IMF Blog IMF Blog

Closer, Ever Closer

(Version in 中文)

Here’s the good news: thanks to relatively strong fundamentals and good policies,  Asian economies have coped well with the global market turbulence of recent years. Now the bad: a major financial shock—say, of type ignited by the bankruptcy of U.S. investment bank Lehman Brothers in 2008—is likely to have a substantial impact on Asia.  The reason: Asia’s increasing financial interconnectedness.

Over the past two decades—in line with the region’s growing role in the global economy—Asia’s equity markets have become increasingly sensitive to global financial developments.   More specifically, we have discovered that equity returns in Asia generally now move in tandem with those in systemic economies.  (By systemic economies, we are talking here about those countries—such as the United States and the United Kingdom which are home to major, global, financial centers such as Wall Street and the City of London.)

How do we measure that degree of financial interconnectedness?  Or put another way, how do we measure the relationship—if any—between those Asian equity returns and the performance of systemic economies?

Tracking interconnectedness

The answer: by tracking Asian financial “betas” which measure volatility and capture the impact of the systemic economies on Asian equities.

These betas describe the fluctuations of those equities in relation to the fluctuations of the benchmark--in this case, the performance of large, systemic economies. A positive beta means that the asset's returns generally follow the market's returns, while a negative beta means that the asset's returns are generally unmoved by the market.

Asian financial betas have followed a modest, but steady upward trend over the past two decades.  This is easily seen in a graph showing Asian financial betas and global financial shocks.

A spike on the graph—whether it represents the bursting of the technology bubble, or more recently, the turmoil in the euro area—is mirrored by a similar spike in Asian financial betas.

An example of that increasing financial interconnectedness is the global financial shock associated with the Lehman Brothers bankruptcy which explains nearly 90 percent of the pickup in financial betas across Asia from 2002‒07 to 2008–11.

Those financial betas differ from country-to-country.  For example, East Asia (including Singapore and Hong Kong, SAR) has the highest financial betas.  That is, they tended to be more financially integrated and so mirror global ups and downs more closely, whereas countries which pursued a more gradual pace of capital market integration, such as China, generally had lower financial sensitivity to the systemic economies.

No longer insulated

But on the whole, given the now high—and increasing—financial interconnections, Asian markets will never be completely insulated against major global financial shocks.

So far, so bad.  But to be clear, this isn’t an argument for Asia’s policymakers to fold their arms and stand helpless in the face of financial globalization.  On the contrary, one of the main conclusions of our research is that macroeconomic policies matter.

The choices made by Asia’s policymakers can help determine the region’s financial betas.  For example, a lower government debt-to-GDP ratio, and a higher stock of international reserves, but up to a limit, are associated with lower financial betas.

Sound macroeconomic policy frameworks are associated with lower financial betas in Asia during both tranquil and turbulent periods and sound macroeconomic policies may yet limit the impact of major downside risks on the real economy.