Riding the next cycle
A looming hike in US interest rates is raising new questions for Asia, after a surge in dollar borrowing increased the region’s exposure to global capital flows.
Plunging oil prices may be a boon for Asia’s energy importers, but they also highlight the region’s exposure to global forces well outside its control.
This year’s ADB annual meeting takes place against an uncertain backdrop, with rate hikes looming in the US, China’s economy slowing, Greece testing the eurozone’s resilience and geopolitical tensions rumbling in Russia and the Middle East. One of these – or any other unforeseen event – has the potential to reshape global capital flows and send investors fleeing from Asia’s emerging markets.
India and Indonesia watched foreign investors run for the exits at the first hint of an end to US monetary easing in 2013, sending their currencies plunging against the dollar. A stronger dollar is adding new pressure on Asian currencies and many countries are just as exposed as they were during the “taper tantrum”. Foreign ownership of Indonesian Government bonds, for example, peaked at 40% in February 2015 from 33.8% in May 2013.
“As the US dollar has appreciated substantially, including against many EM currencies, and US rates are set to rise, many EM corporate borrowers will be vulnerable to debt servicing and refinancing risks.”
Risks also extend to the corporate sector: the Institute of International Finance warned this month that outstanding non-financial corporate debt had reached an average of 80% of GDP in the emerging markets, up from about 55% prior to the 2008–09 crisis.
“As the US dollar has appreciated substantially, including against many EM currencies, and US rates are set to rise, many EM corporate borrowers will be vulnerable to debt servicing and refinancing risks,” said the IIF in its April Capital Markets Monitor, noting that redemptions were due to peak in 2017–19, “when US rates are likely to be significantly higher than at present”.
Indeed, bond sales from Asia in euros, dollars and yen have quadrupled since the financial crisis, exceeding US$200bn in 2014 from US$52bn in 2007. The figures do not include borrowers in Japan, Australasia and Central Asia.
Domestic debt has also grown, but the region’s bigger local bond markets posted a far slower start to 2015 than in recent years in a sign that volatile rates and rising credit concerns may be eating away at Asia’s safety net.
While external funding increases Asia’s exposure to global risks, the region’s governments have also strengthened their fiscal positions and implemented economic reforms. Morgan Stanley economists wrote on March 26 that Asian economies were less vulnerable to a US rate hike cycle than they were either in 1994 or 2004.
“(T)he presence of current account surpluses, a funding structure that is more skewed towards domestic debt, deflationary pressures and the resulting high level of real rates across most countries in the region will mean that the risks of a region-wide external funding-led shock is much lower in this cycle,” the Morgan Stanley analysts wrote.
Shang-Jin Wei, ADB chief economist, says Asian economies can limit their exposure to volatile portfolio flows by focusing on foreign direct investment, which tends to be more stable.
“Having some policies that could tilt the pattern of capital flows more towards FDI could be helpful in building resilience to external shocks,” he said.
Other prudential measures are available, depending on each individual country’s situation.
“This is probably not the time to rush to get rid of capital controls,” said Wei, adding that countries with a history of open markets should not jeopardise that reputation.
“There are other financial prudential tools that can deal with this. By working with banks, you want to minimise the chance of asset bubbles, and do your own stress testing to make sure your financial sector will be able to withstand any shocks and stresses. There are more options in the toolkit.”
Short-term shocks aside, Asia’s future economic stability depends on its ability to generate domestic demand and cut its dependence on exports to the West. Efforts to rebalance some of the region’s biggest export economies are beginning to pay off. In the next few years, Wei says, China will become a net importer of garments.
Financial markets also reward long-term fiscal planning. The IIF notes that India and Indonesia were among the hardest hit during the tapering scare in 2013, but have outperformed Brazil and Turkey in recent quarters, thanks to their progress on economic reform.
“Against this challenging global backdrop it is again clear that good policy pays,” said IIF economists. “EM countries having implemented sensible macroeconomic policies with a reasonable reform agenda to boost economic potential have been much more resilient than others in financial markets.”
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