Tighter global liquidity and Asia: not all gloom and doom

Tighter global liquidity and Asia: not all gloom and doom

Asia's has been under pressure following from tighter global liquidity in 2018, led by a rapid pace of interest rate hikes by the Federal Reserve (Fed) of the Unites States (US). Narrowing interest rate differentials have led to slimmer risk premiums for investors in Asian emerging markets (EMs). This drove capital flows away from the region and into US dollar-denominated assets. Capital outflows also resulted in depreciation relative to the US dollar, leading a number of central banks in the region to hike rates and to intervene in markets to defend their currencies. The Fed is expected to continue hiking rates in 2019, which could further aggravate outflows. Our index measuring relative vulnerability to outflows points to divergence in Asia. Some markets will benefit from strong fundamentals, proactive monetary policies, and ample buffers to resist outflows. In these cases, it is likely that investors may have gotten ahead of themselves, and current valuations are not justified. However, some economies remain under pressure. Above all, the relative sustainability of the real external position remains the most significant consideration. This is a concern in cases where buffers are inadequate to cover external exposure. Lastly, countries that do not possess flexible exchange rate regimes may struggle to smooth currency fluctuations, as the reach of monetary policy is limited by the degree of dollarization of the economy.

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