ASEAN may be eyeing a single, $2 trillion market by 2015 but could the region instead be hurtling toward another financial crisis?
On a day when Indonesian President Susilo Bambang Yudhoyono (SBY) was shaking hands with Australian Prime Minister Kevin Rudd, the front page of The Jakarta Post instead carried warnings of a capital flight.
“Indonesia’s equity market is the most vulnerable to capital outflows in Southeast Asia,” the daily said Friday, citing a report by Morgan Stanley that said it had downgraded its outlook for the Indonesian equity market to “neutral” from “positive” due to currency volatility and rising interest and equity risk premiums.
According to the U.S. investment bank, the Indonesian stockmarket is the most expensive of all emerging economies, and due to its high foreign ownership was “likely to be the most vulnerable equity market within ASEAN in a sudden stop of capital outflows scenario”.
The newspaper noted that foreign investors had withdrawn $2 billion worth of stock investments in June amid the global sell-off sparked by the US Federal Reserve’s “tapering” policy, while foreign ownership of Indonesian bonds had declined by a similar amount.
“Capital outflows and rising real rates from recent QE [quantitative easing] taper concerns have exposed such macro vulnerabilities, or funding needs, forcing policymakers to undertake fuel subsidy rollbacks and interest rate hikes,” Morgan Stanley said.
On Friday, the benchmark Jakarta Stock Exchange Composite Index closed at 4,602, up 8 percent for the year, but still well below its historic high of 5,214 reached on May 20.
The newspaper warned that the huge economic costs caused by a sudden capital reversal highlighted the potential need for capital controls, such as taxes on portfolio investment.
On Tuesday, the World Bank cut its 2013 growth forecast for Asia’s fifth-largest economy to 5.9 percent from the 6.2 percent predicted in March. It noted that “the risk of a more pronounced growth slow-down is high” due to higher fuel prices, international financial market volatility and weaker commodity prices.
According to the World Bank, a growing divergence between high income economies such as the United States and Japan with developing economies such as China sparked the sell-off of emerging market assets, including in Indonesia. The value of emerging market equities dropped 7.5 percent over the quarter, while the cost of government financing rose markedly, including a 220 basis point rise in Indonesian yields.
The International Monetary Fund has also warned of overleveraging by companies in emerging market economies, including in foreign currency-denominated debt.
The fund has cautioned of the risk of a slowdown in China and bond market blowout in Japan, with the region’s increasing interdependence exacerbating the impact of a downturn in its leading economies.
While most of the region’s emerging market economies are still running healthy current account surpluses, “they are not a guarantee against a disruptive financial crisis triggered by a bout of risk aversion among global investors,” the Australian Financial Review’s Alan Mitchell said.
China at “tipping point”
US fund manager and noted bear Kyle Bass has added to the warnings, stating in his latest note to investors that China had reached a tipping point whereby monetary stimulus could no longer sustain economic growth.
“The scale and pace of credit expansion in China over the last five years is truly staggering. The compounded annual growth of bank assets as measured by the China Banking Regulatory Commission has been 30.8 percent,” Bass said.
“To give some perspective, a 30.8 percent compounded annual growth of credit in the U.S. equivalent over five years would be an expansion of $33 trillion. This rate of credit growth is three times the total credit system growth experienced in the U.S. at the peak of the bubble in 2006.”
According to Bass, the Chinese monetary authorities’ increasing monetary expansion has delivered diminishing returns, with the only alternative to a “full-scale recession” being a further reining in of credit growth.
A sharp slowdown in the region’s biggest economy would have a “devastating impact” on Southeast Asia, he said.
Nevertheless, the IMF still expects the ASEAN region to expand by around 6 percent a year through to 2014, with policymakers eyeing the prospects of a 600 million-strong unified market commencing December 31, 2015.
Having already postponed the single market’s launch by a year, ASEAN policymakers will be hoping the high stakes game played by the region’s heavyweights does not backfire spectacularly in a re-run of the 1997 financial crisis.