The last time Southeast Asia mixed a heady cocktail of foreign borrowing with weakening currencies the hangover was a financial crisis.
Now, Indonesia and Malaysia are at risk of repeating the mistakes that led to the 1997-98 meltdown. After the crisis, economists Barry Eichengreen and Ricardo Hausmann coined the term "original sin" to describe the difficulties encountered by developing nations borrowing overseas. This year, Indonesian and Malaysian governments and companies have sold more foreign-currency debt than they did in the whole of 2014 as a global bond rout pushes up yields and their currencies weaken.
“There are worrying signs that original sin is returning,” said Hak Bin Chua, head of emerging Asia economics at Bank of America Merrill Lynch in Singapore. “Governments are forced to opt for more foreign-currency debt financing, as local bond yields surge and foreign appetite diminishes.”
Indonesia’s rupiah fell to its lowest level since 1998 last week and Malaysia’s ringgit dropped to within 1 percent of a dollar peg installed that year to stem a currency collapse. As the dollar gains and the Federal Reserve prepares to raise interest rates, it will become costlier for Asian borrowers to service foreign-currency debt, Eichengreen said.
“I doubt that the ultimate consequence will be another Asian financial crisis, but it will mean rougher sledding for the principal emerging markets,” Eichengreen, a professor at the University of California, Berkeley, said in an e-mailed response.
Indonesia has sold $6 billion of foreign-currency bonds in 2015, compared with $6.8 billion in 2014, Finance Ministry data show, and still plans to offer euro and yen notes before year-end. Malaysia has issued $1.5 billion of the debt this year after no sales in 2014. Companies from the two nations have sold $11 billion of global securities this year, more than the $10 billion 2014 total, data compiled by Bloomberg show.
Foreign currency borrowing accounted for 34.3 percent of Malaysia’s gross domestic product on March 31, compared with 60 percent at the end of 1998, the central bank said in a e-mailed response. It said the government’s share was 1.5 percent of GDP.
“The current landscape of Malaysia’s external position is different from the situation leading to the Asian financial crisis,” Bank Negara Malaysia said. “With the advancement of the domestic capital market, Malaysian companies have been able to tap into domestic sources of funding.”
An index of ’original sin’ compiled by Bank of America that measures the proportion of foreign-currency sovereign and corporate bonds shows Indonesia has risen to 0.67, the highest in more than a decade. Malaysia’s reached 0.37, from an average of 0.1 in 2009 to 2014. Too much foreign debt can fuel currency and capital-market volatility, hurt ratings and restrict monetary policy flexibility, according to Bank of America.
“What could be very detrimental for these countries is not so much the Fed hike, which has been very well telegraphed, but rather the timing and the expectations of the overall tightening cycle,” said Jean-Charles Sambor, the Asia Pacific director of the Institute of International Finance in Singapore. “If markets start repricing this, it would be very negative and impact Indonesia and Malaysia first.”
Warning signs are emerging. The cost to insure five-year Indonesian government debt against default rose to a five-month high of 180 last week, while that for Malaysian notes jumped 23 points to 133 in the last three weeks. The yields on Indonesian and Malaysian local-currency 10-year paper reached the highest in 15 and five months, respectively, last week.
The two countries’ local debt markets are susceptible to shocks given they have the highest proportion of offshore ownership in Southeast Asia: Thirty-eight percent in Indonesia and 32 percent in Malaysia. Bank Negara’s response said that this has contributed to a “higher external debt position.”
Indonesia isn’t selling too many foreign-currency bonds, according to Finance Minister Bambang Brodjonegoro.
“If we sell in different currencies, that spreads out our risk and makes our local market less vulnerable to flow reversals,” he said in a June 11 interview in Jakarta. “What would be risky is if we sell too many rupiah bonds.”
Standard & Poor’s raised its outlook on Indonesia’s BB+ credit rating, one level below investment grade, to positive from stable last month, citing improved external resilience. Fitch Ratings said in March that it saw more than a 50 percent chance Malaysia would lose its A- ranking, four levels above junk, as a state-owned investment company struggled to meet debt obligations.
Unlike the 1997-1998 Asia financial crisis governments in the region are now better prepared, having introduced free floating exchange rates and building up forex reserves. Although as the Fed taper tantrum showed, funds can still flow quickly out of Asia, punishing local currencies.
Since May of that year, when then-Fed Chairman Ben S. Bernanke signaled he was preparing to wind down bond purchases, the rupiah and the ringgit have plunged 26 percent and 17 percent, respectively, the worst performers in emerging Asia.
“Quantitative easing may have fed the illusion that original sin was dead and gone,” said Bank of America’s Chua. “But the start of Fed rate hikes has clearly resurrected the issue once again.”