1 international balance sheets, global imbalances and governance the external wealth of malaysia...

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International Balance Sheets, Global Imbalances and Governance

The External Wealth of Malaysia

Andrew Sheng

Preliminary analysis

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Contents

Introduction

Conclusions

Malaysian Scenario

Global Overview

Regional Perspective

Brief overview of the current trends in global external position

Comparative perspective of regional countries through the crisis and after

A closer look into Malaysia’s external position

Implications for policy imperatives and future directions

for research and surveillance

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Introduction

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Introduction

Financial crises, growing external imbalances and financial globalisation have resulted in increasing interest in looking at economies from a balance sheet perspective.

The balance sheet approach focuses on net assets and liabilities (stock) rather than the IMF practice of looking at flow variables.

Recently, IMF’s Lane and Milesi-Ferritti* introduced estimation of external positions for 140 countries from 1970-2004, presenting a valuable set of data previously not consistently available for scrutiny. This is a rich data-set.

* Lane, Philip R., and Gian Maria Milesi-Ferretti 2006, "The External Wealth of Nations Mark II: Revised and Extended Estimates of Foreign Assets and Liabilities, 1970-2004" IMF Working Paper no 06/69, IMF

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Exciting New Data Source

The balance sheet data, which are derived from flow data and partially stock data, give us an unprecedented total picture of inter-connectivity of stock and flow relationships between trading partners.

In the past, IMF surveillance focused on countries, not on the linkages and transmission mechanisms of trade and capital flow shocks.

The Lane and Milesi-Ferritti* estimates allow a rich analysis of where shocks emanate and how they flow through balance sheets, creating vulnerabilities that authorities were not able to detect before such data.

* Lane, Philip R., and Gian Maria Milesi-Ferretti 2006, "The External Wealth of Nations Mark II: Revised and Extended Estimates of Foreign Assets and Liabilities, 1970-2004" IMF Working Paper no 06/69, IMF

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Global Overview

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Major trends in global external positions

Three trends are particularly notable:

1. International financial integration has increased significantly

2. Global imbalances have widened sharply

3. Differences in rates of return between external assets and liabilities lead to significant shifts in international resources

* The analyses presented here are mainly drawn from the Lane and Milesi-Ferretti (2006) dataset.

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Financial Globalisation Rising

International asset trade increased markedly, especially since mid-1990s. Total foreign assets and liabilities in most countries are much higher than the level of GDP

Source: Lane and Milesi-Ferretti (2006)

0

50

100

150

200

250

300

350

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

United StatesJapanEuropeEast Asia ex-JpnAsian TigersOthers

% of GDPGrowing Financial Integration:

Debt Instruments (assets + liabilities)

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Financial Globalisation in Equity instruments

This heightened financial integration is true for both developed and developing countries, especially in cross-border equity holdings


0

50

100

150

200

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

United States

Japan

Europe

East Asia ex-Jpn

Asian Tigers

Others

% of GDPGrowing Financial Integration:

Equity Instruments (assets + liabilities)

10

Global Imbalances Widening for US & EU

Recent years saw sharp widening of global imbalances

-30

-20

-10

0

10

20

30

40

1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

United States

Japan

Asia ex-Japan

Europe

% of group GDPGlobal Perspective: Net External Positions


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Asia and OPEC are now net creditorsJapan, emerging Asia and oil producing countries are clear creditors, while the United States saw sharp deterioration in net external position. The rest of the world are essentially net debtors.

-3.00

-2.50

-2.00

-1.50

-1.00

-0.50

0.00

0.50

1.00

1.50

2.00

1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

United States

Japan

Asia ex-Japan

Europe

Australia and Canada

OPEC

Others

USD trillion

Growing Imbalances: Net External Positions


12

Rate of Return Differentials Matter

Differences in rates of return on assets and liabilities significantly affect net external positions of countries and lead to shifts in resources across borders

Notes:

1. Figures are in real domestic-currency terms

2. Malaysia figures are returns on direct investment only for 2000-2004, due to the lack of publicly available financial account flow data.

