Economies like Taiwan and South Korea have it relatively easy. Taiwan was running a 10.5 per cent of GDP current account surplus before the virus, using its high level of savings to invest around the world. Its life insurers in particular were big buyers of risky global bonds. Thanks to an effective public health response, Taiwan appears likely to avoid the kind of economic shock experienced by Europe and the United States. But there is no doubt that it can accommodate large fiscal deficits. In fact, more Taiwanese bond issuance would help Taiwan’s insurers, who are being forced abroad by the lack of domestic supply.
South Korea is broadly in the same position. The country stood apart from the rest of the G20 by maintaining (unneeded) fiscal surpluses after the global financial crisis, instead relying on a weak won and exports for growth. As recently as 2018, South Korea ran a fiscal surplus of close to 2 per cent of GDP. As a result, the nation can also reduce its overall risk profile by issuing domestic bonds to its National Retirement System and its life insurers. Financing domestic fiscal deficits is less risky than searching for yield in the US corporate bond market.
Japan fits alongside these countries as well. Japan has long been able to borrow at zero — almost eliminating the real burden of its admittedly large stock debt. Japan’s domestic debt stock gets too much attention, while its role as a global creditor gets too little. Japan’s government, counting the Government Pension Investment Fund, has more external foreign currency assets than it does external foreign currency liabilities. It too can reduce its national risk profile by substituting Japanese government bonds for international assets on its national balance sheet.
China also faces no immediate financial difficulties. This surprises some, as an enormous amount of attention has been paid to the rise in China’s domestic debt after 2008. But that debt isn’t actually central government debt — China chose to carry out its 2009 stimulus through local government investment vehicles, state enterprises funded by state banks and its shadow financial system.
The Chinese Ministry of Finance’s bonded debt is actually very low — around 20 per cent of China’s GDP. In fact, increasing stimulus at the central government level and relying less on local government investment vehicles could help reduce some of the risks building inside China’s financial system.
In the past, too much stimulus was undertaken by entities borrowing on the strength of implicit guarantees. Relying on the central government would also allow China to use the strength of the Ministry of Finance’s balance sheet to finance a major expansion of spending on public health and a much-expanded system of social insurance.
What gets lost in the discussion of China’s domestic debt is that China’s massive borrowing and investment binge was financed entirely internally. China never ran a current account deficit and is steadily building up external assets. China remains, globally speaking, a creditor, not a debtor. In fact, the greatest risk is that China doesn’t do enough stimulus because of misguided concerns about its internal debt load and a persistent unwillingness to use the Ministry of Finance’s clean balance sheet to fund domestic stimulus, instead relying on exports to drive its recovery.
Only one of the major economies in East Asia poses a real concern — Indonesia. Indonesia’s public debt-to-GDP ratio is modest, at a third of GDP. But with a low savings rate and a small domestic tax base, Indonesia has been borrowing externally. Indonesia’s government entered 2020 with around US$200 billion in external debt, including the roughly $80 billion in rupiah-denominated bonds held abroad. Unlike most other Asian economies, Indonesia has never held significant foreign exchange reserves. Thus it screens as vulnerable.
Indonesia’s rupiah borrowing helped buffer its finances from the currency’s fall in 2020, as the burden of domestic currency debt doesn’t change with the exchange rate.
But as Hyun Song Shin of the Bank of International Settlements noted, local currency debt can be a double-edged sword — it helps countries absorb currency shocks, but the flight of foreign investors out of the local bond market can generate volatility.Indonesia is a case in point. Sales of rupiah bonds by foreign investors contributed to the balance of payments outflow that led Indonesia’s reserves to fall by US$10 billion in March. Indonesia was then able to place a US$4.3 billion bond with international investors in April. Higher borrowing needs from a fiscal deficit that is forecast to rise to 5 per cent of GDP without steady foreign inflows into the local bond market do pose a financing challenge.
The bottom line is this: the increase in debt associated with the policies implemented to support income and protect private firms in the face of pandemic control measures do not pose substantial risks to most of Asia’s key economies; only Indonesia may need support and the scale would be manageable.
Brad Setser is the Steven A Tananbaum Senior Fellow for International Economics at the Council on Foreign Relations.
This article appears in the most recent edition of East Asia Forum Quarterly, ‘Immunising Asia’, Vol. 12 No. 2.
This article is part of an EAF special feature series on the novel coronavirus crisis and its impact.