Asia Central Banks Rebuild $6 Trillion Defense as Fed Hike Looms

  • Foreign-exchange reserves are rising across the region
  • Buffers offer central banks a key defence against volatility

Asian Central Banks Rebuild Foreign Exchange Reserves

Asia’s central banks are stacking the sandbags. 

Foreign-exchange reserves are being rebuilt as monetary authorities brace for the Federal Reserve’s third rate hike in six months. While the expected move has been well telegraphed, prolonged periods of Fed tightening can cause jitters for emerging markets. Asia was slammed in 2013 when then-Fed Chairman Ben Bernanke’s hint of an end to quantitative easing sparked the "taper tantrum."

The turnaround is being led by China’s resumed purchases of U.S Treasuries, after it cut holdings last year by the most since 2000. The world’s biggest reserves pile grew by $24.03 billion to $3.054 trillion in May -- the biggest increase since April 2014 -- as a stronger yuan and an easing of capital outflows help authorities in Beijing to shore up their buffer. 

There have also been sizable gains in Malaysia, Indonesia and Singapore. India’s foreign-exchange reserves are at record highs, buoyed by strong inflows into the stock market.

"Asia is strengthening its defenses," said Frederic Neumann, co-head of Asian economic research at HSBC Holdings Plc in Hong Kong. "This will give regional central bankers a stronger hand to counter any potential volatility in the coming months, should the Fed tap the brakes more firmly than expected."

Fed rate hikes can reverberate through Asia as capital is lured to rising yields in America, sparking financial market volatility and driving up borrowing costs for the region. Southeast Asia in particular is often vulnerable because of dollar-denominated debt serviced in local currencies, an arrangement dubbed "Original Sin" by economists Barry Eichengreen and Ricardo Hausmann after the region’s 1997-98 meltdown.

This time around, calmer markets, a dollar that’s yet to sustain a break higher and a steady flow of money into Asia is giving central banks a window to top up their foreign currency holdings.

Improving fundamentals help explain the reserves build-up. Growth across the region remains solid due in large part to China’s economy continuing to defy predictions of a sharp slowdown. Buoyed also by U.S. and European demand, exports from countries such as South Korea and India are at multi-year highs, even amid worries over rising protectionism.

"We think this current Asian trade recovery has legs, driven by a synchronized global recovery, including rising capital spending in both the U.S. and China," said Chua Hak Bin, a Singapore-based senior economist with Maybank Kim Eng Research.

Money is also pouring back into Asia as investors double down on the economic potential of countries like the Philippines, Malaysia and Indonesia. 

S&P Global Ratings raised Indonesia’s credit rating to investment grade in May, bringing it in line with the other two main rating companies and paving the way for more fund inflows into Southeast Asia’s largest economy.

"The region is benefiting from better growth prospects, solid macro fundamentals, advancing of reforms and strong external positions, accompanied by lowering of domestic political uncertainties," said Bejoy Das Gupta, chief economist for Asia Pacific at the Institute of International Finance.

Asia’s expansion will probably exceed 5 percent in 2017 and 2018, compared with about 3.5 percent for the world this year, according to the International Monetary Fund. The better conditions have put a floor under currencies and helped bolster current accounts.

Less Pressure

While the Fed is tipped to raise rates this week, soft reports on employment and inflation mean investors are easing up on bets for additional hikes. Goldman Sachs Group Inc. has pushed back its forecast for a third rate increase this year to December from September and investors are now pricing in less than one rate hike in 2018 for the first time since the eve of the U.S. elections in November. That’s taking the pressure off Asia’s currencies.

"The third big U.S. dollar rally of the post-Bretton Woods era has stalled," economists at Societe General wrote in a recent note.

While all of that’s good news for central bank reserves in Asia, it doesn’t mean governments can afford to ease up on domestic reforms, said HSBC’s Neumann.

"Sound fundamentals, after all, offer the best insulation from potential storms brewing elsewhere."

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