The prospect of a US ratings downgrade due to a debt default could see extra funds flow to Southeast Asia for a short time, but the bigger risk is that a new round of quantitative easing would trigger sizeable inflows that unsettle economies.
Central bank officials in the Philippines, Indonesia and Thailand said inflows could pick-up due to the US economic problems. None expressed concerns about the risk of the US actually defaulting on its debt obligations.
The broad expectation is US politicians will reach a deal to increase the country’s debt ceiling by the August 2 deadline rather than face a default, which could roil financial markets around the world.
“With the ample liquidity in the global system and Europe facing its own problems, we can probably expect any adverse movement to be short-lived,” Philippine central bank governor Amando Tetangco said.
“That said, markets will be carefully watching how US lawmakers would handle this warning from Moody’s.”
Moody’s Investors Service said the stand-off put Washington’s top-notch ratings at risk, and said it wanted to see a credible agreement with long-term measures to cut the deficit.
In the event of a US default and downgrade, analysts said the problem for Asia could be a withdrawal of funds as investors cut exposure to risky assets, rather than an influx.
“First of all, I don’t think it will get to that stage and second, if it does it will be a risk-off scenario — and money in a risk-off scenario does not go to emerging markets,” said Tim Condon, head of Asia research at ING in Singapore.
Asian credit spreads blew out to near their widest levels in 10 months after the Moody’s warning although investors are sceptical this will trigger portfolio liquidation.
“A technical default of the US debt would be troublesome to the market, even for a very short period of time. Look at what happened to Italy on Monday,” said Thomas Kwan, Head of Asian Debt Investment at Baring Asset Management.
Still, he said a technical default may not lead to heavy selling as investors would still believe initially that Washington would come up with a debt service plan.
“If not, it would be disastrous for the global financial system global and economy,” Kwan said.
QE RISK
A more pressing concern for Southeast Asia would be if the Federal Reserve began a third round of quantitative easing (QE3), where it buys US debt to keep markets flush with cash to encourage economic activity.
While holding to a view that recent economic softness would eventually pass, Fed Chairman Ben Bernanke appeared on Wednesday less confident in that projection and more willing to entertain the possibility of another round of stimulus.
Hopes for further monetary support sent US stocks, which have taken a drubbing over the last week on worries about Europe’s debt troubles and a soft US economy, 1 per cent higher on Wednesday, while Treasury bond prices and the dollar tumbled.
“The market wasn’t thinking there would be any mention of QE3 whatsoever and here we’re finding out QE3 is not being ruled out. It’s a tantalizing headline,” said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi.
Emerging markets policymakers worry that investors simply take the US funds released and invest them in their fast-growing markets, exacerbating inflationary pressures, expanding money supply, and driving currencies higher.
“That (QE3) would trigger a repricing of risk assets including emerging market equities and currencies,” ING’s Condon said.
Stock markets in Jakarta, Kuala Lumpur and Manila have all hit record highs this month, and foreign buying has been a factor in their rise.
Large inflows complicate policymaking as central banks need to keep liquidity at a level where the economy can grow, while making sure it is not pumping up asset prices or creating a vulnerability to a sudden reversal — as in the Asian financial crisis of 1997-98.
They also undermine efforts to control inflation, as higher interest rates can simply attract more flows.
“That is the challenge. So when we talk about capital inflows complicating monetary policy, it’s a real challenge,” Tetangco said.
