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| Louis Kuijs, Chief China Economist at RBS |
Asian economies have stronger current account positions now and Asia’s most important economy, China, is also protected by capital controls. That barrier means that relatively little foreign portfolio capital flowed into the country as a result of the Federal Reserve’s QE programme, so it has seen little of investor panic suffered by other emerging currencies and markets. The ability to service foreign debt across much of Asia is substantially less worrisome than in the recent past, exchange rates are more flexible and central banks have larger foreign currency reserves to defend currencies.
Nor have the long-term prospects of emerging markets in Asia changed suddenly. With productivity and income across emerging markets still so much lower than in advanced economies and Asia having shown it can tap such growth potential, these countries are likely to remain the key drivers of global growth in the coming decades.
The manufacturing economies of Asia in particular should welcome the coming normalisation of US monetary policy as a signal of renewed growth in its most important export market. The winding-down of US bond purchases is good news – not something to be feared as more short-termist markets seem to view it. While Fed talk of tapering QE has clearly reversed some EM flows, the region’s economies can be confident that sudden changes in US monetary policy are not on the agenda. The gradual reduction of bond purchases is conditional on positive growth and employment numbers. US interest rates should remain at between zero and 0.25 per cent until 2015.
Nevertheless, we cannot rule out further market turbulence and a further correction, especially given the tendency of financial markets to overreact and overshoot. Policymakers in Asia should now plan how to mitigate further ‘taper turmoil’. Even those countries such as China, which are relatively insulated from the withdrawal of foreign capital, would be affected should growth in other emerging markets be further weakened by more capital outflow.
First, Asian nations should limit the size of current account deficits and maintain a sustainable macroeconomic position by avoiding policies that are too expansionary. Growth remains vital but it must be fostered by productivity-enhancing structural reforms rather than expansionary policies.
In heeding lessons from the current turmoil, policymakers should also resist going cold on the use of foreign capital inflows. In principle there is nothing wrong with them if they are drawn in by a country’s growth story and a healthy investment climate rather than short-term, speculative gains.
Still, it is best not to rely too heavily on financial inflows. Sometimes that could well mean introducing sensible forms of capital control. Indeed, in China, the latest bout of market turmoil underscores the need for a cautious approach to financial reform and the opening up of its capital account.
Finally, Asian countries should ensure they have adequate systems to assist each other in times of stress or crisis. The last decade has seen the roll out of many bilateral swap lines and other arrangements but thus far, they not been greatly used. Governments should ensure that existing arrangements are prepped and ready and would do well to explore whether further opportunities for mutual financial assistance exist.
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