take advantage of that to protect their producers by suspending the single market; they might try to deter economic migrants by restricting freedom of movement. Practically speaking, without the movement of goods, people or capital, little of the EU would remain.
• The heirs of Schuman and Monnet would struggle to restore the Europe of 27 when it had been the cause of such mayhem—even if a euro-rump of strong countries emerged. Collapse would be a gift to anti-EU, anti-globalisation populists, like France’s Marine Le Pen. There would be so many people to blame: Eurocrats, financiers, intransigent Germans, feckless Mediterraneans, foreigners of all kinds. As national politics turned ugly, European co-operation would break down. That is why this newspaper thinks willingly abandoning the euro is reckless. A rescue is preferable to a break-up.
• But not just any rescue. Too much of the debate over how to save the euro puts the emphasis merely on a plan for growth. That would help, because growth makes debt more manageable and banks healthier. Mrs Merkel should have been more accommodating on this. But any realistic stimulus would be too modest to stem the crisis. The ECB could and should cut rates and begin quantitative easing, but official funds for investment are limited. More ambitious ways of boosting growth, such as the completion of a single European market for services, are sadly not even on the table.
• In any case, the euro zone’s troubles run too deep. Banks and their governments are propping each other up like Friday-night drunks. The ECB’s support for the banks cannot prevent the weak economies of Spain, Portugal, Italy and Ireland from enfeebling their banks and governments. For as long as bond yields are high and growth is poor, sovereigns will face doubt about their capacity to service their debt and banks will see loans go bad. Yet that same uncertainty pushes up sovereign yields and stops bank lending, further inhibiting growth. Fear that the state might have to deal with a banking collapse makes government bonds riskier. Fear that the state could not cope makes a banking collapse more likely.
• That is why we have reluctantly concluded that the nations in the euro zone must share their burdens. The logic is straightforward. The euro zone’s problem is not the debt’s size, but its fragmented structure. Taken as a whole, the stock of euro-zone public debt is 87% of GDP, compared with over 100% in America. Similarly, the banks are not too big for the continent as a whole, just for individual governments. To survive, Europe has to become more federal: the debate is how much more.
• A lot, according to some gung-ho federalists. For people like Germany’s finance minister, Wolfgang Schäuble, the single currency was always a leg on the journey towards a fully integrated Europe. In exchange for paying up, they want to harmonise taxes and centralise political power with, say, an elected European Commission and new powers for the European Parliament. Voters will be scared into grudging acquiescence precisely because a euro collapse is so terrifying. In time, the new institutions will gain legitimacy because they will work and Europeans will begin to feel prosperous again .
• Yet to see the euro crisis as a chance to federalise the EU would be to misread people’s appetite for integration. The wartime generation that saw the EU as a bulwark against strife is fading. For most Europeans, the outcome of the EU’s most ambitious project, the euro, feels like misery. And there is no evidence that voters feel close to the EU. The Lisbon treaty and its precursor, the EU’s aborted constitution, were together rejected in three out of six referendums; ten governments reneged on promises to put constitutional reform to the vote. The parliament is hopelessly remote.
• Another version of the superstate is to accept that politics remains stubbornly national—and to increase the power of governments to police their neighbours. But that, too, has problems. As the euro crisis has shown, governments struggle to take collective decisions. The small countries of the euro zone fear that the big ones would hold too much sway. If Berlin pays the bills and tells the rest of Europe how to behave, it risks fostering destructive nationalist resentment against Germany. And like the other version of the superstate, it would strengthen the camp in Britain arguing for an exit—a problem not just for Britons but for all economically liberal Europeans.
• That is why our rescue seeks to limit both the burden-sharing and the concession of sovereignty. Rather than building a federal system, it fills in two holes in the single currency’s original design. The first is financial: the euro zone needs a region-wide system of bank supervision, recapitalisation, deposit insurance and regulation. The second is fiscal: euro-zone governments will be able to manage—and reduce—their fiscal burdens only with a limited mutualisation of debt. But in both cases the answer is not to transfer everything to the EU level.
