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Monetary Authority Of Singapore Releases 2009 Financial Stability Review

Source: Monetary Authority of Singapore
Posted on: 9th November 2009

The global financial system came close to collapse in late 2008 and early 2009, following the failure of Lehman Brothers.

World trade, capital flows and economic activity experienced sharp and synchronised contractions, brought on by the severe financial stress and freezing of credit markets.

Read The Complete Report Here

Policy makers around the world responded with unprecedented action – monetary policy was loosened, large amounts of liquidity were injected into the markets, bank rescue plans and support measures were introduced or augmented, and substantial fiscal stimulus packages were announced.

The raft of policy measures appears to have helped stabilise the global financial system and set the stage for economic recovery. Economic activity has bottomed out and begun to recover. Funding market conditions have eased. Banks are generally better capitalised than at the start of 2009. In response to improving economic conditions, investor risk appetite has returned, triggering a strong rebound in financial markets.

Barring further disruptions, the central outlook for the G3 points to a gradual recovery in 2010. Financial market conditions should improve with the recovery although credit losses are expected to persist for some time as the credit cycle runs its course and defaults continue to rise. The extreme financial stress and collapse in world demand in late 2008 led to some turbulence in Asian financial markets and a sharp fall in economic growth throughout the region. Nonetheless, as Asian economies had entered the turmoil with stronger macroeconomic and financial fundamentals than before the Asian financial crisis and Asian financial institutions had limited direct exposure to troubled assets, financial stress indicators did not reach the levels experienced during the previous crisis. Swift policy responses, combining substantial fiscal and monetary stimuli and other support measures, also helped. Global inventory rebuilding provided a further fillip to growth.

As a result, Asia’s recovery has been sharper and faster than expected, with a significant rebound in GDP growth since Q2 2009. Banking systems in the region have remained resilient, and credit spreads have narrowed to close to their pre-September 2008 levels. We expect Asian economies to continue to recover through 2010, although GDP growth rates would likely be below their long-term averages. There are however several downside risks to this external outlook which the FSR highlights.

G3

  • The rise in risk appetite and sharp rebound in financial markets since Q1 2009 may have outpaced economic fundamentals, given the uncertainties facing the global economy and financial system. Any perception of a stall in the recovery could raise risk aversion and trigger a repricing of financial assets. To the extent that the market recovery has been supported by policy stimuli, asset prices could be highly sensitive to the eventual reversal of these policies. Should these downside risks crystallise, banks’ earnings prospects and asset quality would be negatively impacted, which could in turn intensify adverse feedback loops between the real economy and the financial system.
  • Considerable writedowns by the financial sector are still expected, and could be a key headwind especially if banks’ earnings prospects are tempered by a tepid recovery or a protracted period of lower growth. The strength of the recovery is tightly linked to prospects for banks since ongoing balance sheet repair, coupled with impaired securitisation markets, could mean credit supply remains weak, amplifying any drag on the recovery.

Against this uncertain backdrop, authorities must be cautious about removing support measures prematurely and undermining market confidence. But as the near-term fog lifts, risk would need to be transferred back to the private sector to avoid further strains on public finances. Moreover, moral hazard and expectations of government support could sow the seeds of future excesses.

Asia

  • Any stall in G3 recovery would impact on Asia – particularly the more export-dependent economies. A re-evaluation of the region’s growth prospects or increased risk aversion could trigger market volatility. In addition, to the extent that the run-up in Asian asset prices since Q1 2009 has been supported by abundant global liquidity, markets may be sensitive to the eventual removal of monetary accommodation. Such market volatility could prompt capital outflows from Asia and, in turn, exchange rate volatility.
  • On the other hand, if the economic recovery continues, some Asian countries may need to begin to unwind monetary accommodation before the G3, given their stronger economic recovery and resilient credit supply. This could pose policy dilemmas. If monetary policy needs to be tightened significantly earlier than in the G3, carry trades, capital inflows and exchange rate appreciation pressure could result, potentially entailing a risk of asset price bubbles. As a small open economy, Singapore has not been immune to the financial turmoil but has also benefited from the global recovery. After hitting a trough in March 2009, the domestic equity market has mounted a sharp rebound, in tandem with global and regional equity markets. US$ funding strains in the Asian Dollar Market, which emerged in the immediate aftermath of Lehman’s failure, have abated.

The Singapore economy contracted in Q4 2008 and Q1 2009, but has since posted two quarters of strong sequential growth. For the whole of 2009, GDP growth is projected to come in at between -2.5% and -2%, a much less adverse outcome than expected early this year. The corporate and household sectors have thus far weathered the economic slowdown relatively well on the back of strong balance sheets and Government policies such as the Special Risk-Sharing Initiative and the Jobs Credit Scheme. Turning to the financial sector, banks and insurers have remained resilient through the crisis, maintaining high capital and liquidity ratios. The local banks’ earnings have dipped but remained above market expectations. This, together with successful capital raising efforts during the crisis, should enable the local banks to absorb further credit losses in the coming quarters. Domestic financial conditions should continue to improve as the economy recovers.

However, the situation in the domestic financial system is not without downside risks. First, the sustainability of the global economic recovery remains uncertain and any adverse shock would weigh on the performance of the Singapore economy given its openness. Should economic recovery stall, corporate earnings may come under renewed strain and corporate refinancing may become more difficult.

Unemployment may also rise if the economy slows again. The knock-on effects on consumer and corporate repayment capability could impair banks’ asset quality, resulting in higher non-performing loans (NPLs) and provisioning charges. Loan growth could moderate again, holding back the recovery.

Second, despite the lingering uncertainties in the domestic and global economy, domestic property market activity has taken on its own dynamic. The Government introduced several measures in September 2009 to temper the exuberance in the market and pre-empt any speculative bubble from forming. As Singapore emerges from recession and with the market expecting low interest rates to persist for some time, the risk of a renewed escalation of speculative momentum cannot be discounted.

More measures might then be necessary. The nature and timing of such measures would have to be balanced against the still uncertain path of economic recovery.

As the economy recovers, MAS will continue to monitor global and domestic developments closely and stands ready to address any potential threat to Singapore’s financial system.

Macroeconomic Surveillance Department
Monetary Authority of Singapore
9 November 2009

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