Why Asia will be on top as EMs get shaken

But this time around, Asia is less vulnerable to contagion as the Asian economies are a lot stronger


SINGAPORE • The turbulence seen across emerging markets (EMs) is following a similar pattern to a crisis that rocked global trading more than two decades ago — it involved tequila.

In the mid-1990s, US interest rate increases helped spark a Mexican peso devaluation that fuelled capital flight and caused the so-called Tequila crisis. Within a few years, the sell-off had spread to Asia, which became the centre stage of the EM crisis, during which currencies were devalued as the region was sent into an economic tailspin.

Fast forward to 2018, and history is repeating itself, with a crisis brewing in Latin America as Argentina seeks emergency funding just as the dollar and US bond yields spike.

But this time around, Asia is less vulnerable to contagion, said Macquarie Bank Ltd’s Nizam Idris.

While the current fears emerging out of Latin America remind him of the so-called Tequila crisis, today “Asian economies are a lot stronger”, said Nizam, the bank’s head of strategy for fixed income and currencies in Singapore.

“Current-account deficits are actually smaller, foreign reserves are much larger than before, and currencies are unpegged. The situation today is not entirely the same as compared to 1995.”

He’s not alone. Commonwealth Bank of Australia (CBA) also sees Asian currencies faring better than their peers elsewhere in the developing world if the crisis emanating out of Latin America intensifies.

While there are exceptions — the Indonesian rupiah is more vulnerable than others since it’s one of the few Asian EMs that run current-account deficits — the crises that’s exacerbated the sell-off this time around in Argentina and Turkey are signalling that they are more idiosyncratic in nature with less contagion risks.

After erasing almost all of their gains for the year because of a pick-up in US inflation and global trade tensions, EM assets made a comeback last week. Asian currencies have been the winners, with seven out of the 10 best performers in EMs this quarter coming out of the region.

“The one-two punch of rising US rates and dollar appreciation is leading to a rising market risk premium in EM countries whose balance of payments is vulnerable,” analysts at Nomura Holdings Inc led by Singapore-based Rob Subbaraman wrote in a May 11 report.

Asian nations including Thailand, China and South Korea were among those least exposed to balance-of-payment risks in a Nomura study of 20 EMs.

Asia is much more resilient than in the past for the progress it’s made since the financial crisis two decades ago when many countries were running huge deficits, in addition to the problem of having over-valued exchange rates and too few reserves for short-term debt, Richard Jerram, chief economist at Bank of Singapore, wrote in yesterday’s note.

Here are the reasons why Asia may fare better after all:

Current Account
Six out of nine major economies in Asia outside of Japan enjoy surpluses in their current accounts, led by Singapore, Taiwan and Thailand with excesses of more than 10% of gross domestic products. Indonesia, India and the Philippines have shortfalls.

According to Andy Ji, a currency strategist at CBA, better current-account balances mean that Asia is better equipped to meet their dollar-denominated payment obligations to their bond holders.

Economic Drivers
A two-year rally that drove EM stocks and currencies to the highest level since at least 2007 was supported by economic fundamentals. And Asia still stands out.

Asia’s developing economies are poised to expand an average of 6.5% in 2018 compared to 4.9% for all EMs, according to forecasts from the International Monetary Fund. Inflation in Asia, excluding Japan, will accelerate to 2.3% in 2018 compared to a world average of 3.3%, according to surveys of economists by Bloomberg.

And that’s despite the headwinds of tighter monetary policy by the US Federal Reserve and rising US yields.

While the Philippines became the latest EM to raise interest rates to rein in price gains in a booming economy, both Bank of Korea and the Reserve Bank of India lowered their own inflation projections last month. China has already cut its reserve requirement ratio twice this year.

“The fundamentals in Asia are better than other regions, while political and geopolitical risks are smaller, too,” Koji Fukaya, CEO in Tokyo at FPG Securities Co. “Gains in US yields are a reflection of strong economic condition there, and Asia benefits from the strong US economy more than other regions.”

To be sure, like other EMs, Asia also faces political risks with a slew of elections in the next two years, including in Indonesia and India.

A case in point is Malaysia, where voters last week elected Tun Dr Mahathir Mohamad, the nation’s longest-serving prime minister, as leader in a stunning upset to end the six-decade rule of Datuk Seri Mohd Najib Razak’s party.

“At a time of growing pressure on EM currencies and bonds, the situation in Malaysia bears careful watching for potential knock-on effects, particularly as rising rates and geopolitical uncertainties remain live in the backdrop,” Eli Lee, head of investment strategy at Bank of Singapore Ltd, wrote in a note.