• Begin with the banks. Since the euro’s creation, European integration has moved farthest in finance. Banks sprawl across national borders. German banks fuelled Spain’s property boom, while their French peers funded Greece’s borrowing.
• The answer is to move the supervision and support of banks (or at least big ones) away from national regulators to European ones. At a minimum there must be a euro-zone-wide system of deposit insurance and oversight, with collective resources for the recapitalisation of endangered institutions and regional rules for the resolution of truly failed banks. A first step would be to use Europe’s rescue funds to recapitalise weak banks, particularly in Spain. But a common system of deposit insurance needs to be rapidly set up.
• These are big changes. Politicians will no longer be able to force their banks to support national firms or buy their government bonds. Banks will no longer be Spanish or German, but increasingly European. Make no mistake: this is integration. But it is limited to finance, a part of the economy where monetary union has already swept away national boundaries.
• The fiscal integration can also be limited. Brussels need not take charge of tax and spending, nor need Eurobonds cover all government debts. All that is required is for overindebted countries to have access to money and for banks to have a “safe” euro-wide class of assets that is not tied to the fortunes of one country. The solution is a narrower Eurobond that mutualises a limited amount of debt for a limited amount of time. The best option is to build on an idea put forward by Germany’s Council of Economic Experts, to mutualise the current debts of all euro-zone economies above 60% of their GDP. Rather than issuing new national government bonds, everybody, from Germany (debt: 81% of GDP) to Italy (120%) would issue only these joint bonds until their national debts fell to the 60% threshold. The new mutualised-bond market, worth some €2.3 trillion, would be paid off over the next 25 years. Each country would pledge a specified tax (such as a VAT surcharge) to provide the cash.
• So far Mrs Merkel has opposed all forms of mutualisation. Under our scheme, Germany would pay more on a slug of its debt, subsidising riskier borrowers. But it is not a move to wholesale fiscal federalism. These joint bonds would not require intrusive federal fiscal oversight. Limited in scope and time, they do not fall foul of Germany’s constitutional constraints. Indeed, they can be built from last autumn’s beefed-up “six pack”, which curbs excessive borrowing and deficits; and January’s fiscal compact, which enshrines budget discipline in law and is now being ratified across the euro zone.
• Even this more limited version of federalism is tricky. The single banking regulator might require a treaty change, which would be difficult when ten EU countries, including Britain, are not members of the euro. The treaty setting up Europe’s bail-out fund would also have to be changed to allow money to be supplied directly to banks. Countries would have to find convincing ways to commit future governments to pay their share of the interest on the Eurobonds. Greece’s debts so outweigh its economy that it would need a further rescue before entering any mutualisation scheme—though the sum involved is small on a continental scale.
• So it is a long agenda; but it is more manageable than trying to redesign Brussels from the top down, and it is less costly than a break-up. Saving the euro is desirable and it is doable. One question remains: will Germans, Austrians and the Dutch feel enough solidarity with Italians, Spaniards, Portuguese and Irish to pay up? We believe that to do so is in their own interests. The time has come for Europe’s leaders, and Mrs Merkel in particular, to make that case.

learning from islamic banking

• Across the Middle East and South-East Asia, Islamic financial institutions hold aggregated assets estimated to be worth $50 billion. To some, this cash-rich sector represents a huge opportunity for growth and investment. But perhaps, what Islamic banks can really offer is a set of guiding principles that can enhance financial stability, four years after the crisis.
• Given they are barred from charging interest and must abide by a strict religious code, Islamic financial institutions are often dismissed by sophisticated western bankers as living in the dark ages. However, according to a couple of recent major reports, shariah-compliant financial institutions are not only coming of age, but also have much to teach their western counterparts.
• In a report, Empowering Risk Intelligence in Islamic Finance: Managing Risk in Uncertain times, Deloitte’s Islamic Finance Knowledge Center said that the approach to risk management used in Islamic finance has more in common with the western approach than is often assumed.
