An escalation in Europe’s debt crisis may trigger a selloff in Asian assets, force foreign banks to cut lending to the region and disrupt its currency markets, the International Monetary Fund said.
Asia’s growth has slowed since the second quarter of 2011, the fund said in a report today, cutting its forecast for this year’s expansion to 6.3 percent from an April estimate of 6.8 percent. Inflationary pressures across the region are still “elevated” and financial conditions remain accommodative in most of Asia, the IMF said.
“An escalation of euro area financial turbulence and a renewed slowdown in the U.S. could have severe macroeconomic and financial spillovers to Asia,” it said. “Since 2009, investors from advanced economies have built up substantial positions in Asian markets. A sudden liquidation of these positions could trigger a loss of confidence, and contagion could spread from bond and equity markets to currency and other markets.”
The risk of another global recession has prompted Asian officials from China to Indonesia to shield growth by boosting fiscal measures or easing borrowing costs. The MSCI Asia Pacific Index of stocks slumped 16 percent last quarter, the biggest drop since 2008, and the IMF said today the “panic selloffs” in the region show there is “no place to hide” when advanced nations are in turmoil.
Foreign banks may sell Asian assets, cut credit lines to the region and avoid rolling over maturing loans if they face large losses in their home markets, the IMF said.
“Such cutbacks could have a sizable impact in Asian economies that have large exposures to European and U.S. banks,” the fund said. “Contagion could also occur through Asian currency markets, as long and carry-trade positions are unwound. A loss of liquidity in cross-currency swap markets --as in 2008 -- could be particularly disruptive and spill over to bank funding, as many banks rely on this market to fund dollar assets or to meet regulatory currency matching requirements, notably in Korea and Japan.”
There hasn’t been the same selloff in Asian assets than during the financial crisis of 2008, Anoop Singh, director of the IMF’s Asia-Pacific department, said in an interview in Tokyo.
“It’s been the greatest in the equity side in some countries, but as you look at these effects, compared with what happened in 2008, our sense is it’s still less,” Singh said. “Were the shocks from advanced economies to get worse, we will possibly see further outflows. We can be fairly confident that since Asia growth remains much more robust than advanced economies, eventually capital will come back to Asia.”
Evidence of slowing growth is increasing in Asia as China reported today exports rose the least in seven months in September. The Philippines unveiled a 72 billion-peso ($1.7 billion) stimulus package yesterday as its officials cut growth forecasts for 2011, while Indonesia’s central bank unexpectedly lowered its benchmark interest rate this week for the first time in more than two years.
Asian policy makers are faced with a “delicate balancing act” to guard against risks to growth while limiting the impact of inflation, the IMF said. Headline inflation may peak in the second half of 2011 and ease “gradually” in 2012 even as it remains above the mid-point target range in most countries.
The IMF said economic growth in the region may be 6.7 percent in 2012, lowering its April estimate of 6.9 percent.
“In economies where such overheating pressures remain high, inflation remains above target, and inflation expectations have continued to rise, such as in China, India, and Korea, the current pace of monetary tightening remains appropriate,” the fund said. “In economies where inflation is within target and with greater vulnerability to a global slowdown, a pause in monetary tightening may be warranted at the current juncture, until the downside risks to growth abate.”
The region’s economies have scope to cushion the impact of slowing expansion, it said. Policy makers should also allow more flexible currencies to better manage capital flows, the fund said.
“Allowing greater exchange rate appreciation in line with fundamentals would also help manage existing inflationary pressures in addition to helping rebalance economic growth in many economies,” the IMF said. “Moreover, enhanced upward exchange rate flexibility would reduce the perception of a one- way bet and enable the region to better deal with capital inflows that are likely to be attracted by favorable growth and interest rate differentials.”
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