VZCZCXRO2840
RR RUEHCHI RUEHDT RUEHHM RUEHNH
DE RUEHGP #1517/01 2290835
ZNR UUUUU ZZH
R 170835Z AUG 07
FM AMEMBASSY SINGAPORE
TO RUEHC/SECSTATE WASHDC 3789
INFO RUCNASE/ASEAN MEMBER COLLECTIVE
RUEHBJ/AMEMBASSY BEIJING 2592
RUEHBY/AMEMBASSY CANBERRA 1947
RUEHUL/AMEMBASSY SEOUL 4069
RUEHKO/AMEMBASSY TOKYO 5666
RUEHHK/AMCONSUL HONG KONG 6237
RUEHDN/AMCONSUL SYDNEY 0746
RUEHIN/AIT TAIPEI 6414
RUEATRS/DEPT OF TREASURY WASHDC
RUCPDOC/DEPT OF COMMERCE WASHDC

UNCLAS SECTION 01 OF 03 SINGAPORE 001517 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
STATE PASS TO TREASURY SSEARLS 
STATE PASS TO SF FEDERAL RESERVE TCURRAN 
BEIJING FOR DLOEVINGER 
TOKYO FOR MGREWE 
 
E.O. 12958: N/A 
TAGS: EFIN ECON ETRD EINV PGOV SN
SUBJECT: ANALYSTS UNCERTAIN ABOUT EFFECT OF MARKET 
VOLATILITY FOR REGIONAL ECONOMIES 
 
REF: JAKARTA 2234 
 
 ¶1.  (SBU) Summary: Singapore-based financial analysts 
believe market volatility could have real economic effects on 
Asia even though the region has limited exposure to the 
subprime mortgage and credit derivatives problems afflicting 
the United States and Europe.  Central banks across the 
region this week have been intervening to shore up 
depreciating currencies as Asian equity and foreign exchange 
markets remain volatile.  Analysts foresee the possibility 
that more indirect exposures could come to light and 
inflation caused by currency depreciations could lead to 
monetary tightening in some Asian countries, particularly 
Indonesia.  Many traders and investors are hoping for a 
dramatic response by the U.S. Federal Reserve to stem the 
market decline, but most Asian-based economists are more 
sanguine due to Asia's strong economic fundamentals.  If the 
volatility leads to a slowdown in U.S. demand for Asian 
exports, however, Asia may be in for more economic pain.  End 
Summary. 
 
Market Turmoil Hits Asia 
-------------------------- 
 
¶2.  (SBU) Asian markets finally blinked this week.  Their 
bout of nerves stemmed from the dramatic volatility in the 
U.S. and European money markets caused by liquidity problems 
in the subprime mortgage and corporate paper markets that 
began around August 9.  The results in Asia were not pretty: 
equity markets in Asia were off sharply on August 16, with 
Indonesia falling as much as 8 percent during the day and 
developed markets such as Singapore losing more than 4 
percent of their value.  Overall, the Morgan Stanley Capital 
Index of the market capitalization for stock markets in Asia 
excluding Japan dropped 18 percent from its July 24 peak 
through August 16, although it remains up year-to-date by 5.2 
percent. The fact that Asian stocks have shown positive gain 
for the year has led some analysts to believe that hedge 
funds are selling Asian stocks to help make up for losses 
elsewhere in the world. 
 
¶3.  (SBU) Foreign exchange markets also took large hits, with 
many analysts noting that the sharp appreciation of the yen 
(reaching 3 percent in 3 days) reduces incentives for 
so-called "carry trade" investments in high-yielding 
currencies such as the Indonesian rupiah.  (Note:  The yen 
carry trade involves funding investments in currencies 
earning high interest rates using the yen-denominated assets 
which have a low interest rate.  While commentators often 
assume that these types of trades are mostly undertaken by 
hedge funds, in fact, Japanese households in search of better 
returns on their investments make up a significant portion of 
these trades.  See Reftel Jakarta 2234.  End note.) 
 
Weak Linkages to Subprime Problems 
---------------------------------------- 
 
¶4.  (SBU) Regional banking analysts have told us that 
Southeast Asian financial systems have "very little" exposure 
to  the U.S. subprime mortgage sector.  They note that most 
regional banks are not sophisticated enough to "dabble in 
complex credit derivatives."  Exposure in Indonesia, 
according to one official source, is non-existent among the 
major banks, although it is impossible to rule out 
inappropriate investments by smaller, private banks.  Only 
one smaller bank admitted exposure in Thailand.  Singaporean 
banks have the largest exposure in the region, with a total 
of S$2.3billion (US$1.5 billion) in total exposure to 
collateralized debt obligations (CDOs), the vast majority of 
which are still highly rated by credit rating agencies. 
Moreover, only S$0.6 billion (US$0.4 billion) of the 
Singaporean banks' CDO portfolio is related to mortgages -- 
the section of the market under pressure in the U.S. and 
Europe.  One analyst estimated that writing off half of the 
mortgage related CDOs would only reduce the banks' estimated 
profit for 2007 by 5 percent. 
 