Sources: Lane, Philip R., and Gian Maria Milesi-Ferretti, 2005, “A Global Perspective on External Positions" IMF Working Paper no 05/161,

IMF; Author’s Estimates

US ‘superior’ return differential explains its relatively stable net external position despite massive net external borrowings in recent years

Asset Returns Returns on Liabilities Return Differentials

1995-1999 2002-2004 1995-1999 2002-2004 1995-1999 2002-2004

United States 11.8 9.6 10.5 0.9 1.3 8.7

Japan 6.2 2.8 10.1 5.8 -3.9 -3.0

Euro -4.2 -1.0 -3.2

Malaysia -0.1 13.2 -13.4

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Regional Perspective

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Onset of the Asian Crisis

Except for Korea, countries affected by the crisis saw significant worsening of net foreign positions prior to the crisis, breaching negative 60% of respective GDPs.


-140

-120

-100

-80

-60

-40

-20

0

1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

Thailand

M alaysia

Indonesia

Philippines

Korea

% GDP

Onset of the Asian Crisis: Net External Positions

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After the Asian Crisis

After 1998, net foreign positions improved in all crisis countries, but Malaysia made the most progress, putting the country’s external balance sheet virtually at balance.


-140

-120

-100

-80

-60

-40

-20

0

1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

Thailand

M alaysia

Indonesia

Philippines

Korea

% GDP

Onset of the Asian Crisis: Net External Positions

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A Wider Comparison

Except Korea, the crisis countries clearly have very different net external positions compared to the ‘Asian tigers’

China was relatively unaffected by the crisis, and enjoyed improving net external position due to peg to dollar


-150

-100

-50

0

50

100

1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

Th, Ph & In

M alaysia

Sg, HK, Tw & Kor

China

% GDP

Net External Positions: Malaysia and the Rest

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China: Currency Peg forced Structural Adjustment

China’s GDP powered ahead during and after crisis, while others only recovered to pre-crisis level in the past two years


1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

ChinaSingaporeMalaysiaKoreaTh, Ph & In

Number of times of 1990 level

China and the Crisis: Nominal GDP (US$)

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China: FDI driver of growth & competitiveness

Stock of FDI liabilities relative to GDP have declined for crisis economies since 1998, while FDI to China kept on expanding…


0.5

1.5

2.5

3.5

4.5

5.5

6.5

7.5

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

China

Korea

Th, Ph & In

Malaysia

Number of times of 1990 level

China and the Crisis: FDI Liabilities Stock (% of GDP)

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Malaysian Scenario

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Net External Position: Composition

-100%

-80%

-60%

-40%

-20%

0%

20%

40%

60%

1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

ReservesNet debt (portfolio debt + other investments)Net FDI Net portfolio equity

% net external position total = 100

Malaysia's Net External Position: Composition

The profile of foreign asset for Malaysia evolved considerably from 1970 to 2004.

The 1980s witnessed large buildup of debt liabilities.


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The 1990s saw an increase in net portfolio equity liabilities

-100

-80

-60

-40

-20

0

20

40

60

1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

ReservesNet debt (portfolio debt + other investments)Net FDI Net portfolio equity

% of GDP Malaysia's Net External Position: Composition


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After the crisis, Malaysia saw buildup in foreign reserves and overall improvement of net external position

-80

-60

-40

-20

0

20

40

60

80

1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003

Net portfolio equityNet FDI Net debt (portfolio debt + other investments)Reserves

% GDP Net External Position: Composition


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Portfolio equity2% FDI

19%

Portfolio debt + Others

28%

Foreign reserves51%

Foreign Assets

Composition of Malaysia's Net Foreign Assets, 2004

Portfolio equity20%

FDI40%

Portfolio debt + Others

40%

Foreign Liabilities


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External Wealth and the Economy: Some Observations

Income

Total foreign assets and liabilities (% of GDP), especially the former, have grown in line with income. This suggests a positive relationship between level of income and the holding of foreign assets

0

2

4

6

8

10

12

14

16

18

1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003

0

20

40

60

80

100

120

140

GNP per capita (LHS)

