Now that Dr Janet Yellen has set the stage for Federal Reserve rate hikes, the conventional wisdom is that Asia is in trouble. If the taper tantrums of 2013 threw markets and currencies into turmoil, just wait until the United States tightens for the first time since 2006. But what if the coming Fed cycle is really an opportunity for the region?
A positive new report from Morgan Stanley would seem to bolster the case. Two years ago, the bank created a list no one wanted to be on: the "Fragile Five" economies most at risk as the Fed drains liquidity. Much to their chagrin, Brazil, India, Indonesia, South Africa and Turkey made the cut. This week, Morgan Stanley whittled the group down to three, dropping Asia's two weak links. As its economists put it, New Delhi and Jakarta are implementing enough changes - and pledging to go further - to have passed a "point of inflection away from their old models of growth".
Naturally, much of the credit goes to central bankers in those two nations: India's Mr Raghuram Rajan and Indonesia's Mr Agus Martowardojo. But history will show that the Fed effect played an outsized role in disciplining Asia. "The lessons from the mid-2013 Fed taper tantrums have led to Indonesia and India basically trying to improve their macro risk profile," says Mr Gundy Cahyadi, an analyst at DBS Group.
Would Mr Rajan and Mr Martowardojo have acted so expeditiously to raise borrowing, tweak regulations and stare down speculators if not for the threat of Fed rate hikes? Would Indian Prime Minister Narendra Modi and Indonesian President Joko Widodo feel as much urgency to reduce current-account deficits, trim subsidies and strengthen national balance sheets without Fed chair Yellen holding their feet to the fire? I highly doubt it.
There's every reason to think a tightening Fed will transform the economic landscapes for both countries in the year or two ahead. Take India, toast of the developing world with a China-beating 8 per cent growth rate projected for the next fiscal year. Prime Minister Modi is shrinking the current-account deficit and pledging to reduce government debt and red tape. Last week, he scored his first big reform win: an increase in the amount foreign companies can own in insurers to 49 per cent, from 26 per cent.
Much remains to be done. The insurance Bill was the easiest to pass. Steps to liberalise land laws, open the retail sector, deregulate labour and enact a goods and services tax will require Mr Modi to spend considerable political capital. The good news is there's no going back. With the turmoil of 2013 fresh in policymakers' minds and the Fed on the move, backing off progress just isn't an option. Just two years ago, hedge funds bet New Delhi would become the first government of a Bric nation- Brazil, Russia, India and China - to be downgraded to junk. The semi-perpetual risk of returning to those dark days gives Mr Modi a sizeable bargaining chip in negotiations with opposition parties.
And if Mr Modi fumbles with the reform-or-crisis argument, he can always enlist the widely respected Mr Rajan, who correctly predicted the 2008 global crisis while working at the International Monetary Fund.
Governments will need to act differently when there's less Fed money sloshing around global markets. Challenges like excess money supply in China and asset bubbles from Hong Kong to Singapore will seem preferable to massive capital outflows.
In Indonesia's case, the threat of Fed austerity is forcing policymakers to improve fundamentals. Case in point: President Widodo's bold move to scrap fuel subsidies to trim the Budget deficit to 1.9 per cent of GDP. He's also ramping up efforts to attack corruption and implement a two-pronged growth strategy. By investing in education, infrastructure and healthcare to ensure productivity grows in sync with wages, he is trying to win more foreign investment and address income inequality. Also, says Standard Chartered economist Eric Sugandi, expect central banks in Jakarta and beyond to "display anticipating gestures" like adding foreign-exchange reserves.
As the Fed ratchets up the pressure, Mr Joko will find markets to be merciless arbiters. Capital will flee at the slightest hint of backsliding. Officials in Jakarta never much liked being included on Morgan Stanley's "fragile" list. But as 2015 unfolds, says economist David Sumual of PT Bank Central Asia, "Fed policy will have a positive disciplining effect for both companies and regulators in emerging Asia." Today, that's something leaders in the region can and should welcome.