EM Asia’s first line of defense – strong safeguards against capital outflows & the current account

Resilient as they are, EM Asian economies are not immune to tighter USD liquidity and investors’ risk aversion from escalated US-China trade tensions. Year-to-date, the Indian rupee has lost 12%, Indonesian rupiah 9% and the Philippine peso -8% versus the USD. A weaker domestic currency may be welcomed for the Bank of Japan, where inflation is low and earnings are primarily overseas, but is treated with trepidation by domestic-demand driven economies, particularly those that are not in the position to stomach higher imported inflation, higher funding costs through both existing financing needs and foreign currency debt, which may spillover to not just financial market sentiment but also real economic activity. This report aims to determine whether risks are appropriately priced on two aspects for emerging Asian economies: How susceptible they are to reversal of funds by looking at the external debt and foreign liabilities exposure; Their funding needs and whether the steps that they have taken are enough to address shaky investors’ confidence. Our analysis of the total portfolio liabilities of EM Asian countries show that the stock of portfolio liabilities is much larger for more open and deep markets such as Singapore and South Korea, which have space to use a weaker FX to absorb shocks should it become necessary. The three current account deficit countries – the Philippines, India and Indonesia – have relatively lower exposure, with Indonesia most vulnerable to outflows. That said, these three countries have enough reserves to cover short-term external debt, and relatively more closed capital accounts to limit excessive outflows. Although the Philippines, India and Indonesia had a wider current account deficit in Q2 2018, they have taken difficult steps to ensure financial stability by sacrificing growth such as raising rates and curbing import demand for the case of Indonesia. Moreover, these central banks are also trying to attract investors by making risk management easier through adding more hedging tools. Their actions illustrate that they are willing to shield their economies through the first line of defense – the current account.