SINGAPORE 00001517  002 OF 003 
 
 
 
¶5.  (SBU) Singaporean banks admit that their asset management 
companies have approximately S$81.5 billion (US$53.6 billion) 
in third-party assets that are invested in CDOs, of which 
S$4.8 billion (US$3.2 billion) are mortgage-related products. 
 While banks do not disclose who holds these investments, 
analysts presume these assets are widely dispersed and mostly 
highly rated, diminishing the risks for systemic problems. 
 
¶6.  (SBU)  Sources speculate that non-bank financial 
companies may face more problems from the market turmoil than 
banks due to their higher subprime and credit market 
exposure.  Insurance companies, for example, may have 
purchased these products.  However, insurance companies would 
likely have purchased more highly rated tranches of credit 
derivatives and would typically hold these investments for 
the long term, thereby mitigating short term volatility risk. 
 The closure of the corporate paper markets may affect 
finance companies that rely on debt (rather than deposits) to 
fund their lending activities.  However, these finance 
companies could present some risk to financial stability to 
the extent that many of them are owned by banks.  Whether 
this would have a systemic effect would depend on how large 
the finance companies were relative to the banks and how long 
the credit markets stayed closed, according to analysts. 
 
Currency Moves Could Mean Inflation 
------------------------------------- 
 
¶7.  (SBU) Media reports and market participants observed that 
many central banks in the region were intervening to defend 
their currencies.  Most notably, Bank Indonesia, Bank Negara 
(Malaysia), and the Monetary Authority of Singapore (MAS) 
were cited in the press as selling their U.S. dollar reserves 
to prevent further depreciation.  Rapid depreciation, if 
sustained, could lead to a surge in inflation.  Analysts 
cited Indonesia as particularly at risk for inflation, and 
noted that the rise in the exchange rate to 9,500 rupiah per 
dollar significantly reduced the likelihood of further 
interest rate cuts for the rest of the year, something the 
central bank had been planning to implement.  Only Thailand, 
which faces increasing political pressure due to a rapidly 
appreciating currency over the last year, appears to welcome 
the devaluation pressures. 
 
Money Market Stability 
---------------------- 
 
¶8.  (SBU) In contrast to the foreign exchange markets, 
Southeast Asian interbank lending markets have not seen much 
volatility.  Analysts noted, for example, that neither 
Singapore nor Indonesia had seen volatility in overnight 
interbank lending rates, suggesting that the excess liquidity 
in the banking sectors and lack of direct exposure to the 
U.S. subprime issues has translated into little if any 
increased risk in lending to Asian banks. 
 
The Way Forward? 
---------------- 
 
¶9.  (SBU) Several analysts mentioned that investors were 
"praying for a Fed rate cut" to stem the slide and bail them 
out.  They noted that the futures market was now pricing in a 
rate cut in the United States.  Most Asian-based economists, 
however, contend that an interest rate cut -- especially an 
emergency cut by the U.S. Federal Reserve -- is unnecessary 
to stop the turmoil in Asian markets.  They compare the 
current situation to previous bouts of instability in the 
emerging markets, in particular those that lasted 5 to 6 
weeks in April, 2006 and February - March, 2005.  Most 
analysts observed that it was probably good that investors 
were reconsidering the relative risk of their investments. In 
fact, as a result of the current turmoil, global risk 
appetite has had its largest shift in ten years, according to 
Merrill Lynch. 
 
 
SINGAPORE 00001517  003 OF 003 
 
 
Comment 
------- 
 
¶10.  (SBU) Fundamentals in Asia are strong: most countries 
are running current account surpluses; banks are well 
capitalized and highly liquid; companies are not highly 
leveraged; central banks have the power to limit currency 
instability thanks to large FX reserves; growth is generally 
solid; and direct exposure to subprime issues appears low 
across the region.  However, should the U.S. economy -- 
especially U.S. personal consumption -- weaken dramatically, 
there will likely be spillover affects on the real economy in 
Asia.  The United States is, after all, the largest market 
for Asian exports. 
 
Visit Embassy Singapore's Classified website: 
http://www.state.sgov.gov/p/eap/singapore/ind ex.cfm 
HERBOLD