Asia's central bankers are about to have their mettle tested, and they know it. "Stay calm on the weakening of the Hong Kong dollar," Norman Chan, chief executive of the Hong Kong Monetary Authority, said in a message posted on the central bank's website last Thursday.
The currency had slipped close to the lower limit of its trading band of HK$7.75-HK$7.85 to the US dollar. It had been declining since November, alongside a rise in American interest rates and a widening gap between Hong Kong and US yields, Nikkei reported.
A little over a week earlier, on Feb. 26, the new chief of Taiwan's central bank was frank when he spoke at his inauguration. "Looking ahead, it will be a great challenge for Taiwan's central bank to adjust monetary policies, including currency and interest rates, within such a dynamic environment," said Yang Chin-long, an experienced hand but still the island's first new central bank governor in 20 years.
US' long-term interest rates jumped in February, and Jerome Powell, the new chairman of the US Federal Reserve, sounds like a hawk. As the Fed and the European Central Bank unwind their quantitative easing policies and shift to full-on tightening, it is likely to create a vacuum effect, sucking money out of emerging countries in Asia and elsewhere. There are already signs of this.
The pivotal moment comes 10 years after the collapse of Lehman Brothers. Central banks, the lenders of last resort, staved off a full meltdown and today have a much greater presence in the financial markets.
Veterans and New Heads
The moment also comes as a number of Asian central bankers wrap up their terms in the first half of the year. Some will stay on, as in Japan, where Haruhiko Kuroda has been reappointed by the government. In other cases, like China, the reins will be passed to new governors.
South Korea is leaving those reins with Lee Ju-yeol, a decision that underscores President Moon Jae-in's desire to avoid sudden policy changes in these tense times.
Indonesia, meanwhile, is poised to turn things over to Perry Warjiyo, a central bank deputy selected by President Joko Widodo as the sole candidate to replace incumbent Gov. Agus Martowardojo. Warjiyo still needs parliament's blessing, but this is considered a fait accompli, since Widodo's coalition holds a majority.
Net Outflow
Last year, when US long-term rates were low and stable, Asian stocks kept climbing. The reversal in February coincided with a flare-up in US inflation concerns, with the 10-year treasury yield jumping to 2.8% at one point.
The conditions were ripe for an outflow of funds from Asian markets—the dreaded vacuum effect. The Institute of International Finance reported that a net $4.5 billion streamed out of Asian and other emerging economies' securities markets in February. This was the first net outflow on a monthly basis since November 2016.
You can almost hear the echoes of the Asian financial crisis that battered emerging economies 20 years ago. In July 1997, Thailand's currency and stock prices tumbled on heavy short-selling by hedge funds. The crisis spilled over into Indonesia, South Korea and other Asian countries, and spread to Russia in 1998 and Brazil in 1999. For now, few economists say Asia is on the verge of another crisis.
Blind Spots
Bank of Thailand Gov. Veerathai Santiprabhob, speaking with the Bangkok Post, issued a warning to overly optimistic market players. "The correction is a wake-up call for all parties, including operators, investors and risk appraisers, to not be complacent when they see low volatility or risk in the market," he was quoted as saying in a report published in February.
The lack of volatility and apparent risk is the result of the American, European and Japanese central banks running huge monetary easing programs in sync. Now that the Fed and ECB have turned toward normalization, it may not take much to spark turmoil with consequences for the real economy.
Money supplied by the Fed, ECB and Bank of Japan through quantitative easing will drop to zero on a net basis in October 2018, according to the estimates of Ayako Fujita, senior economist at Nomura Asset Management. She cautioned that the "market will likely become overly susceptible" to triggers as a result. Many experts say investors have a tendency to ignore fundamentals and overshoot.
Pushing Up Rates
Even if the region is not destined for another crisis, the monetary shift in the US and Europe is pushing interest rates higher in Asia, clouding the economic outlook. China, not surprisingly, warrants particularly close attention.
Consider a Japan Center for Economic Research report published in late February. Concerns about higher US long-term rates pulling money out of Asia, JCER argues, could force China to raise interest rates to prevent the yuan from weakening against the dollar. This presents a major challenge for the People's Bank of China, which is on the cusp of a leadership change after about 15 years under Gov. Zhou Xiaochuan.
Chinese corporate debt hit 167% of gross domestic product at the end of June 2016, up from 97% at the end of 2007, prompting the International Monetary Fund to sound the alarm. A rate hike would compound the debt problem, with higher interest payments potentially causing a wave of company failures, damaging the economy.
Reflecting China's deceleration, the growth of four core Southeast Asian economies—Indonesia, Thailand, Malaysia and the Philippines—is expected to level off. The four nations' real rates are projected to average 5.2% in 2018 and fall to 5% in 2019. Thailand and Malaysia, which heavily depend on China, face more abrupt slowdowns than the other two.
For Asia's veteran and new central bank governors, the stakes are as high as they come. A misstep could cause the regional economy—the world's growth engine—to falter.
