Asia's sovereigns must exercise caution

Sovereigns have remained resilient during the financial crisis, but increasing risks are testing policymakers, says Standard and Poor's.
Despite benign conditions in Asia in the last two to three years, the flow-on effects of the housing and economic problems in the US are becoming more obvious, according to a report released by Standard and Poor's yesterday. These include: reduced Asian exports; a decline in capital flows; the credit crunch and liquidity tightening; volatile or weakening asset markets; and lower corporate profits.

Moreover, structural capacity and seasonal supply issues in food, energy, infrastructure and labour, combined with continuing Asia domestic demand are ôbrewing into an explosive mix of inflationary pressuresö, continues the report. While governments attempt to balance the short-term growth targets against longer-term structural and inflationary challenges, the ratings agency questions the extent to which policymakers will exercise prudence for the sake of longer-term benefits, or implement ill-conceived measures in the hope of gaining support for the upcoming legislative and presidential elections due across the region this year.

Although the general credit outlook for AsiaÆs sovereigns is stable, a number of governments face the dilemma of wanting to support high economic growth while needing to tackle inflation. Domestic growth drivers and increased intra-regional trade will not offset a significant slowdown in exports to the US and Europe. As a result, governments might pursue loose fiscal or monetary stances to support growth, and further exacerbate inflationary pressures.

Indonesia, Sri Lanka and Vietnam all face inflation and policy risks. The first is facing budget and inflationary pressures due to high fuel prices which affect its budget deficit through the government's continuously increasing subsidies. Failure to increase domestic fuel prices (effectively a cut in subsidies), or decrease subsidised volume, could threaten macroeconomic stability and affect the sovereignÆs ratings.

Sri Lanka requires forceful action to tackle a 20% inflation rate, but a lack of fiscal consolidation suggests the sovereign continues to prioritise growth, using high levels of government expenditure to achieve it. Moreover, its share of eternal debt now stands at 49%, with a growing proportion of more expensive, shorter maturity commercial funds. Further fiscal slippage, or a worsening in the countryÆs debt profile, could lead to a ratings downgrade.

Although Vietnam is still on stable outlook, the government is failing to adequately address its overheating economy. Inflation has accelerated to 20% year-on-year in March 2008.

Other countries face general political and policy risks. In Taiwan, recent victories of the Kuomintang in legislative and political elections should improve the policy environment and cross-strait relations, and Thailand has enjoyed a successful transition to a democratically elected government. However, the latter is experiencing difficulty in appointing qualified people to key cabinet posts, while the challenges of a multi-party coalition is also affecting sound policymaking. Moreover, ongoing investigations could lead to a dissolution of one or more of the parties.

Pakistan continues to suffer from high political risk despite the recent transition from military to democratic rule. The country faces an untested and potentially fractious government, a volatile relationship with president Musharraf, and militant insurgencies. Further unrest is looming with the coalition's decision to reinstate all supreme court judges, including the chief judge who was sacked by Musharraf in late-2007. Clashes between the president and the new government could still happen should the supreme court once again look into the constitutionality of his presidency, and rule against it. The sovereign's rating is at risk if it fails to take action to halt its growing twin deficits.

In Japan, important reform programmes and fiscal decisions have been delayed due to the current political stalemate. Its stable outlook could be compromised if the political gridlock results in a reversal of the public reforms achieved so far.

Malaysia's surprise outcome of its latest political election has created some short-term uncertainties, which could lead to an overhaul within the ruling coalition, which could affect the normally smooth passing of legislation, or lead to significant policy shifts.

Korea is striving for 7% economic growth but it also needs to improve the strength of its financial system, corporate governance, disclosure, protection of minority shareholders' rights along with the deregulations on activities of its chaebols. Currently though, the biggest risk to its ratings are associated with North Korea.

India, for its part, is relatively insulated from a US slowdown, but its balance of payments could suffer should the US recession become more protracted. The sovereign benefits from strong external liquidity and growth prospects, and is expected to continue with its fiscal consolidation process. A reversal of this trend, and further increases in off-balance sheet spending, together with a deterioration of the country's balance-of-payments performance could lead to pressure on its credit standing.

China and Hong Kong's outlook changes will depend on reform momentum and policy response to domestic and external challenges, while China's positive outlook is based on its expected ability to achieve a soft landing while continuing with structural reforms.

Cambodia, Mongolia and the Philippines may experience some outlook changes due to their vulnerable positions. No movement on Singapore's credit rating is expected anytime soon.
¬ Haymarket Media Limited. All rights reserved.
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