Total Foreign Asset

Total Foreign Liabilities

RM ('000) % of GDPIncome versus Foreign Assets and Liabilities

Sources: Lane and Milesi-Ferretti (2006); Department of Statistics, Malaysia

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Vulnerabilities

Both cases of crises (1985, 1997) were preceded by bouts of worsening net external position, both breaching negative 50% of GDP

-80

-70

-60

-50

-40

-30

-20

-10

0

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

-12

-8

-4

0

4

8

12

Net External Position (% of GDP)

GDP Growth (LHS)

% %Net External Position and Real GDP Growth

If NEP worsens to -50% of GDP, crisis looms

Sources: Lane and Milesi-Ferretti (2006); Department of Statistics, Malaysia

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Net external position shows a negative correlation with REER, pointing to a probable link between exchange rate policy and the improvement in external position after the crisis

Real Effective Exchange Rate & NEP

Sources: Lane and Milesi-Ferretti (2006); Bank for International Settlement; Author’s estimates

80

90

100

110

120

130

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

-30

-20

-10

0

10

20

30

REER (LHS)

Change in Net External Position

Index (2000=100) % GDP

Correlation: -0.61

80

90

100

110

120

130

1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

-80

-60

-40

-20

0

REER (LHS)

Net External Position

Index (2000=100) % GDP

Correlation: -0.65

Net External Position and Real Effective Exchange Rate

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Investment

Capital formation, particularly public investment, showed very significant positive relationship with foreign debt and FDI liabilities

The relationship was clearest in late 1980s up to 1998, in which up to 90% of variations in investment can be explained by changes in foreign debt liabilities

Public Investment associated with Debt + FDI growth

Note: Calculated as correlation between rate of change of respective nominal variables, investment variables lagged 2 years.

Sources: Lane and Milesi-Ferretti (2006); DOSM; Author’s estimates

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0

1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

total investment

public investment

Total FDI + Debt Liabilities versus Gross Fixed Capital Formation

Correlation Coefficient (rolling 10-year window)

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1.0

1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

total investment

public investment

Total Debt Liabilities versus Gross Fixed Capital Formation Correlation Coefficient (rolling 10-year window)

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0

5

10

15

20

25

30

35

1980 1984 1988 1992 1996 2000 2004

0

200

400

600

800

1000

1200

1400

PEL (LHS)

KLSE CI

% of GDP index

Correlation: 0.94

0

5

10

15

20

25

30

35

1980 1984 1988 1992 1996 2000 2004

0

50

100

150

200

250

300

PEL (LHS)

KLSE Market Cap

% of GDP % of GDP

Correlation: 0.87

0

5

10

15

20

25

30

35

1980 1984 1988 1992 1996 2000 2004

0

100

200

300

400

500

PEL (LHS)KLSE Turnover

% of GDP RM million

Correlation: 0.90

Foreign Portfolio Equity Liabilities (PEL) and the Stock Market

Share Market

Foreign portfolio equity liabilities are very significantly correlated to share market movements

The high level of share market activities for the period 1992 to 1998 was clearly related to the steep inflow in portfolio equities

Foreign Portfolio Flows drive Equity Market

Sources: Lane and Milesi-Ferretti (2006); KLSE; Author’s estimates

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The difference between net external position and cumulated current account provides an estimate of the valuation component* of net external assets, which represents:

• cumulated value of net capital gains; and

• exchange rate adjustments

Further Analysis: Valuation Effect

Sources: Lane and Milesi-Ferretti (2006); DOSM; Author’s estimates

* Estimate using methodology presented in Gourinchas, Pierre-Olivier, and Helene Rey, 2005, “From World Banker to World Venture Capitalist: US External Adjustment and the Exorbitant Privilege,” NBER Working Papers 11563, National Bureau of Economic Research

-80

-60

-40

-20

0

20

40

1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003

Net External Position

Cumulated Current Account

% of GDP

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Two clear stylised patterns are notable:

• Valuation effect has been persistently negative suggesting large net capital losses, especially during period when foreign liabilities was large*