• The report – based on a survey of 20 Islamic financial institutions located across the Middle East and South-East Asia, which have aggregate assets of $50 billion – suggested that Islamic finance, a cash-rich sector, has much to teach the west’s financial system, which has yet to fully recover from the near-death experiences of 2007-09.
• The Empowering Risk Intelligence report found that Islamic financial institutions came late to adopting formal approaches to risk management. 79% of respondents had established their risk-management departments in the past five years, with only 5% having a risk management department prior to 2002. But things are changing, and fast. The report found that 83% of Islamic finance firms today have both a formal risk-management function and a risk committee responsible for overseeing all risks.
• Yet Deloitte acknowledged there is room for improvement in the risk management area. Key risk-management and regulatory challenges facing the Islamic sector include that two-thirds of Islamic financial institutions don’t have any external credit rating, and that only 25% have considered or received an external rating from a specialist Islamic rating agency such the Bahrain-based Islamic International Rating Agency. The report said:
• “This constitutes a real challenge posed to industry participants and standard-setters such as the [Kuala Lumpur-based] Islamic Financial Services Board, [Bahrain-based] Accounting & Auditing Organization for Islamic Financial Institutions (AAOIFI), [Bahrain-based] International Islamic Financial Market (IIFM) and the Islamic International Rating Agency (IIRA), to enforce best practices.”
• The report suggested that the main causes of shariah-compliance risks include non-standardized practices, diverse interpretations of shariah law, and the fact shariah laws are unenforced in many jurisdictions. Dr Hatim El Tahir, director of Deloitte’s Middle East Islamic Finance Knowledge Center, said: “One thing is certain – the traditional operations and management of Islamic finance will need to change. Institutions offering Islamic financial services around the globe will not only need to deal with risk management but will also need operational effectiveness and a skilled workforce to empower risk intelligence in Islamic finance.”
• The Deloitte findings came as an op-ed published by Project Syndicate, The Challenge of Islamic Finance, sang the praises of Islamic finance and suggested it has an important role in counter-balancing the bonus-fuelled procyclicality and morally hazardous nature of western finance.
• Authors Andrew Sheng, ex-chairman of the Hong Kong Securities & Futures Commission (and one of the voices of sanity in the movie Inside Job) and Ajit Singh, emeritus professor of economics at Cambridge University, said there is growing convergence between Islamic and western finance.
• “Despite skepticism regarding accommodation between Islamic and global finance, leading banks are buying Islamic bonds (also known as sukuk) and forming subsidiaries specifically to conduct Islamic finance. Special laws have been enacted in non-Muslim financial centers – London, Singapore, and Hong Kong – to facilitate the operation of Islamic banks and associated financial institutions.”

The Dangerous Race For Oil

• The world’s biggest oil and gas companies are competing for the enormous reserves of natural gas and oil in the Arctic, but the ecological and economic consequences of a major oil spill would be catastrophic.
• The rush to explore the Arctic’s enormous oil and gas reserves is both hypocritical and absurd, says Rod Downie, Polar Policy and Programme manager at the World Wildlife Fund (WWF),UK.
• “In the UK, we are committed to legal targets with big reductions in carbon emissions of 80 percent by 2050 in our Climate Change Act. Globally, at the UN climate change summit in Cancun in 2010, 194 nations committed to a less than 2°C rise in temperature.
• But to achieve those international targets, over 80 percent of all known oil and gas reserves has to stay in the ground. And if we can only take out 20 percent of what remains, going ever deeper into more remote locations will be absurd and illogical,” Downie exclaims.
• Yet the risk of looking stupid has rarely ever deterred a company from trying to earn a quick buck; and with oil and gas supplies running out in more accessible places, the world’s top oil companies – aided by Arctic governments willing to supply licences – are now clamouring for their share of the reserves at the top of the world.
