Investment appeal

by **Cals** Tue 17 Sep 2013, 03:05

Published: Saturday September 14, 2013 MYT 12:00:00 AM
Updated: Saturday September 14, 2013 MYT 6:35:13 AM
Investment appeal
BY CECILIA KOK
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ALL eyes are on the US Federal Open Market Committee (FOMC) meeting to be held in the week ahead as the world awaits further clarity on when and how the US Federal Reserve would reduce the volume of cash it has been pumping into the world’s largest economy via its US$85bil per month bond-buying programme, or quantitative easing (QE).
The possible change in US monetary policy will undoubtedly have a significant implication on emerging economies including those in Asia. As evidenced by recent experience, hints of a possible reduction in the Fed’s monthly bond purchases – or what is commonly referred to as the tapering off of the QE – would result in foreign capital outflow, and subject some emerging economies to severe financial market turbulence and significant depreciation of their currencies.
This is because the prospective tapering off of the QE has led to higher US bond yields, attracting capital back to the United States and sparking a selloff in the equity and bond markets of several emerging economies, especially in Asia, most notably India and Indonesia.
While economists reckon the recent financial market turbulence has exposed the inherent weaknesses of some Asian economies, they argue that the volatility has not immediately altered the long-term growth prospects of emerging Asia in general.
As Louis Kuijs, the Hong Kong-based economist of the Royal Bank of Scotland (RBS), puts it, there is still a lot of room for growth in the region.
“The prospective normalisation of the US monetary stance will take place for a good reason: sufficient economic growth and unemployment reduction in the world’s largest economy. That is good for the global economy and the export-oriented Asian economies,” Kuijs explains in his recent note.
In arguing that the long-term economic growth prospects in most emerging markets have not changed suddenly, Kuijs says, “With their current levels of productivity and income much lower than the levels in high-income countries, emerging markets still have a lot of room to grow. Emerging Asia, in particular, has shown it is capable of tapping such long-term growth potential.”
Kuijs adds that he believes emerging markets will likely remain as the key drivers of global growth in the coming decades. What’s needed, he points out, are the right policies to position the region well in the face of an evolving global environment.
Blessing in disguise
The recent selloff in emerging Asian markets reveals the discriminatory behaviour of investors as they choose to exit economies with weak current account balance, and stick to economies with healthier fiscal and external balances as well as decent growth prospects and low inflation.
“There are underlying reasons for the recent selloff in emerging markets. Some of the capital inflows were not financing long-term growth. Instead, they were of a short-term nature and not resistant to higher US yields,” Kuijs argues, adding that financial vulnerabilities built up in countries such as India and Indonesia because they ran up sizeable current account deficits and relied on financial capital inflows to finance them.
“Other emerging Asian economies have faced these issues in a less pronounced manner. At the same time, economies with strong current account positions that do not rely on financial capital inflows, such as China, Taiwan and South Korea, have not seen much financial turbulence,” he notes.
Regional economists at investment bank Nomura International, however, see the recent capital outflows from Asia as a “blessing in disguise”.
“Markets are disciplining policymakers to get their houses back in order – whether it be more proactive monetary policy, reversing populist policies or jump-starting structural reforms – before economic fundamentals worsen so much that a full-blown financial crisis becomes unavoidable,” Nomura argues.
According to Nomura, Asia’s economic fundamentals have been deteriorating over the past four years because policymakers in the region in general have kept their monetary policies too loose for longer than necessary, while being slow in implementing structural reforms.
These weaknesses are reflected in the substantial narrowing in current account surpluses or swings to deficits as experienced by some countries; a rise in short-term external debt; diminishing productivity growth; a rapid build-up of household debt; and overextended property markets.
“Some countries in Asia are now paying the price for allowing their economic fundamentals to worsen, to which investors are now demanding a higher risk premium,” Nomura says.
It points out that the current account deficits (or significantly narrowed surpluses) and a higher investor risk premium as experienced by some countries in the region means that the era of broad-based, trend appreciation of Asian currencies is likely over. The performance of Asian currencies will now likely be more varied, Nomura says.
Mitigating impact
According to RBS, the prospect of a reduction in global liquidity, as the Fed scales down its QE programme, and higher interest rates could lead to further corrections in the financial markets, which tend to over-react and overshoot. But Asian policymakers can manage the shift to tighter global monetary conditions and mitigate the impact with the right policies.
“They would do better to limit the size of current account deficits and keep the macroeconomic position sustainable, basically by avoiding expansionary macro policies. Growth remains key, but it should be stimulated by growth and productivity enhancing structural reforms, not by expansionary policies,” Kuijs opines.
“Governments should also work to reassure markets of long-term stability.
On the other hand, it is best not to rely too much on financial capital inflows, which could well call for introduction of sensible forms of capital controls at times,” he adds.
Kuijs also believes that Asia could explore mutual financial assistance to mitigate the impact of financial volatility.
“The past decade saw the rollout of many bilateral swap lines and other arrangements. During the 2008/09 global financial crisis, these were not used as often as they should have been. Therefore, it would be useful to ensure the existing arrangements are used in times of need and make room for more such arrangements,” he explains.
Kuijs adds that emerging Asian countries would gain by maintaining a good investment climate to attract foreign direct investment. He explains, “Foreign capital that flows into a country because of its growth potential poses less risk than capital that rushes in to reap short-term financial gains.”