Asian policy responses: More decoupling from the Fed - Nomura

Research Team at Nomura expects net capital outflows to continue to overwhelm current account surpluses, and Asian central banks to exercise their flexible exchange rate regimes, allowing currencies to depreciate.

Key Quotes

“In 2017, we forecast the whole bloc of Asian currencies to depreciate against USD, including China’s CNY to 7.29 by end-2017. If the adjustment becomes disorderly, some FX intervention is likely, but we believe central banks would be wary of draining too much of their FX reserves. We do not expect a retreat to capital controls; exchange rates are the ideal shock absorbers to deal with stagnant exports and the preponderance of downside external risks.” 

“We have a high conviction that Asian central banks will not raise rates in 2017 to defend currencies, or in response to rising inflation; the exception is the central bank of the Philippines, with 50bp of hikes, a rare case in Asia where domestic demand is running hot. There is a compelling case to look through a rise in inflation when it is starting from a low level and is not demand-driven, and many Asian central banks are probably amenable to lower real interest rates to shore up domestic demand. But the fundamental reason not to raise rates is the asymmetry of risks in a late-stage credit cycle. Hiking rates would escalate the cost of servicing high domestic debt and could trigger corporate defaults, abrupt deleveraging and possibly recessions. In short, many Asian central banks seem stuck in a debt trap. Hence, we expect more decoupling from the Fed, with central banks cutting rates in 2017 in Australia (25bp), India (25bp), Korea (25bp), Malaysia (2 x 25bp) and Thailand (2 x 25bp).” 

“Given the pressure on Asian currencies, it is on the fiscal side that we see greater room for stimulus; after all, Asia has more room for fiscal expansion than most other regions. At below 50% of GDP in 2016, Asia ex-Japan’s average public debt is low compared to the 116% ratio of the G20 advanced economies. Yet many Asian governments seem reluctant to aggressively go down this path, recognising large contingent liabilities from under-funded pensions and private debt overhangs, plus fears of sovereign credit rating downgrades, which could exacerbate capital flight. We expect fiscal policy to be more stimulatory in 2017 than in 2016, in China, Hong Kong, Indonesia, Philippines, Singapore and Taiwan; neutral in India, Korea and Thailand; and contractionary only in Malaysia.”