Asia braces as Fed tapering looms, with Indonesia at risk
Indonesia, Thailand and Malaysia vulnerable given large current account deficits, foreign investors' significant holdings of assets, say analysts
The panic that rippled through Asia's markets in May and June might just be a prelude to a more serious capital flight when the US Federal Reserve starts winding down its stimulus measures for real.
How quickly the US Federal Reserve reduces its US$85 billion a month of bond purchases, which keep interest rates low, will determine how quickly money is pulled out of Asia.
Countries with large current account deficits where foreign investors hold a significant portion of stocks and government bonds, such as Indonesia, Thailand and Malaysia, look vulnerable, analysts say. Fleeing capital would drive bond yields higher and local currencies lower. Asian companies that borrowed in US dollars but have local currency revenue streams, not uncommon in the property, telecommunications and fertiliser sectors, are also vulnerable as are those that have borrowed in the dollar high-yield bond market.
"Emerging markets have received a quantitative easing boost and when the money gets pulled out, the risks of an accident are high given the very poor secondary market liquidity," said Kaushik Rudra, a strategist with Standard Chartered Bank in Singapore.
Indonesia's rupiah, the Thai baht and Malaysia's ringgit all fell during the May-to-June rout and have been under pressure since, suggesting further capital flight would do more damage.
Foreigners own 34.7 per cent of Indonesian government bonds (US$31 billion), 31.7 per cent of Malaysian ones (US$48 billion) and 18.9 per cent of Thai government bonds (US$28 billion), BNP Paribas estimates.
These countries have higher foreign exchange reserves than ever but they may not be the central banks' main weapon to support their currencies given the reserves offer limited import cover.
Indonesia has reserves to cover just seven months of imports, Korea eight months and Malaysia nine months, central bank data shows. By contrast, Hong Kong reserves cover 27 months of imports, China 20 months and Singapore 17 months.
"The most aggressive selling in emerging markets has been in those rate markets that offered very attractive yields and fundamentals were not as strong," said Endre Pedersen, fund manager with Manulife Asset Management, in Hong Kong.
"Now fundamentals are playing out. What people are watching are twin deficits (current account and fiscal) so markets like Indonesia and India are vulnerable to any reversal of monetary easing in the US."
Forward currency markets are already pricing in further falls. The Singapore non-deliverable forward (NDF) market puts the rates one year ahead for the rupiah, ringgit and baht at down 11 per cent, 5 per cent and 4 per cent respectively.
So far, Indonesia's central bank has propped up the rupiah by spending some of its US$100 billion in foreign reserves. But it raised its key interest rate on June 13 as the rupiah came under pressure, suggesting it is reluctant to rely too heavily on reserves to defend the currency. A weak currency also leaves Indonesia's state-owned companies, who owe US$20.5 billion and are banned from hedging their foreign debt, exposed to a firmer dollar.
India faces less risk from foreign investors, who own just 6.4 per cent of its government bonds. But a record current account deficit of 4.8 per cent of gross domestic product in June suggests the economy's reliance on overseas funding will keep the rupee under pressure. The rupee, which hit a record low of 61.21 on July 8, is trading at 63.80 in a year in the NDF market.
India also has the weakest foreign exchange position among major emerging markets in Asia with reserves covering just six months of imports.
The tightening of dollar liquidity in Asia will shut out many companies from capital markets.
Local currency bond markets are liquid but investors are risk averse. Top companies can secure funding but firms with low or no credit ratings have to borrow in US dollars, often by offering high yields to attract capital.
"A challenge that policy makers and market participants must now address is the need for lower-rated issuers to have access to local currency bond markets," said Surinder Kathpalia, managing director for ASEAN at Standard & Poor's in Singapore.