Ben Bernanke: The US Federal Reserve’s decision to not reduce quantitative easing in September has recently brought some relief for several emerging market economies that had experienced capital outflows.
Is the credit outlook turning for Asia-Pacific sovereigns?
The positive trend of Asia-Pacific sovereign ratings we saw over much of the past decade looks likely to break in the next one or two years. We do not see a high likelihood of a sovereign rating upgrade during that period. Instead, three sovereign ratings in the region currently carry negative outlooks – India, Japan and Mongolia. We do not have any Asia-Pacific sovereign on a positive outlook.
What’s driving this change in trend?
We believe the most important reason to be that policy responses by some Asia-Pacific governments may be insufficient to maintain their credit fundamentals in a less-supportive and still-uncertain global economic environment. Economic prospects both here in the Asia-Pacific and in major economies elsewhere are weaker than expected.
For example, our latest 2013 economic projections for the US and Eurozone (European Economic and Monetary Union) are for less robust performances than we had expected early this year. China, too, saw its economic growth decelerating more than we had earlier forecast. This has also led us to lower growth projections for most other Asia-Pacific economies. A number of sovereigns - including China, Korea and Vietnam - have seen relatively slow government revenue growth so far this year. On top of this, the specter of US quantitative easing being wound down adds further uncertainties for some economies in the region.
What are the key downside risks in the next 6-18 months?
Among top of the list is a renewed global economic slowdown triggered by a deepening of Eurozone banking sector problems or US fiscal policy shock/uncertainty, as well as a sharper-than-anticipated slowdown in China.
Other risks we are closely watching include any disorderly market response or inappropriate policy responses to the withdrawal of quantitative easing. In any scenario of external shock, the heightened levels of domestic credit in some key economies limits policy responses of their sovereigns.
What are the implications of the US shutdown on Asia-Pacific economies?
Although ongoing political fighting over US fiscal policy has increased policy related risks in the US, we do not expect the US government to default on its financial obligations. Consequently, we expect the negative impact of the impasse on Asia-Pacific economies to be limited and temporary. This could change, however, if political uncertainties drag on and affect the US private sector more severely.
Asia-Pacific exports to the US have picked up so far this year to the benefit of regional growth. Any significant slowdown of US private sector activities could hurt confidence, investment, and hiring for a prolonged period. This would have some knock-on effects for Asia-Pacific economies through the export channel. In the unlikely scenario of a US default, global financial markets would likely become extremely volatile, affecting all economies around the globe, including all of those in Asia-Pacific.
How big a concern are capital outflows for the Asia-Pacific?
The US Federal Reserve’s decision to not reduce quantitative easing in September has recently brought some relief for several emerging market economies that had experienced capital outflows, exchange rate depreciation, and foreign exchange losses since the Fed chairman's remarks in May.
We are not certain how long this respite will last. The US central bank is unlikely to maintain its current policy stance for very long. And even before it changes, investor sentiment may turn even more negative on emerging markets. Without addressing the causes behind the capital outflows, the capital accounts of some countries, such as India and Indonesia, could weaken further.
Apart from emerging economies facing current account deficits like India and Indonesia, higher funding costs associated with an orderly normalisation of global monetary conditions are unlikely to be economically disruptive. However, higher financing costs may exacerbate the economic and financial pressures that a potential external shock could bring.
Why have India and Indonesia faced more capital outflow pressures?
In both India and Indonesia, relatively strong capital outflows appeared to be linked to their current account deficits. However, the deficits reflected high investment rates rather than weak savings. These investments should yield future economic benefits. Investors, however, have not looked at things this way. Rather, they seem to have focused more on changes that have increased uncertainties for foreign investors in both countries. Over the past two years, new policies or court judgments have increased restrictions of foreign businesses or have reduced clarity on rules governing their activities in these countries.
Whether strong capital outflows will resume depends significantly on policy actions, if any. If India and Indonesia tolerate higher financing costs, a fall in the investment rate, and slower growth, the current account may become a lesser concern. On the other hand, measures that can improve investor confidence may help sustain strong investments without triggering more capital outflows. However, politics could complicate the introduction of such measures. Both countries face key elections in 2014.
Are smaller developing sovereigns on the rise?
In our recent analysis of unrated sovereigns – including Bhutan, Brunei, Laos, Micronesia, Myanmar, Nepal, Palau, Solomon Islands, Timor-Leste, and Vanuatu – we found that political changes in a number of these countries have set in motion economic liberalisation and faster development.
Even nations in relative economic isolation, such as Laos and Bhutan, realise that foreign investment can bring significant advantages to their development efforts, such as for large infrastructure projects. Once fundamental political changes take place, the ensuing economic transformation and an opening-up to foreign investment can be quite rapid, as illustrated by Myanmar. Faster growth entails increasing interaction with greenfield foreign investors, followed by greater integration with international capital markets.
KimEng Tan, the author of this article, is a Singapore-based sovereign analyst for Standard & Poor’s Ratings Services.
Source: Standard & Poor's. e--estimates. f--forecasts. *GDP and CPI figures follow fiscal year.
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