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China Economy

A hawkish Fed is biggest danger for Asia, development bank warns

Lender says rising US interest rates may spark capital outflow from region

PUBLISHED : Friday, 07 April, 2017, 9:30am
UPDATED : Friday, 07 April, 2017, 10:54pm

Rising US interest rates could spark a capital exodus from Asia and put highly leveraged households in the region at risk, the Asian Development Bank said on Thursday.

In its annual report on the economic outlook for Asia, the Manila-based bank said more capital would leave emerging Asian markets than would flow in over this year and the next, as higher interests rates in the United States depreciated Asian currencies against the dollar and drove investors away.

As a pillar of the Asian economy, China’s capital outflow exceeded US$130 billion in the third quarter of last year, including outbound direct investment, according to the bank. Beijing’s State Administration of Foreign Exchange has since tightened control of outbound investment.

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The bank said US interest-rate increases would also push up the risks from highly leveraged corporate sectors in countries such as China, and highly indebted households in places like South Korea. This would be particularly true if these countries followed the US lead and raised their own rates.

“Central banks could find themselves torn, wanting on the one hand to lower interest rates to support growth and householder balance sheets, but on the other to raise rates to stem capital outflow and support national currencies,” the bank said in the report.

Consumer debt has grown sharply in Asia due to abundant cheap credit, with the majority in mortgage loans. In South Korea, total household debt rose to 91 per cent of gross domestic product last year, while both Thailand and Malaysia saw household debt jump to about 71 per cent of GDP, the report said.

Why is China so afraid of US Fed’s interest rate increase?

While Chinese households are not as indebted as the ones in these countries, their leverage is shooting up at an alarming speed, according to the National Institution for Finance and Development in Beijing, a government-backed think tank. In 2016, the country’s ratio of household debt to GDP climbed by 5 percentage points, or 6 trillion yuan (US$870 billion).

“Even though compared to China’s GDP, household debt remains low [more than 40 per cent as of December 2016], in terms of proportion of household debt to residents’ net wealth the leverage rate is quite high,” the think tank wrote in a recent report.

Yasuyuki Sawada, ADB’s chief economist, said on Thursday that he hadn’t seen any concrete policy changes from the US and therefore would not expect to see any tangible economic impact on Asia in next two years.

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The administration of President Donald Trump is studying US trade relationships and trying to pinpoint which countries are “stealing jobs” from the country, as Trump has claimed about China.

Sawada said that for many middle-income Asian economies, the key to making the leap to “high income” was to increase productivity, which requires innovation and investment in people and infrastructure.

The World Bank defines a middle-income country as one with a gross national income per capita between US$1,026 and US$12,475. The ADB estimated that in 2015, more than 96 per cent of Asians were in the middle-income bracket by the World Bank’s standards.

There has been debate in China over whether it is “trapped” in the middle-income bracket.

“Whether you are trapped or not is not so much the issue,” said Joseph Ernest Zveglich, the ADB’s director of macroeconomic research.

“It’s just that from low income to middle income, certain drivers in growth are going to be there. Economies that have made it that far have succeeded. But those factors are not going to be the ones that take them to the high income.”