Can Asia beat the rising-dollar curse? The question is far from academic considering the central role that a strengthening U.S. currency played in sparking the region's 1997 crisis, as well as Latin America's own financial woes a decade earlier. When the dollar slides, liquidity flows into emerging markets, pumping up growth and assets. As the dollar rallies, it can act like a gargantuan money magnet drawing much-needed investment away from the developing world.
With the dollar now experiencing what many observers believe may be its third "super-cycle" rally in 30 years, emerging markets have reason to worry. Since the 2008 global crisis, outstanding dollar-denominated credit to non-bank borrowers overseas has surged to $9 trillion from $6 trillion, according to the Bank for International Settlements. (That figure is roughly equivalent to China's annual economic output.) Chinese companies alone owe at least $1.1 trillion.
In emerging economies with volatile local currencies such as India and Malaysia, issuing debt in dollars can be a smart and pragmatic strategy -- until it isn't. With the dollar up sharply almost across the board since the start of 2014 -- 23 percent versus the euro and 13 percent versus the yen -- and the Federal Reserve set to raise rates, borrowers are going to have a harder time paying back what they owe, let alone taking out new loans. That helps explain why the Shenzhen property developer Kaisa is suddenly making global headlines. It may soon be the first Chinese company to default on dollar bonds -- and could set off a domino effect across Asia's biggest economy.
Fortunately, the region seems better prepared to withstand currency swings than in 1997. "People are watching the rise of the dollar nervously this time around, but this cycle is fundamentally different from a key structural perspective," notes economist Glenn Maguire of Australia & New Zealand Banking Group in Singapore. "We must take into account the incredible journey many Asian economies have made from low-income, to middle-income, even to higher-income since 1997."
Maguire offers up several reasons for optimism. Asian exchange rates generally aren't pegged to the dollar anymore. Current-account balances are less worrisome, and many countries have stockpiled substantial currency reserves. There are fewer currency mismatches between assets and liabilities. Banking sectors are stronger and central banks are far more transparent than they once were.
Still, if emerging markets worldwide slide into chaos, Asia won't be immune. As recently 2013, remember, when the Fed first started talking about tapering its bond-buying program, India and Indonesia quickly found their currencies in freefall.
In particular, the region may come to regret the still relatively high level of non-financial sector dollar debt. It stood at around 10 percent of gross domestic product on average in mid-2014, compared with roughly 11 percent in 1997. That "poses a potentially new source of vulnerability" as Fed rate interest rates hikes begin, says Callum Henderson, global head of foreign-exchange research at Standard Chartered in Singapore.
In recent weeks, central banks in India, Thailand and South Korea have surprised markets with rate cuts. But Asia's window for further cuts may be closing as policy makers take stock of how many local borrowers could face default if currencies fall too far. That goes especially for China, where dollar loans are a fast-growing risk to stability. As Bloomberg economists Tom Orlik and Fielding Chen write in a new report, the "dollar’s strength is China’s weakness." A weaker yuan, they argue, "would add to repayment costs, adding to financial stress for debtor firms."
Standard Chartered's Henderson takes heart from the fact that central banks are encouraging corporations to trim or hedge their dollar debts before the Fed taper begins. Still, even if underlying fundamentals are stronger now, the inevitable flow of capital out of local stock and bond markets will pose serious management challenges.
Both central banks and government policy makers should be acting nimbly and proactively to stabilize their economies. That means devising so-called macro-prudential policies, including limits on capital to defend against turmoil. Governments should batten down the hatches, narrowing current-account deficits even further and widening surpluses. They must prepare emergency fiscal-stimulus packages, yet also stay focused on investments that raise productivity and competitiveness so that in the long run their economies are less dependent on credit and foreign capital.
It may not be 1997 again in Asia. But the region has 9 trillion reasons to be ready if things go awry.
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