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Asian central banks under strain

Asian central banks under strain

Better policies mitigate outflow risk

by Bhavin Patel in London

Tue 13 Dec 2016

Central banks in Asia are under significant strain. The November election of Donald Trump and expectations the Federal Reserve will raise interest rates have generated significant outflows from Asian markets. In the five weeks since 8 November, the ringgit has fallen by 5.3%, the yen by 9.4%, and the renminbi by 1.8% against the dollar.

Geopolitical volatility is widespread. Several Southeast Asian countries are enduring political turbulence. India is experiencing the fallout of a clumsily handled demonetisation initiative. Trump’s rise raises the risk of a US-China trade war.

Outflows from key Asian states have been comparable to those experienced during the 1997-98 crisis. China – which has recorded a foreign exchange reserve loss of $69bn in November – suffered outflows of more than $530bn in first 10 months of 2016, according to estimates from ANZ Bank. Outflows from emerging Asian economies reached $22bn in November. This compares with the extreme position of 1997, when Indonesia, Malaysia, the Philippines, Singapore and Thailand experienced commercial loan withdrawals of $210bn.

Southeast Asian central banks have been able to surmount volatility partly as a result of improved policy frameworks. Foreign exchange reserves are much stronger than 20 years ago. Additionally countries are following more flexible currency regimes, allowing the exchange rate to take the strain.

Central banks from the region are aware the environment is more than usually risky. In a poll at a joint OMFIF-South East Asian Central Banks (Seacen) meeting in Kuala Lumpur on 23 November, central banks and other participants identified ‘fintech, interconnectedness, disruption to the banking sector and technology risk’ as the most significant risk to financial stability. This was followed in importance by ‘geopolitical risk’ and ‘increased regulatory and compliance risk’.

One factor helping protect central banks from financial fluctuations has been a strengthening of bank capital and liquidity positions after the 1997-98 and 2008 crises. Southeast Asian central banks have also moved to set up the Chiang Mai safety net through reserve pooling – although there is considerable doubt as to how effective the mechanism can be in case of genuine market turmoil.

These economies are still vulnerable to contagion, as in the 1990s, when the interconnectedness of financial markets caused Thailand’s currency troubles to escalate into regional disturbance. Japanese banks 20 years ago precipitated additional turbulence by withdrawing loans to the rest of Asia, but there has now been some improvement in excessive Japanese exposure.

Some Asian challenges remain unchanged. At a time when there is insufficient regional monetary policy harmonisation, central banks must ensure that the system is stable, secure, and competitive, without stifling innovation in areas like fintech which are seen as potential sources of risk.

Regulators and central banks have done their best to lower vulnerability – but 2017 will be a difficult year.

Bhavin Patel is Economist at OMFIF

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