Speaking Of Asia

QE wind-downs could bother Asia

While markets are generally calm, concerns may arise over private-sector debt, a tech downturn and political risk.


And so, the United States Federal Reserve has finally announced the start to what promises to be a prolonged unwinding of the US$4.5 trillion (S$6.1 trillion) balance sheet it ran up to meet the ravages of the global financial crisis.

Thanks to the infamous "taper tantrum" of 2013, when Asia joined other emerging markets that went into a swoon when the prospect was first mentioned, the Fed has been careful to handle this softly-softly, with extended signalling before the actual event.

The unwinding, to start next month, will be no more than US$30 billion a quarter initially, in a 60:40 ratio between US treasuries and mortgage-backed securities. The amount will gradually rise in quarterly increments so as to reach a monthly cap of US$50 billion in about a year. It would be "like watching paint dry", Fed chairman Janet Yellen promised earlier this year and she has kept her word.

Asian markets, long primed for the news, have responded calmly to Dr Yellen's announcement on the unwinding, just as they did a few days later when she gave a slightly hawkish speech, saying the Fed had to continue raising interest rates gradually in the face of "significant uncertainties". That would make another rate hike look fairly certain come December.

Next to watch is the impact of US tax reform, plans for which President Donald Trump unveiled late on Wednesday Asia time, boasting that it is the largest in the history of the US. His proposals would slash the corporate tax rate to 20 per cent from 35 per cent, taking it below the average of the industrialised world.


As these words were being written yesterday, Asian markets were higher on the tax cut news. Yet, it stands to reason that in the medium term, the sum effect of the moves by both the Fed and the administration should make it attractive for investors to consider putting more money into the US and its currency, given commensurate yields in Asia come only with a higher level of risk.


That begs the question: Is Asia being too sanguine?

A level of complacency could be excused if it were just about the US Federal Reserve alone. It isn't. A host of other central banks are poised to adopt a more normal posture vis a vis the markets and Asia must be mindful of the consequences.

After the Fed, many economists expect the European Central Bank (ECB) to announce its own tapering plans next month, with actual action to start in January perhaps. The ECB's quantitative easing (QE) plans expire at the year end and there is little need for the easing to continue. After all, the euro-zone economy has been showing its best strength in a decade.

Quite a bit of the ECB's monthly purchases, while reduced to €60 billion (S$96 billion) lately from €80 billion earlier this year, is done through buying from the private sector, thus giving companies more cash to put to work. With the easing coming off, some drying up of funds that head to Asia will inevitably take place. The European Union is the largest source of foreign direct investment for Asean.

Separately, the Bank of England is expected to raise interest rates in November, with Bank of Canada to follow in December, along with the US Federal Reserve. It is a good guess that perhaps ECB, too, would have acted to tighten rates, except that it looks like its hand is stayed until at least the middle of next year because euro-zone inflation is expected to stay weak and below its targeted 2 per cent.

Some seasoned economists such as Mr Robert Subbaraman, chief economist and head of global markets research for Asia at Nomura, see another wrinkle that bears watching - a massive build-up of private-sector debt.

"Credit to the private non-financial sector, that includes households and companies, is currently estimated at 155 per cent of gross domestic product in Asia ex-Japan," he says. "Before the Asian financial crisis of 1997, that was about 83 per cent. It has gone up a lot and China is a big part of it."

Besides China, the biggest Asian economy, Mr Subbaraman notes debt build-ups in several others, including Hong Kong, South Korea, Thailand, Singapore and Malaysia.

While it is worrying enough when this happens during times when interest rates are low, it takes on more significance when advanced economies begin to tighten interest rates, inducing capital to flow towards those parts. A matching movement of interest rates in Asia would make repayments dearer for companies and individuals, raising risk of defaults.

Besides, Asian currencies could come under pressure, increasing the vulnerability of large economies such as India and Indonesia that need capital inflows to offset the deficits they run on the current account. Malaysia runs a small current account surplus but its forex reserves, at less than US$100 billion, are not substantial, making it vulnerable as well.


To be sure, Asia is nowhere near as threatened today as it was in 1997. Most countries have adopted more flexible exchange rates and have adequate foreign-exchange reserves. External debt, too, is not much of a worry.

But private-sector debt is another matter. A decade ago, a lot of the external debt involved foreigners buying the foreign currency-denominated bonds of Asian companies. In recent years though, they have also started to buy local-currency bonds, which also constitute domestic private debt.

And that's the worry - that as the big central banks normalise, global asset managers and investors start relooking their Asia exposure and begin to pull money out. This will then knock on credit spreads, causing them to widen. As market interest rates rise and currencies weaken, some companies can be expected to come under stress, and even default. That could hurt domestic banks, which tend to be the biggest lenders to local firms.

All this comes at a time when some big economies are slowing.

India's world-beating growth has slipped to below 6 per cent in the latest quarterly data, thanks to a combination of local and global factors. China's property market has started to ease again. The Hang Seng Index's property sub-index this week has been the lowest in more than a month, thanks to tumbling China-related property stocks.

Some forecasters believe the global tech cycle may be poised to turn next year, which will affect economies such as Singapore and Taiwan that rely heavily on electronics exports.

Metal prices are starting to come off and the impact is already showing in mining-dependent areas such as Australia's Queensland and Northern Territory. Moody's Investor Service said this week that the proportion of Australian residential mortgages more than 30 days in arrears rose to 1.62 per cent in May this year, the highest rate in five years. It said delinquencies would continue to increase through the year.

And then there is political risk. Asia has reasons to cheer that Britain's exit from the European Union has been effectively postponed for two years. Still, the recent German elections have rekindled Europe's worst memories because of the advances made by the far right. Chancellor Angela Merkel, once seen as the best placed to lead the so-called free world at a time when the US is looking inward, looks certain to be preoccupied with domestic management in the foreseeable future. There's also no knowing what will happen in next year's Italian polls. A fissiparous Europe isn't good news for Asia.

Closer to home, the Japanese will decide next month if they want to keep Mr Shinzo Abe or pick an audacious challenger as his replacement. Mr Abe chose to go for snap polls just as the growth data in Asia's No. 2 economy had begun to look good. China's key party congress, also next month, will probably be less tricky for President Xi Jinping, but there's always a hint of uncertainty until the last apparatchik has departed the plenary hall. As for India's Narendra Modi, who supervises the region's third-biggest economy, he will soon enter campaign mode as he eyes re-election in polls that must be held before May 2019.

And, of course, North Korea can always be counted on to stir things up. All told, there is no special cause for despondency. Asia's long-term growth story is intact. But the months ahead promise to be anything but dull. And watch inflation in the West. An unexpected uptick could hasten interest-rate tightening and you never know how that could play out for the rest of the world.

A version of this article appeared in the print edition of The Straits Times on September 29, 2017, with the headline 'QE wind-downs could bother Asia'. Subscribe