INSIGHT: Asia awaits Fed decision on tapering

16 September 2013 16:04  [Source: ICIS news]

By John Richardson

PERTH (ICIS)--Next Wednesday will be a crucial day for many Asian economies. It is then that the US Federal Reserve is due to conclude its latest two-day Federal Open Market Committee meeting.

“We should hear more details on Wednesday of when, exactly, the Fed will start tapering back its purchases of $US85 billion worth of Treasury and mortgage-backed bonds each month,” said a Perth-based resources analyst.

“The results of the meeting should give us a bit more clarity on the timing for tapering of quantitative easing [QE] and what economic conditions will need to be in place for it to happen.”

The worrying thing for many Asian economies, excluding China, is that few analysts expect that the Fed will backtrack from its intention to taper QE sooner rather than later. This could prompt another round of selling of already weakened currencies, such as India’s rupee and the Indonesian rupiah, and more capital flight from equity and bond markets.

Before the Fed first hinted at QE tapering there was a lot of talk of how macro-prudential government policies in countries such as Indonesia, Thailand and Malaysia, and the rise of the Asian middle classes, promised sustained growth.

But then in May, when the Fed dropped its first hints about reining-back QE, there was a major shift in the consensus on many of Asia’s emerging and developed countries.

Some $60bn of funds has flowed out of emerging market equity and bond funds since May, according to an 11 September Financial Times article. 

“Investors have developed cold feet towards Indonesia, Malaysia etc because yields have improved in the US, thanks to the prospect of less QE,” the analyst added.

“Structural problems in emerging markets have been there for a long time, of course. It is just that until May, some investors chose not to notice.”

Let’s assume that the Fed announces on Wednesday that it has radically changed course and that bond purchases will be kept at $85bn per month for a longer period than is expected by the markets.

It is hard to imagine how investors can suddenly regain their appetite for many of Asia’s economies, given that there is now so much discussion about the flaws in their growth models.

“In a sense, the last five years [since the global financial crisis] amount to a lost opportunity,” said HSBC in its Q3 Asian Macroeconomic Report. HSBC, it must be stressed, has been warning about over-leverage and other problems in Asia long before May, as have other analysts.

“Rather than pursue continuous reforms, the [Asian] region rode the wave of easy cash with scant regard for how the journey might be sustained without the tail winds of record low interest rates,” wrote the bank in the same report.

Excessive leverage has taken several forms, according to HSBC, which are:

           A rise in dollar-denominate debt in India and Indonesia. This was fine until the dollar started strengthening, but since May, the rupee and rupiah have tumbled in value against the greenback, causing India and Indonesia’s current account deficits to widen. This has tied the hands of their central banks. Unable to stimulate their economies, the banks have had to maintain or increase interest rates in order to defend currencies and keep inflation in check. For example, on Thursday 11 September, Bank Indonesia raised the cost of borrowing by a further 25 basis points to 7.25%. This was the second hike in the space of two weeks and interest rates have now been raised by 150 basis points since June.

           The largest overall increases in debt-to-GDP ratios since 2008 have been in Singapore, Japan and Malaysia. Much of this debt has been in the form of consumer borrowing, thanks to historically low interest rates. Rising mortgage and credit-card debt have therefore been significant drivers of their GDP growth. Thailand, too, has seen a sharp rise in consumer debt. Thus, these economies have a lot to lose from Fed tapering.

           South Korea falls into another category. Although bank lending has risen relatively modestly since 2008, corporate-bond debt has surged with foreigners playing a big role in the local bond market. The country is, as a result, very vulnerable to capital outflows.

But since the collapse of Lehman Bros, Asia has at least become less dependent on exports to the US and more reliant on exports within Asia, continued the bank.

“US growth will not have the same positive feed through to Asia as in the past,” said HSBC.

“First, US demand may have become less import intensive given (a) the changing composition of US GDP growth away from household spending, (b) a weaker dollar, (c) rising production costs in Asia, and (d) the energy competitiveness of the US following its shale gas revolution (just to name a few).”

The further downside, though, is that the shift in export dependence has been from the US to China, believes the bank, especially in the case of South Korea. Hong Kong (HK) and Taiwan (TA) have also been a big change in their dependence on China:

 China’s economic growth has recovered over the past two months. However, once the extra credit released into the financial system runs out, and once major economic reforms take place after the important November plenum meeting, it looks as though growth will moderate again.

The only way forward for Asia ex-China economies, therefore, seems to be to tackle long overdue economic reforms. Chronic corruption, poor infrastructure, excessive bureaucracy and falling labour productivity growth are among the problems that many analysts say need to be addressed.

But can such reforms take place when GDP growth is on the decline, as the reforms will hit some sections of society very hard economically?

“I don’t think that reforms can take place as the political climate will be too difficult,” said a Malaysia-based petrochemicals trader.

“The impact on demand across the region is not going to be good. I think that, as a result, you are going to see some more of the ambitious cracker projects in southeast Asia drifting quietly into the background.

“They won’t be cancelled, these things rarely are. Instead, they will be repeatedly delayed to the point where they will have to be deleted from demand and supply balances.”

But another interpretation is possible.

“While not being strong enough to knock out Asia altogether, the recent turmoil nevertheless raises the pressure on local officials to face up and administer some bitter medicine,” added HSBC in their Q3 report.

“As the recent years have shown, reforms rarely materialise when life’s easy. As challenges grow, it’s a lot more likely that those things get done that are needed to set Asia on a path to lasting prosperity.”

During the 1997-1998 Asian Financial Crisis, for example, major economic reforms were successfully implemented as politicians took bold risks.

Read Paul Hodges’ Chemicals and the Economy blog
Bookmark John Richardson and Malini Hariharan’s
Asian Chemical Connections blog

By: John Richardson
+65 6780 4359

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