Asian markets are now in a better position to withstand the impact of the expected US rate hike due to improved monetary and fiscal conditions, according to Invesco Asset Management.
“There is less risk of a similar reaction for a number of reasons. Unlike in 2013, most Asian countries now have greater monetary policy flexibility thanks to low inflation risk, lower external debt and higher foreign exchange reserves,”
During the second half of 2013, most Asian markets saw substantial capital outflows after the US Federal Reserve announced plans to taper its stimulus programme. Foreign capital pulled out, market volatility spiked, and in some countries currencies plunged.
“There is less risk of a similar reaction for a number of reasons. Unlike in 2013, most Asian countries now have greater monetary policy flexibility thanks to low inflation risk, lower external debt and higher foreign exchange reserves,” wrote Paul Chan, chief investment officer for Asia ex-Japan, in a research note.
“Improved monetary and fiscal conditions reduce contagion risk.”
Globally, China has the largest foreign exchange reserve at $3.7trn, while seven out of the 10 Asia ex-Japan countries have foreign exchange reserves that exceed the US, according to Invesco.
Indonesia and India have boosted their foreign exchange reserves by about 25% since 2013 and now there is a greater confidence in reform and policy agendas in these countries, the note said.
Meanwhile, Asian countries also have less external debt exposure compared to most non-Asian emerging markets. Indonesia and Malaysia are the only countries where foreign holdings of local currency bonds is quite high.
Chart provided by Invesco
Chan said the firm remains confident that Asian markets are now better positioned to withstand any short-term deterioration in global sentiment when the Fed decides to raise rates, which is expected sometime this year.
Another factor that has the potential to ease volatility is that the markets are expecting a small and gradual increase in interest rates. In other developed markets, the European Central Bank and the Bank of Japan are continuing with their aggressive quantitative easing policies, which could additionally cushion global economies from any fallout from the Fed tightening, the firm said.
Chan also downplayed concerns the Fed rate hike cycle may constrain monetary easing in Asia.
“Unlike in the past, including 2013, subdued inflation risk is keeping the door open for many central banks to ease policy if necessary.“
This time inflation is expected to remain low in Asia given weak commodity prices, early stage recoveries and ongoing structural reform agendas in major countries.”
Notably, current account balances in Asia have also significantly improved since the easing ended in 2013. Eight out of 10 Asia ex-Japan economies have current account surpluses.
India and Indonesia were among the “fragile five” economies due to large current account deficits and were the worst hit markets in 2013. But now India and Indonesia have managed to narrow deficits.
Chart provided by Invesco