Asian governors brace for outflows

Emerging Markets, September 2011

Southeast Asian nations are braced for volatile capital flows caused by problems in developed world economies, but insist they are now strong enough to deal with them.

“We are seeing very significant surges in capital outflows and reversals,” said Dr Zeti Akhtar Aziz, Governor of Bank Negara Malaysia. “Previously it destabilized us quite significantly. But in the current environment we are seeing these flows are better intermediated by emerging economies.”

In Indonesia, Rahmat Waluyanto, in the debt management office of the Ministry of Finance, said foreign ownership of bonds had fallen from 35.4% to 33.6% in the space of the last week, but said net inflows into the government bond market stood at $5.5 billion year to date. “There is no reversal yet: the real money accounts still stay,” he said. “We have the capacity to withstand flows.”

In 2009, deleveraging by international investors led to the withdrawal of large sums from Asian markets, particularly Korea and Malaysia. “Our currency depreciated to levels we haven’t seen for a long time, and our reserves declined by 25 to 30 billion dollars,” Zeti said. “But we could take it in our stride.” Around 20% of Malaysian government bonds are foreign-held. Emerging markets generally have been heavy recipients of foreign capital since the 2008 global financial crisis, but Asian nations worry about the impact of sudden reversals during times of macroeconomic stress.

Both policymakers said their countries had specific reasons for being more resilient to capital flight. Zeti in Malaysia cited more resilient financial institutions, more developed financial markets, higher reserve levels and a more flexible exchange rate. “The central bank also has a wider number of instruments to absorb them and to sterilize some inflows so they don’t lead to the formation of asset bubbles,” she said.

Waluyanto said Indonesia was protected by its large foreign exchange reserves (which passed US$100 billion for the first time earlier this year), a widening domestic investor base, including retail investors and the growth of pension funds and insurance, and a measure called the bond stabilization framework. He said this involves strategies to anticipate negative impacts of sudden reversals, including buybacks of government securities by his office, the coordinated purchase of government securities by state-owned corporations, and using cash surpluses with the approval of parliament to buy into the market.

However Zeti said Malaysia is still not ready for full currency liberalization. Although foreign exchange in Malaysia is much liberalized since the Asian financial crisis, with no restrictions on inflows or outflows by residents and non-residents, the ringgit has not been internationalized in a way that would allow access to the currency in offshore markets. “At this stage, our assessment is that the internationalization of the ringgit should not be hastened,” she said. “The benefits must outweigh the costs. In an environment of highly volatile global financial markets, opening the ringgit offshore market could increase the risk of significant disruptions in our domestic financial markets.”

She set out the pre-conditions to internationalizing the currency: a stronger domestic foreign exchange market, with enough market players and products to promote two-way flows; capacity among domestic companies and investors to manage foreign exchange exposures; and better risk management and corporate governance practices.

Zeti said inflation had largely ceased to be a pressing issue for Asian central banks. “As commodity prices stabilized, which was a major factor from the supply side producing higher inflation, demand has slowed globally. This will limit inflation, so most central banks have paused their increases in interest rates.” Bank Negara hiked rates in four steps from 2% to 3% from late 2010, “to normalize interest rates and adjust the degree of monetary accommodation,” but ceased in July “given the increased uncertainties and the significantly heightened risks to growth.”

Zeti said she expected emerging markets to continue to grow, but at a slower rate due to the global economy. “In emerging markets we are doing better [than the west] but we are going to see moderation in our growth.” Malaysia’s economic growth was just 4% year on year in the second quarter of 2011, though Zeti has said she expects full year growth of at least 5%.

For central bank governors in Asia, “the biggest challenge is to have price stability in an environment of sustainable growth. You have rising prices, and at the same time you also have risks to growth, and those risks have become higher because of what is happening around the world.”