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Southeast Asia's overseas borrowing masked by market rally
[SINGAPORE] In Southeast Asia, original sin hasn't gone away. Even as the region's currencies rally, stock markets rise and foreign investors return, a legacy of debt remains one of the biggest threats to economic stability.
Governments and companies in Indonesia, Malaysia and other countries in the region have continued to add to borrowing this year after selling the most amount of dollar bonds in three years in 2015, increasing risks if the US Federal Reserve again lifts interest rates, the dollar rallies and local currencies tank.
The recent rebound in emerging-market sentiment may simply be masking the threat of "original sin" - a term coined by economists Barry Eichengreen and Ricardo Hausmann after the region's 1997-98 meltdown and used to describe the difficulties faced by developing countries that run up overseas borrowing.
Emerging markets for now are benefiting from reduced expectations of US interest-rate increases, and further monetary easing in Japan and Europe. The danger is that developing nations, including those in Southeast Asia, are forgoing the current period of stability to address underlying vulnerabilities, such as from dollar debt.
"The sweet spot for Southeast Asian economies now is very short term," Santitarn Sathirathai, head of Southeast Asia and India economics and strategy at Credit Suisse Group AG, said at a conference in Hong Kong on Wednesday. "If the Fed hikes more aggressively than expected, some of these economies will still be vulnerable."
Governments and businesses in the Association of Southeast Asian Nations, or Asean, have raised US$10 billion from dollar bond sales so far this year, according to data compiled by Bloomberg. That compares with US$37 billion issued for the whole of last year. Dollar borrowing this year was led by Indonesia at US$4 billion, the Philippines at US$2 billion and Malaysia at US$1.75 billion.
The risk of "original sin" is most acute in Malaysia. The International Monetary Fund last year estimated Malaysia's corporate debt at about 70 per cent of gross domestic product, compared with 20 per cent in Indonesia. Household debt in Malaysia was the highest in the region, at more than 89 per cent of GDP, compared with 16 per cent in Indonesia, according to a report from Nomura Holdings Inc.
The country's contingency buffers aren't as strong as those of its peers. According to estimates from Societe Generale SA, only two major emerging-market economies have foreign-exchange reserves below the IMF's recommended range: Malaysia and South Africa. Malaysia's reserves fell 18 per cent last year to US$95.3 billion, and have only rebounded modestly this year.
Malaysia is also in the middle of an unprecedented political crisis, with Prime Minister Najib Razak facing widespread calls to resign amid a corruption scandal. Adding to the uncertainty are plans by central bank Governor Zeti Akhtar Aziz to step down this month after 16 years at the helm.
To be sure, Southeast Asian governments have come a long way since the Asian financial crisis, building up reserves, freeing up currencies and strengthening government balance sheets. Together, that means the region is in much better condition to fend off any new storm, according to Mr Eichengreen.
"Southeast Asian countries have made a lot of progress in reducing foreign-currency debt relative to GDP since the mid-1990s," he said in e-mailed comments.
For now, the region is benefiting from a sharp reversal in emerging-market sentiment compared with the start of the year when capital was fleeing amid tumbling oil prices, a slowdown in China and concerns about the effect of another Fed interest-rate increase.
Take Indonesia: About US$5 billion of net inflows have made their way back into the nation's sovereign bonds and US$300 million into the stock market so far this year, according to an estimate from Oversea-Chinese Banking Corp.
Much of the returns are being driven by a weaker dollar as investors bet the Fed will raise rates at a slower pace than previously expected.
Analysts at Goldman Sachs Group Inc said last week that Asia Pacific markets are under-pricing the probability of further Fed rate increases. When these happen, there's a clear potential for a "reversal of recent foreign inflows to equity and credit markets," the analysts wrote in a report.
Any change in the outlook for the Fed's interest-rate tightening cycle may trigger a sudden depreciation in the region's currencies as the dollar rallies.
"That could present a tricky situation for a region that is seeing capital inflows anew again," according to OCBC.