We discuss three debates on implications from stronger USD and tighter liquidity conditions.
Debate #1: How much have AxJ currencies really moved? Does this reflect a deeper idiosyncratic macro problem, like those faced in other EM economies?
Our view: In AXJ, economies running current account deficits (India and Indonesia) have been most exposed to funding pressure. We see the INR and IDR moves as more a reflection of broad dollar strength and their external funding gap, rather than a reflection of idiosyncratic macro challenges.
In fact, a comparison of Asia with eight other key EM economies (in Latin America and CEEMEA) suggests that macro fundamentals in Asia are generally more manageable – current account deficits more moderate, foreign reserve adequacy more comfortable, inflation lower, fiscal policy more conservative, and public/external debt buildup less.
Debate #2: Some central banks have hiked rates to fend off currency depreciation. How will rate tightening affect growth outlook?
Our view: Asian economies can be grouped three ways. Group 1 (Korea, Taiwan, China, Malaysia, and Thailand) has no major funding issues and central banks have not tightened this year. Group 2 (India and Indonesia) has moderate funding risk but no major resource misallocation. Policy rates have been hiked 50bps-125bps this year but no major tightening is needed from here.
The growth impact is likely manageable because a cyclical recovery means the economies can absorb the countercyclical hikes. A less-than-perfect monetary transmission mechanism also blunts the rate hike impact in Indonesia. Group 3 (Philippines) has moderate funding risk and an overheating problem. Significant tightening is needed to slow growth/restore macro stability but rates have only been hiked 100bps.
Debate #3: How much more funding pressure could we see? What can policymakers do and when would this start to hurt growth?
Our view: Our global EM team expects temporary stability in EM FX and rates. Should funding pressure re-emerge, FX intervention and liquidity injection would be the first response. More rate hikes to lift real rates, measures to manage balance of payments
