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Why Asia Will Come Out on Top as Emerging Markets Get Shaken

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(Bloomberg) -- The turbulence seen across emerging markets is following a similar pattern to a crisis that rocked global trading more than two decades ago -- it involved tequila.

In the mid-1990s, U.S. interest-rate increases helped spark a Mexican peso devaluation that fueled capital flight and caused the so-called Tequila crisis. Within a few years, the sell-off had spread to Asia, which became the center stage of the emerging-market crisis, during which currencies were devalued as the region was sent into an economic tailspin. Fast forward to 2018, and history is repeating itself, with a crisis brewing in Latin America as Argentina seeks emergency funding just as the dollar and U.S. bond yields spike.

But this time around, Asia is less vulnerable to contagion, says Macquarie Bank Ltd.’s Nizam Idris.

While the current fears emerging out of Latin America remind him of the so-called Tequila crisis, today “Asian economies are a lot stronger,” said Nizam, the bank’s head of strategy for fixed income and currencies in Singapore. “Current-account deficits are actually smaller, foreign reserves are much larger than before, and currencies are unpegged. The situation today is not entirely the same as compared to 1995.”

He’s not alone. Commonwealth Bank of Australia also sees Asian currencies faring better than their peers elsewhere in the developing world if the crisis emanating out of Latin America intensifies. While there are exceptions -- the Indonesian rupiah is more vulnerable than others since it’s one of the few Asian emerging markets that run current-account deficits -- the crises that’s exacerbated the sell-off this time around in Argentina and Turkey are signaling that they are more idiosyncratic in nature with less contagion risks.

After erasing almost all of their gains for the year because of a pick-up in U.S. inflation and global trade tensions, emerging-market assets made a comeback last week. Asian currencies have been the winners, with seven out of the 10 best performers in emerging markets this quarter coming out of the region.

“The one-two punch of rising U.S. rates and dollar appreciation is leading to a rising market risk premium in EM countries whose balance of payments is vulnerable,” analysts at Nomura Holdings Inc. led by Singapore-based Rob Subbaraman wrote in a May 11 report. Asian nations including Thailand, China and South Korea were among those least exposed to balance-of-payment risks in a Nomura study of 20 emerging markets.

Asia is much more resilient than in the past for the progress it’s made since the financial crisis two decades ago when many countries were running huge deficits, in addition to the problem of having over-valued exchange rates and too few reserves for short-term debt, Richard Jerram, chief economist at Bank of Singapore, wrote in a May 14 note.

Here are the reasons why Asia may fare better after all:

Current Account

Six out of nine major economies in Asia outside of Japan enjoy surpluses in their current accounts, led by Singapore, Taiwan and Thailand with excesses of more than 10 percent of gross domestic products. Indonesia, India and the Philippines have shortfalls.

Better current-account balances mean that Asia is better equipped to meet their dollar-denominated payment obligations to their bond holders, according to Andy Ji, a currency strategist at Commonwealth Bank of Australia.

Economic Drivers

A two-year rally that drove emerging-market stocks and currencies to the highest level since at least 2007 was supported by economic fundamentals. And Asia still stands out.

Asia’s developing economies are poised to expand an average of 6.5 percent in 2018 compared with 4.9 percent for all emerging markets, according to forecasts from the International Monetary Fund. Inflation in Asia, excluding Japan, will accelerate to 2.3 percent in 2018 compared with a world average of 3.3 percent, according to surveys of economists by Bloomberg.

And that’s despite the headwinds of tighter monetary policy by the Federal Reserve and rising U.S. yields.

While the Philippines became the latest emerging market to raise interest rates to rein in price gains in a booming economy, both Bank of Korea and the Reserve Bank of India lowered their own inflation projections last month. China has already cut its reserve requirement ratio twice this year.

“The fundamentals in Asia are better than other regions, while political and geopolitical risks are smaller, too,” Koji Fukaya, chief executive officer in Tokyo at FPG Securities Co. “Gains in U.S. yields are a reflection of strong economic condition there, and Asia benefits from the strong U.S. economy more than other regions.”

Politics

To be sure, like other emerging markets, Asia also faces political risks with a slew of elections in the next two years, including in Indonesia and India.

Read more: How emerging market rebound set for political tests

A case in point is Malaysia, where voters last week elected Mahathir Mohamad, the nation’s longest-serving premier, as leader in a stunning upset to end the six-decade rule of Najib Razak’s party.

Read more: what Malaysia’s shock vote result means for economy and markets

“At a time of growing pressure on emerging-market currencies and bonds, the situation in Malaysia bears careful watching for potential knock-on effects, particularly as rising rates and geopolitical uncertainties remain live in the backdrop,” Eli Lee, head of investment strategy at Bank of Singapore Ltd., wrote in a note.

©2018 Bloomberg L.P.

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