More needs to be done as bounce may not last

The latter is risky: even if fundamentals are relatively robust, financial fear can trump these. Defences need strengthening, especially in India and Indonesia, but elsewhere, too. Otherwise the latest bounce may not be sustained.
The recent EM wobble was really nothing new. Something like this happened before; only think of Latin America in the 1980s, Mexico in 1994, emerging Asia in 1997, Russia in 1998 and Argentina and Brazil in the early 2000s. Well, the latest episode was nowhere near on the same scale. But the common thread is that Fed tightening often exposes vulnerabilities among emerging markets. The non-taper has delayed, but not eliminated, those risks. Our US chief economist, Kevin Logan, expects tapering to commence in December and, as before, QE to end by next summer.
There is a key lesson from all those emerging market crises over the past three decades. Dithering will only make things worse, quick action is the best shot at avoiding the worst. Central banks can put up defences most rapidly, fiscal responses and structural reforms take much longer to enact, although they are more important in the end.
India’s surprise decision to hike its repo rate last week was an important such step. True, it rolled back some of its emergency measures and cut the rate for its marginal standing facility. But, as our chief India economist, Leif Eskesen, notes, the hawkish tone was hugely reassuring. Meanwhile, Indonesia also delivered a surprise hike the week before, after having already tightened monetary policy shortly before. In both cases, more may need to be done. First, curtailment of subsidies and sharp depreciations (even if partly reversed of late) imparted a stinging dose of inflation.
Second, with the Fed’s taper to come, and, because of the FOMC’s hold last week, possibly at a faster pace than initially assumed, both central banks need to stand ready to push rates quickly higher if market volatility reoccurs. With elections looming ever closer – the two countries will hold polls starting in the second quarter next year – such action will become both harder to deliver and more important to implement.
Meanwhile, structural reforms are becoming equally pressing. In part, this is because the recent sell-off has sharpened pressures. For example, falling currencies have raised the cost of subsidies applied to imported fuel. Tax revenue, too, is likely to take a hit. To prevent further slippage of fiscal balances, more hikes in energy prices may be needed – an unpalatable task at the best of times, but doubly tricky to enact with elections looming and growth stumbling.
A second area is shoring up capital inflows by attracting more foreign direct investment. With portfolio capital likely becoming more volatile again, the funding of current account deficits needs to be put on a more stable footing. Otherwise, growth will suffer further. The good news is that both economies offer attractive long-term growth potential. However, investment restrictions and a sluggish local policy process are dissuading still too many firms from taking the plunge.
On balance, Indonesia’s challenges are a little less daunting. The central bank’s earlier and more aggressive hikes forcefully underlined its commitment to exchange rate defence. The government, too, arguably faces less political constraints to implement reforms, with the president and vice-president not up for re-election in the upcoming polls (though parliamentarians are, so headwinds persist). Equally important, Indonesia will likely receive support from the expected acceleration in Japanese investment, whether through banks or directly by firms.
Elsewhere, more needs to be done as well. Thankfully for policy continuity, Malaysia’s prime minister, after having won elections earlier this year, will not face an opponent in the upcoming party leadership poll. But, the country needs to press on with reforms: while it can probably weather market volatility over the short-term, its long-term growth potential is increasingly being questioned. Similarly, in Thailand, the short window of reprieve provided by the non-taper should not be wasted. Subsidies are becoming costly and surging energy imports are weighing heavily on the trade balance.
Time to deliver some action.
 
Author Frederic Neumann is HSBC’s co-head of Asian Economics Research.