China can dodge Fed bullet, but Malaysia is right in the firing line, says HSBC

SINGAPORE (BLOOMBERG) - When the US Federal Reserve last week opted against its first rate hike in nine years, governments around Asia breathed a sigh of relief. But that relief could be short lived.  While the region's biggest economy, China, can likely withstand any negative flow through whenever the Fed does eventually move, others, like Malaysia are braced for a hit to growth.

That's because a US rate hike could accelerate declines in developing Asian currencies and in the process raise funding costs for firms and consumers, constraining demand and disrupting growth, according to HSBC. The relationship is particularly dangerous in economies where consumption and investment is driven by debt and may be exacerbated when US dollar interest rates begin to rise, it said.

Take Malaysia, where credit to the non-financial private sector as a share of gross domestic product rose to 135 per cent in the first quarter from 115 per cent in the same period in 2009, data from the Bank for International Settlements show. The ratio is even higher in China, where it rose to 198 per cent from 130 per cent.

China's "exchange rate adjustment in August, and resulting capital outflows, may have temporarily tightened financial conditions in the country," said Frederic Neumann, co-head of Asia Economics Research at HSBC. "However, PBOC easing helped to blunt this effect and reinforced capital controls should ensure that there's only a tenuous link between currency moves and funding conditions on the mainland."

The People's Bank of China has cut interest rates five times since November and lowered the proportion of deposits banks have to set aside as reserves in a bid to boost lending and avert a further slowdown.  The yuan has fallen about 2.6 per cent against the US dollar this year, compared with Malaysia's ringgit, which has dropped more than 18 percent against the greenback, thebiggest loser among the 11 most-traded Asian currencies tracked by Bloomberg.

Malaysia's economy expanded the least in almost two years in the three months through June. Private consumption is expected tomoderateas households continue to adjust to the implementation of a new consumption tax and the more uncertain economic environment, the central bank said in a Sept 15 statement.

"Malaysia is among the most vulnerable given that it has seen among the biggest moves in the currency and it has a high debt-to-GDP ratio," said Mr Neumann. "That would make Malaysia likely to suffer a tightening of financial conditions which could impact growth over time."

With Fed officials arguing an interest-rate increase is still warranted this year, emerging Asia's recovery may be a ways off.