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Tuesday, June 25, 2013

How the QE tapering could hurt Asean


KUALA LUMPUR: The tapering of the US Federal Fund's quantitative easing (QE) stimulus is likely to bring headwinds to the countries in the region including Malaysia, said research houses.
One of the main risks is a `sudden stop' in capital inflows, where the Asean markets recently bore the brunt of sell-off. 

Drawing parallels with the 1997 Asian financial crisis were however, misplaced even though there may be similar factors which led to the contagion, said economists. 

Frederic Neumann, senior Asian economist for HSBC Bank said the differences outweigh the similarities. 

“What's needed to restore confidence is an all-out move towards structural reforms; above all in China, but elsewhere, too." 

In events leading to the contagion, debt had soared as capital rushed into the region, spurred at first by a generous Fed and sustained by the Bank of Japan. 

While the borrowed money was used to build and purchase property, this was not matched by productivity growth which led to shaky fundamentals and the reversal of capital, he said.
Neumann said growth has shifted downwards in the region and market volatility will likely persist for a while.

“Still, the region's defences are sturdier than 16 years ago...that should help it brave the coming headwinds with a little more poise.” 

Current account positions of most countries are in surplus which should cushion the blow from departing funds, while the region also no longer suffers from a currency mismatch between its assets and liabilities. 

Although a stronger dollar will not impose `a crippling spike in debt service costs', it does not mean that foreign investors may not pull their cash out of emerging markets. 

Given their exchange rate exposure, they may now be more likely to do so than before but given the excess savings available, local financial systems should be able to cope. 

“But there are two complications here. One, the transition of funding from foreign to local sources in itself is bound to be bumpy. The cost of capital is likely to rise, with fewer investors chasing assets,“ he said, adding that with excess savings at hand, volatility is bound to persist, funding costs to rise and growth to slow. 

Neumann also pointed out that unlike the 1997 situation, the banking systems in most countries in the region are more robust, with capital buffers are higher, loan-to-deposit ratios lower, and the regulatory and risk control frameworks more advanced than they once were. 

“The `sky-high' foreign exchange reserves, and the potential availability of regional swap lines (though so far untested), are perhaps the biggest dissimilarity between now and then,” he said, adding that for the most part, they should still prove plenty enough to stave off bigger trouble. 

Since every crisis takes on a different guise, Neumann warned of vulnerabilities which may raise risks but confidence is key to maintain growth. 

“With volatility on the rise, however, it takes a much smaller upset to knock down confidence, with unpredictable consequences for liquidity, leverage, and growth.” 

Bond markets have also grown at a rapid rate, which has also raised risk that their institutional infrastructure -- building blocks such as a deep local investor base, tested legal certainty and experienced rating agencies - has not kept pace. 

Distribution of debt also matters, he said. 

He said leverage is also another risk to watch out for. If in the run-up to the Asian financial crisis, it was generally large, often listed firms that accounted for a big chunk of debt, today, the rise in leverage has been more concentrated in households, smaller companies and government entities (state-run enterprises or local government vehicles). 

Touching on capital inflows, Dr Chua Hak Bin of Bank of America Merrill Lynch warned that Malaysia looks most vulnerable to a “sudden stop”. 

Foreign ownership of Malaysian government securities is currently about 48.3 per cent, compared with 13.4 per cent in February 2009, just before the first QE started. 

He pointed out that foreign ownership of Bank Negara Bills is even higher, at about 58 per cent of outstanding. 

Although Malaysia bonds yields have risen because of the recent sell-off, the spike has not been as dramatic as some of the other Asean countries. 

"Markets have treated Malaysian bonds as more defensive and stable in part because of the pension fund’s (Employees Provident Fund) captive savings. 

"But soaring quasi-public debt and risk of a ratings downgrade if fiscal reforms are delayed may question these qualities." 

Malaysia is the largest recipient of capital flows since QE started (whether QE1, QE2 or QE3), measured as percentage of recipient gross domestic product (GDP). 

Since QE1 began, foreign portfolio inflows into Malaysia is the highest (7 per cent of GDP), followed by Thailand (2.7 per cent), the Philippines (2.3 per cent), Indonesia (1.5 per cent) and Singapore (0.3 per cent). 

Portfolio inflows into Malaysia are largely through bond, rather than equity inflows.
Between 2004 and 2012, cumulative foreign portfolio investment flows totalled US$248 billion, with the largest inflows seen in Indonesia, Malaysia, Thailand, the Philippines and Singapore.

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