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Asia Economics Comment - Still Squeezed

Asia Economics Comment - Still Squeezed

It's true. Recent data has been a bit more re-assuring. China, possibly helped by some quiet stimulus, may be stabilizing. And yet, the region's financial squeeze continues. Bond yields have pushed higher again of late, partly in sympathy to rates in the West where tapering remains on investors' mind. Meanwhile, in India, financial conditions continue to tighten amid a wobbly currency. In Indonesia, too, the central bank tightened the screws again last week. Even in China, bond yields have risen again, surpassing on some measures the spike seen in June. All this will leave a mark on growth.

Sentiment has vastly improved. No doubt. Much of this has to do with China's better performance in July. Commodity prices, too, signal that demand on the Mainland is reviving. Copper and iron prices, for example, have ticked up of late - somebody must be buying the stuff. Infrastructure and property investment in particular seem to be holding up well, possibly spurred on by some extra fiscal kick. That's quite a relief after months of tumbling data. HSBC's flash PMI for China, out this week, will provide an important gauge of how widespread this pick-up really is.

The past week, however, delivered stark reminders of how sensitive Asia's financial conditions remain to developments elsewhere. Firming expectations of a Fed taper in September pushed up yields in the US and much of the West. In Asia, too, rates climbed higher, especially in India and Indonesia, but also in much sturdier places like the Thailand and Korea. Even China is not immune, although there are local factors at play as well: bond yields have climbed again, comfortably exceeding the highs seen during June's cash crunch. Admittedly, it's important to differentiate a little. Not all markets have shown the same sensitivity. India and Indonesia remain arguably the most exposed for now.

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Still, given how credit driven growth currently is across the region, even small rate moves will have a larger impact on activity than, say, before the Global Financial Crisis when leverage was a lot lower. Moreover, the move in benchmark yields often masks greater pain in corporate funding markets where issuance has become a lot, well, chewier compared to the first few months of the year. According to some estimates, investors have pulled 6 billion US dollars in debt out of the region in the past two months.

That, in itself, is hardly terminal. Plus, as we have argued before, more liquidity is on its way thanks to the Bank of Japan. Japanese investors have started to buy foreign bonds again, doing so for the sixth consecutive week. In early August, their net purchases hit a three year high. But that's not all. Bank lending and direct investment will have an even bigger impact on regional liquidity, especially in ASEAN. Only witness the recent trail of M&A announcements, with four bank and three life insurance deals completed or reportedly in the works by Japanese buyers in Thailand, Indonesia, and Vietnam.

What to make of all this? Current jitters are unlikely to evolve into a classic financial crisis. It's easy to draw parallels to 1997. But that would be misplaced. A better example is 1994 when the Fed unexpectedly tightened and US yields spiked. That year, the Bank of Japan continued on its easing path. That meant that liquidity in emerging Asia remained ample enough to sustain growth for a while longer. At the time, Japanese banks in particular helped to cushion the blow.

But this doesn't mean that Asia can shrug off the taper jitters entirely. Financial conditions have undoubtedly tightened. The result is that growth will limp along, unlikely to accelerate sharply any time soon. In most markets, debt levels are higher than in 1994, or at any time in the previous two decades. Higher funding costs, even if not prohibitive, are thus bound to weigh on growth. And there is little central banks can do to offset this - nor should they for their primary objective must surely be to curb even greater financial excesses rather than to boost growth artificially.

There are two special cases. The first is India. Here, financial stress has grown more sharply than in other markets. This reflects pressure on the rupee and the central bank's intention to stem the currency's slide. While various measures unveiled in the last several weeks will help at the margin, the fact remains that the RBI will not be able to loosen the reins any time soon. Much slower growth will be required to bring its external position back into balance.

The second exception is China. While not entirely immune to global financial developments, capital controls and the size of its market afford the Mainland a degree of protection. However, any rebound in growth is bound to be constrained by efforts to curb shadow financing. Even if regular bank lending expands, this may be insufficient to offset deleveraging in other parts of the financial system that in recent years has provided the bulk of liquidity.

In short, better data notwithstanding, Asia remains financially squeezed. Climbing US rates in themselves are not sufficient to knock out the region's financial system and spark a crisis that many apparently fear. At the same time, high leverage renders Asian growth a lot more sensitive to global financial conditions than in the past. For most, this means steadying growth at best.


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