Is it too quiet in emerging Asia?

As the old saw goes, never let a good crisis go to waste. According to Australia’s central bank, that’s something emerging Asia took on board after the Asian financial crisis of two decades ago.

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In a time of growing geopolitical and economic volatility emerging Asia actually looks pretty good. But there’s an interesting debate lurking beneath: what is the appropriate trade-off between growth in the region and stability?

"How to balance the increased threat with the need to further develop economies can’t be ignored.” 

It is of course impossible to ignore the trade war US President Donald Trump has instigated and naïve to expect we can simply look through this corrosive bout of anti-globalisation. But from the Reserve Bank of Australia’s point of view – and the bank is not alone – the threat doesn’t detract from what Asian regional economies have achieved to bolster stability.

Moreover, if the trade war continues to heat up and volatility spikes while investment ardor cools, these economies are much more resilient – particularly when compared with other global emerging markets.

A different question

The evidence is strong but it’s a different question to whether countries like Indonesia have actually been too cautious and sacrificed growth. Spoiler alert: we won’t actually know that until after the next crisis.

As the Reserve Bank of Australia notes in its August policy statement, this year most emerging market economies have experienced tighter financial conditions.

“While most emerging markets have experienced asset price declines, exchange rate depreciations (relative to the US dollar) and outflows of foreign capital of late, these developments have tended to be more pronounced in economies with significant economic, financial or institutional vulnerabilities,” the RBA says.

“Compared with other regions, emerging Asian economies have generally been less affected by the tightening in external financing conditions.”

The RBA assessed several economies in south and south-east Asia: India, Indonesia, Malaysia, Thailand and the Philippines. Together these economies account for around 12 per cent of Australia's exports, comparable to Japan's share. These are also the financial markets in emerging Asia in which international investors are most active.

“In part, the more modest effect of the tighter external financing environment on emerging Asian economies reflects efforts by policymakers to build more resilient institutions, economies and financial systems in the two decades since the Asian financial crisis,” the RBA says.

Emerging financial markets by region

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Central to the RBA’s case is emerging Asia’s superior economic growth, lower inflation, accommodative interest rates, modest public debt and realistic exchange rates.

The caveat to this more optimistic view is China. In a large part, emerging Asia’s superior economic performance hinges on strong economic ties with China. So too then are fortunes hostage to how the China-US trade spat plays out.

“Reflecting the region's strong economic and financial linkages to China, a significant increase in trade protectionism and/or a sharp slowdown in Chinese economic growth represent downside risks to regional economic growth that bear close monitoring,” the RBA says.

RBA backs regional stability

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External debt (share of GDP) Source: World Bank


Any significant corrosion of global trade machinery would be an issue for Asia more broadly – both because many countries run trade surpluses but also because the region is actually quite integrated in terms of component manufacturing and supply chains.

A recent paper from the Lee Kuan Yew School of Public Policy analysed currency trends with authors Ramkishen S Rajan and Sasidaran Gopalan notes Asian economies which are “significantly export-dependent as well as those that export intermediate goods to China such as Taiwan, South Korea, Malaysia and Singapore will likely be most impacted in the first round”.

“If the tit-for-tat trade war is escalated and prolonged, it could lead to a notable disruption of supply and distribution chains and one can expect a consequent decline in foreign investments,” the paper says.

“If such an event occurs, then all countries in Southeast Asia that are heavily dependent on foreign direct investment (FDI) like Singapore will be especially negatively impacted in the second round.”

Moreover, if the trade war also becomes a currency war, Asia will be front and centre. Already some from the US side are arguing China is intentionally weakening the renmimbi (RMB) even though these broader currency trends have been shifting for some time.

Rajan and Gopalan’s view is “an RMB depreciation may likely offset some of the tariff impacts but there are worries that it could create a ‘domino’ effect with other countries following suit”.

Critically, they point out “it is far from clear as to whether the RMB depreciation can be deemed deliberate. The weakening could well be in part due to a hike in US interest rates as well as China’s own efforts to ease its monetary policy through injecting more liquidity into its troubled banking system in the broader context of its softening economy”.

Trump, unsurprisingly, disagrees.

Writing in global-is-asian, Rajan and Gopalan were cautious further anti-trade contagion could still affect emerging Asia.

“If a series of depreciations were to occur in the region, it could likely destabilise countries in Asia both due to imported inflation and the relatively high levels of US dollar denominated corporate debt accumulated by many Asian firms, not unlike the case of other emerging economies - like Turkey whose currency has taken a battering,” they said.

“Although several Asian economies are better placed than Turkey in terms of the foreign exchange reserves buffer needed to absorb such shocks, Turkey’s vulnerabilities and a looming crisis have stoked fears of a possible contagion.” 

“The worst scenario being that if a currency war turns into a currency freefall in Asia, interest rates will need to rise to stabilise the currencies, leading to significant economic slowdown.”

Mutually exclusive

The other challenge for Asian policy makers is the balance between growth – which implies risk – and systemic stability.

Currency analysts at BNY Mellon see this specifically as a challenge for Chinese policy makers: they want both growth to reach targets and systemic stability. BNY Mellon cites evidence of official guidance to banks to funnel funds to firms in need.

“The problem stems from (near) mutually exclusive objectives of limiting systematic risk – Beijing’s primary objective this past year - and bolstering the money supply anew,” according to Neil Mellor, senior currency strategist.

“In other words, the transmission mechanisms of monetary policy in China are being compromised just as the economy’s dependence upon its support has started to grow once more.”

This tension between stability and growth is actually playing out more widely in the region and at more macro-policy levels too.

For example, writing for the Lowy Institute, Roland Rajah argues Indonesia as focussed on stability at the expense of higher potential growth.

“Since the 1997–98 Asian financial crisis, Indonesian economic policy has consistently prioritised stability over riskier pathways to rapid economic growth,” Rajah argues.

“Conversely, with the waning of the China-fuelled commodity boom, the adequacy of economic growth has become the bigger concern. Indonesia is now looking at its fifth consecutive year of subdued growth at about 5 per cent, down from more than 6 per cent during the commodity boom and well below government ambitions to reach 7 per cent to 8 per cent.”

Over the longer term this is the more substantial question for emerging Asia. The Asian financial crisis taught policy makers not to be too gung-ho on growth prospects – and that is proving wise as the current trade war escalates.

But at what cost to the longer-term potential growth of a region with such opportunity? Collateral damage from Trump agenda is one thing, it is on one front unavoidable. How to balance that increased threat with the need to further develop economies for the benefit of citizens can’t be ignored however.

Andrew Cornell is bluenotes Managing Editor

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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