Fears For Carry Trade as Asian Growth Drops


Amid a slide in Southeast Asian currencies, the World Bank has forecast slower growth for the region in 2014, including China. As the U.S. dollar continues to surge, analysts have warned that the famous “carry trade” that powered emerging markets may finally be unwinding.

Announcing Monday in Singapore its latest forecasts, the World Bank said developing East Asia and the Pacific region would post a 6.9 percent economic expansion this year and next, down from 7.2 percent in 2013.

Excluding China, growth in the region’s developing economies is expected to bottom out at 4.8 percent in 2014, rising slightly to 5.3 percent next year as exports increase and domestic reforms take effect in the larger Southeast Asian economies.

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Asia’s biggest economy, China is expected to continue to slow, easing to 7.4 percent growth this year and 7.2 percent in 2015, “as the government seeks to put the economy on a more sustainable path with policies addressing financial vulnerabilities and structural constraints,” the World Bank said.

The report did however contain some positive news, with Malaysia’s 2014 growth forecast revised to 5.7 percent, up from 4.9 percent in April, following robust exports in the first half of the year. Rising garment exports are expected to boost Cambodia’s growth rate to 7.2 percent, while Thailand should benefit from the global recovery “if the respite in political unrest is sustained,” increasing its growth rate from 1.5 percent this year to 3.5 percent in 2015.

Among the Pacific nations surveyed, Papua New Guinea’s growth is expected to surge by 20 percent in 2015 on the back of liquefied natural gas investment, although easing to 4 percent the following year.

Another bright spot for the region is strong private consumption, aided by election-related spending in Indonesia and Malaysia’s solid labor market, along with buoyant remittances to the Philippines from its army of workers overseas.

Yet despite its new reformist president, Indonesia is forecast to see growth falling to 5.2 percent this year, down from 5.8 percent in 2013, hit by lower commodity prices, reduced government spending and slower credit.

The World Bank also identified significant uncertainties to the growth outlook, including downside risks facing the Eurozone and Japan, a tightening of global financial conditions, and worsening international and regional geopolitical tensions.

“The region also remains vulnerable to a sharp slowdown in China, which, though unlikely to happen, could hurt commodity producers especially hard, such as metal exporters in Mongolia and coal exporters in Indonesia,” the Washington-based lender said.

“The best way for countries in the region to deal with these risks is to address vulnerabilities caused by past financial and fiscal policies, and complement these measures with structural reforms to enhance export competitiveness,” Sudhir Shetty, chief economist of the World Bank’s East Asia and Pacific Region, said in a statement.

Specific reforms cited include measures by Southeast Asia’s major economies to “bolster revenues and reduce poorly targeted subsidies,” while China was urged to reform its state-owned enterprises to offset the impact of measures curbing local government debt and shadow banking.

Meanwhile, a separate report released Monday by the World Bank in Washington predicted that South Asia’s economy would expand by a real 6 percent in 2015 and 6.4 percent in 2016 compared to 5.4 percent this year, potentially becoming the second-fastest growing region in the world after East Asia and the Pacific.

The improved growth prospects are due to a predicted upturn in India, which should post a 6.4 percent expansion in fiscal 2016 as it benefits from a “Modi dividend” and a recovering U.S. economy, the report said.

Carry Trade ‘Cracking’

Yet while the developing East Asia and Pacific “remains the fastest-growing region in the world,” a recent slide in Southeast Asian currencies has raised fears that the long-predicted capital flight out of emerging markets may be underway. The carry trade has involved investors borrowing in low-interest currencies such as the dollar, euro or Japanese yen to invest in higher-yielding emerging markets, but the strategy’s effectiveness is diminishing.

September’s fall in Southeast Asian currencies has virtually wiped out most of this year’s gains, with a resulting slowdown of funds making their way into local stocks as investors await the anticipated rise in U.S. interest rates.

A gauge of emerging market currencies, the JPMorgan EMCI index, recently plunged to its lowest point against the dollar in 11 years, with analysts warning that the multi-trillion dollar flow that aided emerging markets may be reversing.

“The carry trade strategies are finally cracking,” Luis Costa, currency strategist at Citibank, told the Australian Financial Review (AFR).

“The market has been so flooded with liquidity and interest rates have been so low for so long, but this is turning now.”

Bank of America Merrill Lynch’s David Hauner told the Australian financial daily that “this isn’t the end of the carry trade forever, but it is a correction.”

The dollar’s rise has been aided by an improved U.S. economy, the forecast ending of the U.S. Federal Reserve’s quantitative easing and also the European Central Bank’s “dovish” monetary policy, according to the AFR’s James Kynge.

Issuance of emerging economy local currency debt has also dropped, with just $22 billion in bonds launched in September compared to the year’s monthly average of $62 billion, according to the Institute of International Finance.

The reduced appetite for emerging economy debt has left Southeast Asian economies vulnerable, with the proportion of government bonds owned by foreign investors exceeding 45 percent in Malaysia and 35 percent in Indonesia.

According to Credit Suisse, only India and Thailand among Asian economies received net inflows of funds in September, marking the “first signs of foreign investor capitulation” to currency swings.

Nevertheless, stockmarkets in Indonesia, the Philippines and Thailand are still up more than 20 percent this year, with investors eyeing the potential impact of market-friendly reforms.

“Fears are overdone” about the impact of the Fed’s monetary policy change on Southeast Asia, Amundi’s Pascal Blanque told the Wall Street Journal.

Nevertheless, policymakers have plenty to worry about should global investors make a mad rush for the exits on Asia’s emerging markets, threatening the region’s economic buoyancy.

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