SINGAPORE – Due to risks posed by higher-for-longer interest rates and rising debt burdens, policymakers in Asean and its top three trading partners in the region (Asean+3) should act to curb high household and corporate debt and excessive property-developer leverage, said a report on the region’s financial stability.

The report was issued on Dec 5 by the Asean+3 Macroeconomic Research Office (Amro), a think-tank that advises the bloc, which consists of 10 member states of the Association of South-east Asian Nations, China and its special administrative region of Hong Kong, Japan and South Korea.

It said that while economies in the bloc have demonstrated financial resilience in multiple trials over the past few years – when inflation surged and their central banks raised interest rates in response – they are facing heightened uncertainties.

A potential resurgence of inflation is still a risk and may result in even higher interest rates persisting for an even longer period, said the inaugural Asean+3 Financial Stability Report (AFSR), released as the group met for its second Economic Cooperation and Financial Stability Forum in Kanazawa city in Japan.

This may lead to volatility in financial markets as they adjust to the new normal of a higher-for-longer interest rate environment, the AFSR said.

There are also concerns of potential spillovers to Asean+3 economies during episodes of global financial stress, such as a repeat of the March 2023 bank failures in the United States. Such episodes are usually followed by global investors hoarding US dollars, which may result in further tightening of financial conditions.

“Furthermore, accelerated cross-border capital flows, driven by greater financial market integration and digitalisation, can rapidly transmit shocks, creating new challenges for policymakers,” said Dr Khor Hoe Ee, chief economist at AMRO.

Asean+3 central banks should continue to be ready to provide temporary US-dollar liquidity support to financial markets during such times of stress, the report said.

Mitigating cross-border currency liquidity risk is a priority for Asean+3 banks as their regional financial ties are substantial, including those with the Hong Kong and Singapore international financial centres. This reliance on cross-border financing can make banks more vulnerable to market volatility, given that most claims and liabilities are in US dollars, which adds to liquidity risks due to foreign exchange fluctuations, the AFSR said.

The report also said that the resilience of some banks and non-bank financial intermediaries in the region, acting as debt intermediaries and creditors, may be tested, potentially exacerbating vulnerabilities in the financial market. In-depth analysis of financial stability risks in the AFSR underscored the risks from elevated overall debt levels that had reached 300 per cent of the region’s gross domestic product at the end of 2022. The report showed that Asean+3 household debts in 2022 reached 60 per cent of the region’s GDP. South Korea’s household debt stood at more than 100 per cent of GDP, while Hong Kong, Thailand and Japan had higher household debt than the region’s average debt-to-GDP ratio.

“The low-for-long interest rate environment, that existed before the recent global rise in inflation, facilitated substantial debt accumulation by businesses, households and governments. Monetary and fiscal stimulus measures implemented during the pandemic further contributed to the rise in debt-to-GDP ratios,” it said.

Hence, the increased debt burdens and rising debt servicing costs in the current high interest rate environment have increased risks to financial stability, especially as pandemic support measures have been or are still being phased out, it noted.

“A correction in house prices and escalating debt burdens due to higher interest rates or a recession may heighten the risk of defaults, particularly for highly leveraged households,” the report added.

Companies with weakened balance sheets may encounter challenges in refinancing and meeting interest expenses, while governments with elevated debt-to-GDP ratios may face increased refinancing costs and rollover risk on maturing debt.

Asean+3 corporate debt, at close to 150 per cent of GDP, was higher than the global average of 100 per cent. Hong Kong’s corporate debt was even higher at above 250 per cent, followed by China at more than 150 per cent and Singapore at above 100 per cent.

However, a substantial share of corporate debt in Hong Kong and Singapore – both global financial centres – was held by non-residents, the report noted.

Also, Singapore’s public debt, at more than 134 per cent, was the second highest after Japan at about 225 per cent.

While Singapore’s public debt-to-GDP ratio was high by global standards, the debt consisted mostly of Special Singapore Government Securities and Singapore Government Securities, which are issued for non-budgetary purposes – such as investment – and not to finance a budget deficit, it said.

AFSR advised that in response to rising private debt and other systemic risks, policymakers could deploy macro-prudential tools – measures used by financial regulators and central banks to limit the expansion of credit – to curb risks from high household and corporate debt and excessive property-developer leverage.

For corporate debt, more responsible corporate lending practices could be encouraged, including fostering a better governance framework and mitigating credit risks of small- and medium-sized enterprises with credit guarantee schemes.

Meanwhile, to mitigate financial stability risks associated with high public debt, policymakers’ strategies should include medium-term fiscal consolidation, maintaining a sound debt structure and diversifying the investor base.

“In addressing the risks posed by the higher debt levels amid tighter monetary conditions, the authorities need to strengthen their defences through a well-balanced policy mix across monetary, fiscal and macro-prudential policies. Close cooperation across jurisdictions is also essential,” said Dr Khor.