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Taper tantrum nightmares won’t haunt Asia’s emerging markets

FOR ALL the worries of emerging markets staring down a repeat of the 2013 taper tantrum, policy makers in Asia should be considerably calmer.

Unlike then — when the Federal Reserve sent shock waves through global markets with surprise plans to unwind its massive monetary stimulus programs — Asian emerging economies are largely in stronger positions, while the Fed has signaled a longer lead time on any change.

The fear has been that a hike in US rates will trigger an outflow of capital as investors chase yield elsewhere, setting off an inflation-fueling currency selloff, a spike in borrowing costs or forcing policy to be tightened faster than what seems healthy for local economies.

But, compared with their situations in 2013, as well as to their global emerging-market peers now, Asian central bankers can rely on bigger foreign reserve stockpiles, relatively benign inflation, a thriving goods trade and deeper local-currency bond markets. Rather than the Fed, the biggest risk now is a worsening virus outbreak as the Delta variant spreads through the region.

“EM Asian central banks are able to be more accommodative precisely because of improved fundamentals,” said Mitul Kotecha, chief emerging-market (EM) Asia and Europe strategist at Toronto Dominion Bank in Singapore. “Inflation remains relatively well-behaved across the region — though there are some exceptions — while external balances have strengthened.”

“The only caveat is that several countries are lagging behind in terms of pace of vaccinations, fueling risks to recovery,” he said.

Once Fed Chair Jerome Powell signaled last month an openness to starting discussions about curbing asset purchases, analysts rushed to compare the eventual tightening to what happened eight years ago. It’s already helped prompt interest-rate hikes in Mexico, Brazil, and Hungary in June.

To be sure, the Fed has tried to be more transparent and signal its plans clearly. Federal Reserve Bank of Dallas President Robert Kaplan said last week in a Bloomberg Television interview that the Fed has given sufficient lead time to investors to allow for a smoother tapering this time.

Yet policy makers and investors also see a different story in emerging Asia, where South Korea is the lone central bank expected to hike as early as this year — and more for growth reasons around normalization, rather than inflation. During the first half of the year, 13 Asia-Pacific central banks held interest rates steady, the only exception being a cut in February by Indonesia.

Asia remains an attractive investment destination, Mr. Kotecha said, despite some temporary flows toward higher-yielding markets in Latin America and the Europe, Middle East, Africa region as rate hikes boost yields.

Since the Fed’s surprise hawkish shift in June, the Mexican peso — a popular candidate for carry trades — has outperformed, gaining about 2.8%. In contrast, declines in Asian emerging currencies range from 0.7% in the Taiwan dollar to 3% in the Thai baht.

“Any flow that is happening right now is still chasing the recovery,” said Paul Sandhu, head of multi-asset quant solutions Asia Pacific at BNP Paribas Asset Management. “I do think it’s temporary because the fundamentals in Asia are better.” 

Outside of currencies, foreign funds continued to favor Asian assets last month, demonstrating confidence in the region. Led by China, they added $14.4 billion worth of securities, more than half the total to all emerging markets, according to data from the Institute of International Finance.

Here’s a closer look at some of the region’s biggest emerging economies:

In China, a continued rebound in the economy and a more stable — albeit slowing — recovery is reassuring for the nation’s central bank, which had already taken steps to normalize policy late last year.

Being a step ahead of the Fed, it’s unlikely to raise interest rates to follow the US tightening cycle to prevent capital outflow fears, especially as money has been gushing into China. The benchmark 10-year bond yield in China peaked in November and has since resumed a downtrend.

For Thailand, stronger foreign reserves, low external debt, local-dominated bond markets and a hearty financial sector all are providing some buffer, even as the tourism-related economy still struggles to pick itself up.

“It’s different! It’s different. EM Asia is very different from other EMs,” Bank of Thailand Governor Sethaput Suthiwartnarueput told Bloomberg last month. “If you look at the context and the policy challenges for, say, emerging markets in Latin America and the policy challenges for other emerging markets, it’s very different. It’s very different.”

Bank Indonesia Governor Perry Warjiyo was similarly dismissive of bets that a taper tantrum would repeat this time around, noting that the world was getting sufficient lead time from the Fed on its tapering, which seem a way off from execution.

As well, positive developments in the financial markets and global economy have “reinvigorated the capital flow to developing markets, including Indonesia, and has contributed to the strengthening of the exchange rate in some nations,” Mr. Warjiyo said June 17 as the central bank announced a decision to keep its benchmark interest rate unchanged.

Asia-wide, the world’s export engines continue to be cushioned by strong global goods trade. Many of the continent’s economies — not just Thailand — have massively built up their foreign reserves over the past decade. And inflation largely remains benign, removing a threat that’s very real to other emerging markets.

Emerging economies in Asia can also take comfort in the fact that since inflows weren’t surging before the pandemic set in — as they were before the last crisis — thus capital flight won’t be on the same scale as in 2013, according to Khoon Goh, head of Asian research in Singapore at Australia & New Zealand Banking Group Ltd.

“While the foreign equity selling this year put pressure on Asian currencies, it also means that there will be a limit to how much more outflows we will see due to Fed normalization concerns,” he said.

The mean of seven real-effective exchange rates in the region is 0.5% below a five-year average, indicating undervaluation that could limit a selloff, according to Bloomberg calculations. This compares with a significant overvaluation of 7.4% before the taper tantrum. — Bloomberg

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