Fears of an Asian crisis might be overblown

Taper terror” returned to haunt Asian markets last week, spurring investors to dump regional shares and currencies on growing dread that the US central bank may reduce its gigantic stimulus programme. They fear that a pullback of quantitative easing (QE) will mean less liquidity going into Asian assets while also raising US interest rates and the greenback – an outcome that will make Asia less attractive as an investment destination.

But a few observers are entertaining an even scarier vision: a repeat of the Asian financial crisis. Across Asia, economies have been borrowing heavily to fuel spending, sparking a run-up in asset prices, inflation and credit intensity. And just as it did in 1997, the party may be coming to an abrupt end.

Growth in Asia’s trade-dependent economies has slowed, and once-surging capital inflows are reversing direction, depressing currency values in the region and making it difficult for nations to balance their external accounts.

Interest rates, which were slashed to near zero in developed countries to spur growth, are also rising again, which means firms and households rolling over their debt will do so at higher cost.

Some economists portend the tapering of QE will be the trigger that exposes deeper economic weaknesses, by removing cheap foreign funding from Asia just when it is most reliant on it. This could mean the region is headed for more serious and lasting trouble than a one-off panic.

Investors have made it clear which Asian economies they are most concerned about. India’s rupee has fallen almost 20 per cent against the greenback this year and hit new all-time lows. Indonesia’s rupiah has lost about 12 per cent, while the Malaysian ringgit is down about 8 per cent and the Thai baht has shed 5 per cent. These four countries are in the line of fire as a slowdown in China and lower commodity prices weigh on their exports. This has led to deteriorating current account positions and weaker growth.

India, Indonesia and Thailand have been running record or near-record current account deficits, which means they are not exporting enough to pay for their imports. Malaysia is still in surplus, although not by much.

The economic outlook is also dimming. Sluggish exports have led Malaysia, Thailand and India to cut growth forecasts for this year, with Thailand slipping into recession in the second quarter. Indonesia is also fighting rising inflation, which led it to raise interest rates this month.

Meanwhile debt levels have been rising. Malaysia’s households already owe 177 per cent of their income, the highest in Asia. In Thailand, it is the speed of the rise in debt that is worrying.

The situation is tricky for policymakers. If they cut interest rates to stimulate growth, they risk more capital outflows as investors seek higher returns elsewhere.

Malaysia and Indonesia are especially vulnerable, given their reliance on foreign investors. More than 30 per cent of their government bonds are held by foreigners.

But if the authorities tighten monetary policy to stabilise currencies or reduce inflation, that risks sapping economic vitality. The worry is that policymakers, stressed by the recent capital flight, will make a wrong step. They need nuanced policies to shore up their currencies and restore investor confidence without doing so at the expense of growth.

Still, most economists are not losing sleep over the situation. Deutsche Bank economist Taimur Baig agrees that while the currencies of India, Indonesia and Malaysia are particularly stressed, they do not “appear to be in danger of falling into an outright currency crisis”.

“Reserves cover, despite recent declines, is still ample. Even when one adds up the entire stock of short-term liabilities and the projected current account needs for this year, all three economies have reserves to finance them comfortably,” he said.

The picture also looks brighter in most other Asian economies. Those with current account surpluses, large foreign currency reserves to counter exchange rate volatility and solid banks and growth policies are well-placed to weather the storm.Singapore, for one, has several factors in its favour. Its trade account is constantly in the black, it has robust reserves and does not rely on debt to fund government spending, and it received relatively fewer capital inflows from QE.

Other Asian economies that have strong current account positions, which means they export much more than they import – such as the Philippines, South Korea and Taiwan – are also unlikely to be dragged down. The Philippines is also on a better footing due to its current account surplus and lower reliance on commodity exports.

As a whole, economists such as Jimmy Koh, United Overseas Bank’s head of research, are fairly sanguine about history not repeating itself in Asia. “We believe that though QE tapering will be a short-term destabilising factor, the economic fundamentals of the region have strengthened due to the prudent economic policies implemented since the 1997 Asian Financial Crisis,” he said.

Foreign reserves and current account levels are generally strong, and most countries now have flexible exchange-rate policies, making a 1990s-style currency crisis and contagion more unlikely. Asian policymakers are also more proactive about managing credit cycles.

Companies and banks are also financially healthier. While there will be some inevitable pain as borrowing costs rise and asset markets adjust, a domestic banking crisis is less likely.

Another upbeat sign often lost in the market muddle is that QE will be tapered only once the Federal Reserve is convinced the US economic recovery is self-sustaining. All signs so far – from manufacturing to consumer spending – are pointing to a firmer rebound, not just in the US but also in Europe and Japan. This is likely to give a bigger boost to global growth and Asia’s exports, although lingering shakiness means the benefits may not be felt until next year at least.

Meanwhile China, while down, is not out. A surprise turnaround in its factory activity hints at a stabilisation that bodes well for its neighbours, as does its move to a more sustainable growth trajectory.

So while Asia may be in for a rocky ride as the US eases out of QE, most economies are in a good position to manage the adjustment without giving in to fears of a new crisis.

As former US president Franklin Roosevelt, who saw the US economy out of its last massive recession, once said: “The only thing we have to fear is fear itself.” Asia's fundamentals are still strong – there is little reason to let investor panic be stronger.