• Depreciation of ringgit corresponded to worsening valuation effect, as shown in the shaded areas

Persistent Negative Valuation Effect

Sources: Lane and Milesi-Ferretti (2006); BNM; Author’s estimates

* Given the conceptual relationship, this can potentially explain the large return differential between foreign assets and liabilities

-40

-35

-30

-25

-20

-15

-10

-5

0

1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003

0.25

0.30

0.35

0.40

0.45

0.50

Net Valuation Component

Exchange Rate (RHS)

% of GDP USD/RM

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Preliminary Conclusions

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Implications of Analysis

• Malaysia clearly in much better shape and less vulnerable to external flow shocks - fiscal retrenchment has worked

• Malaysia is not short of savings and therefore improvement of domestic financial intermediation would cushion Malaysia against external shocks

• Letting excessive savings flow out, while deepening domestic intermediation clearly reduces overall risks (equity return swap).

• We need NATIONAL RISK MANAGEMENT strategy and policy. The way we finance development and growth exposes us to different risks. When we are net debtor (negative NEP), we are exposed to shocks on our debt. When we are net creditors, we must learn how to manage our return on assets.

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Implications on Policy

• Policy Management for rich country (net creditor) very different from poor country (net borrower).

• Example: If net assets are held in USD and liabilities are in Yen, then Malaysia would be in double squeeze, a declining asset and appreciating liability.

• This is true not only of Public Sector Risk Management, but also for Private Sector.

• This makes the case for faster development of Asian financial markets, so that we can invest in countries and currencies that appreciate together relative to USD/Euro, rather than being depreciated on our asset holdings.

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Direction of Research

Increase in international financial integration increases exposure to external financial shocks, meaning that balance sheet vulnerabilities will need to be closely monitored.

Thus, research initiatives should be directed to improve the understanding of the economy through the balance sheet perspective.

The devil is in the details. We need to study more carefully not just the components of our balance sheet and flows, but also the inter-relationship with other economies.

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A Macro-Micro Prudential Framework

Surveillance should be reemphasised to include the balance sheet approach to complement the existing surveillance effort. Macro-behaviour have micro-origins, and micro-behaviour have macro-implications

Comprehensive surveillance would require detailed understanding of balance sheet conditions of all the different sectors of the economy, from the financial sector to the public sector and so on.

* Mathisen, J. and Anthony Pellechio, 2006, “Using the Balance Sheet Approach in Surveillance: Framework, Data Sources, and Data Availability" IMF Working Paper no 06/100, IMF, provides an excellent starting point for the understanding of the balance sheet surveillance approach.

This means that different departments within the central bank [and with other regulators] need to have greater co-operation and information sharing in order to have a holistic view of potential shocks to the financial system.

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Growth, Stability and Governance

Economic Growth can only occur in environment of political and financial stability. Central Bank is in charge of monetary stability and systemic financial stability.

Central Bank challenges are very different from emerging market to middle income market to developed economy.

As markets get more sophisticated, regulation and oversight of systemic stability becomes much more complicated. This is because we are in global competition and local regulation.

You have to help locals compete globally, but you have much greater difficulty regulating large foreign giants, some of which may be much larger than the whole economy.

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Learning to trust Market, but carry big stick

In order to regulate market, you have to learn to think how the market thinks. Hence, there must be greater inter-change of staff between the regulators and the regulatees.

Example: how do we regulate Hedge Funds who now account for 50%+ of turnover in London and New York?

You have to learn how they operate and use the language they understand in order to influence their behaviour. Example: Fraga handling Brazilian crisis.

WTO rules require regulators to use International standards to regulate financial markets. This means that we must use the Big Regulators to regulate Big Financial Groups.

In order to compete regionally and globally, we must learn to both cooperate and compete with the Big Financial Groups.

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Thank YouQuestions to [email protected]

1 international balance sheets, global imbalances and governance the external wealth of malaysia...

Documents

imf slide

global overview slide

external imbalances

external assets

introduction slide

surveillance slide

global external positions

flow data