• The energy companies are well aware of the Arctic’s energy. According to an estimate by the US Geological Survey, the Arctic may contains 30 percent of the planet’s undiscovered natural gas reserves and around 160 billion barrels, or 13 percent, of its undiscovered oil.
• Most of the reserves are thought to be in less than 500 metres of water, though the oil and gas are in different locations. The three areas thought to contain the most amount of oil are Alaska, the Amerasia Basin and the East Greenland Rift Basins; while more than 70 percent of the natural gas supply is likely to be found in three provinces: The West Siberian Basin and the East Barents Basins (both of which are in Russia), and Alaska, in the US.
• Drawn by this major potential, all the oil giants are now trying their luck in the North.
• British multi-national energy company BP for instance is one of the biggest players in the race for cold black gold, despite its catastrophic experiences last year in the Gulf of Mexico – when the Deepwater Horizon oil spill leaked around five million barrels of crude oil into the ocean.
• BP has a joint venture agreement with Russian energy firm Rosneft to exploit potentially huge deposits of oil and gas in the Arctic continental shelf; and the two firms have agreed to jointly explore three areas of Russian territory – known as EPNZ 1,2,3, and covering 125,000 square kilometres in an area of the South Kara Sea – for the coveted oil. A further US$10 billion is expected to be spent developing onshore oilfields in the autonomous Yamal-Nenets area of Russia.
• Meanwhile, Scottish company Cairn Energy lost US$942 million last year in a failed attempt to find oil off the coast of Greenland. The futile pursuit was the main reason behind Cairn’s US$1.2 billion loss for 2011, though chairman, Sir Bill Gammell, has vowed to continue the quest this year.
• Across the Atlantic in the United States, Shell also has plans to begin drilling up to six shallow water exploratory wells in the Chukchi Sea – 70 miles off the northwest coast of Alaska – in June. The US Bureau of Safety and Environmental Enforcement approved the firm’s oil spill response plans in February this year.
• But perhaps the largest offshore Arctic energy project remains the development of the huge Shtokman gas field, which lies 350 miles into the Russian-controlled part of the Barents Sea. The consortium of three companies exploiting the site is made up of Gazprom from Russia, French energy giant Total SA, and Norwegian energy company Statoil. According to some estimates, the field could contain around 3.8 trillion cubic metres of natural gas and more than 37 million tons of gas condensate, with the expected investment into the project to reach US$50 billion.
• Not surprisingly, the scramble for oil, which appears to put money before the long-term good of the planet, has angered many experts. Veteran arctic commentator Professor Oran Young, a former vice-president of the International Arctic Science Committee, said: “They are trying to continue along the business-as-usual trajectory as long as possible. We can’t stop using oil overnight, but we should be proceeding more vigorously with the development of alternatives rather than continuing to the last gasp of the hydrocarbon economy.”
• Even without the damage to the environment, the financial risks are not necessarily viable, added Professor Young.
• Arctic oil and gas will be expensive to transport to market so its attractiveness will be sensitive to fluctuations in the world market. Production and transport costs for Saudi oil, for example, will be around a quarter of the same costs for Arctic oil.
• “The melting icecaps are making it easier to transport the oil, and a fully loaded oil tanker did make a passage through the Northern sea route last summer demonstrating the feasibility of doing that. But navigation in the Arctic is still a tricky proposition and there’s obviously a very black irony in going in for oil because global warming has caused the icecaps to melt.”
• Lloyd’s of London, the world’s biggest insurance market, has also cast doubt on the business case for Arctic oil and gas. In a recent paper, the City firm estimated that US$100 billion of new investment was heading for the Far North over the next decade. But the report’s authors, Charles Emmerson and Glada Lahn of Chatham House said that cleaning up an oil spill, particularly in ice-covered areas, would present “multiple obstacles, which together constituted a unique and hard-to-manage risk.”
• Richard Ward, Lloyd’s chief executive, urged energy companies not to “rush in [but instead to] step back and think carefully about the consequences of that action” before the right safety measures were in place.