The Asean+3 region is expected to see a “wide range” of risks and challenges to financial stability in the near- to long-term, says the Asean+3 Macroeconomic Research Office (AMRO) on Oct 10. The “+3” refers to China, including Hong Kong, Japan and South Korea.
However, the overall financial stability risk across the region in 2024 is lower compared to last year.
“Relative to the situation during the launch of the inaugural Asean+3 Financial Stability Report (AFSR) 2023, global financial conditions initially eased as the end of the central banks' tightening cycle appeared in sight,” says AMRO in its Asean+3 Financial Stability Report for this year.
However, conditions tightened again after risks surrounding the growth outlook of the US emerged with market participants navigating the risks of US growth and inflation.
“Initially, the primary concern was persistently high inflation—or, in an extreme scenario, a resurgence—which could have delayed US monetary easing. By August, however, the focus had shifted to the risks of an economic hard landing and the Fed’s response to such a scenario,” reads the report.
“These concerns were exacerbated by growing apprehension over the potential overvaluation of the ‘Magnificent Seven’ tech stocks, which had fuelled much of the equity market gains earlier in the year. This uncertainty culminated in an equity sell-off and volatility spikes, further aggravated by the unwinding of yen carry trades,” it adds.
See also: Asean conglomerates may need Geneen’s spirit
Over the same period, the Asean+3 markets saw spillovers from strong US equity markets to regional equities while the rise in US Treasury yields led to wider interest rate differentials and weaker currencies in the region.
Portfolio flows in the region were relatively muted in the early part of 2024 as asset valuations in Asean+3 became less attractive compared to the rest of the world. Valuations picked up recently, however, as US Treasury yields eased.
Asean+3 central banks may maintain current monetary stance
See also: Foreigners dump Thai bonds as BOT signals no further rate cuts
With easing easing inflationary pressures and robust growth, many Asean+3 central banks may maintain their current monetary stance for some time, says AMRO. However, “idiosyncratic factors” may cause some divergence in the timing and pace of rate cuts. Moreover, several Asean+3 authorities have intervened in the foreign exchange (forex) market or increased interest rates to support their currencies amid concerns over the weakness in their exchange rates.
“Some authorities have implemented measures to encourage repatriation, and portfolio inflows, and to manage demand for US dollars in domestic markets to mitigate pressures on exchange rates,” AMRO notes.
Shifting near-term risks
Even though the US Federal Reserve (US Fed) began cutting rates in September, uncertainties around inflation and growth outlook linger.
The timing and magnitude of further rate cuts will depend on any developments on inflation and employment. While markets have adapted to the likelihood of a higher-for-longer interest rate environment, concerns over growth and employment have also surfaced.
“Given that the pace of disinflation has been slower than expected, a resurgence in inflation remains a potential threat, which could lead to renewed rate hikes. The worst-case scenario is stagflation, where high inflation constrains the Fed's ability to address an economic slowdown,” says AMRO.
Geopolitical uncertainties have also intensified with tensions in the Middle East, which have disrupted global supply chains, increasing commodity prices and shipping costs. Meanwhile, the outcome of US presidential election, which will take place on Nov 5, will significantly influence US trade, monetary, and fiscal policies where either outcome could affect global and Asean+3 economies and markets.
To stay ahead of Singapore and the region’s corporate and economic trends, click here for Latest Section
Moreover, rising geopolitical fragmentation and potential conflict escalations could lead to increased risk aversion and capital outflows from regional markets.
That said, AMRO sees that some risks have receded over the past three quarters. This includes the concerns surrounding the US regional banking system, where three lenders, Silicon Valley Bank (SVB), First Republic and Signature Bank collapsed in the first quarter of 2023.
“Although stress in corporate real estate (CRE) has intensified in the US and other major developed markets, spillovers to the financial sector have been limited, with only a few banks reporting losses on their CRE exposures,” says AMRO. “Nonetheless, CRE weakness remains a risk to financial stability.”
“Meanwhile, US dollar funding conditions have remained stable, and with the Fed easing its monetary policy, the risks of funding stress have lessened,” it adds.
Medium-term risks
In the medium-term, AMRO sees risks from the downturn in the real estate market with high interest rates after the pandemic leading to defaults and, or severe liquidity constraints seen in developers. Eroded buyer confidence has also dampened demand, AMRO notes.
“From 2021 to 2023, property companies in the Asean+3 region exhibited significant vulnerabilities, with declining profitability, liquidity, and debt servicing capacity compared to pre-pandemic levels. Some Plus-3 economies showed more pronounced weaknesses.”
That said, risks from property developers have not escalated into systemic threats. Spillover risks from the property sector to banks in Asean+3 also remain limited, given the banks’ “robust” capital buffers.
However, AMRO sees pockets of vulnerability existing in institutions that are subject to less regulatory oversight, including small or local banks, nonbank financial intermediaries (NBFIs), and other shadow banking activities.
Risks to the reliance on the US dollar
With the Asean+3 relying heavily on the US dollar in cross-border transactions, this exposes the region’s financial system to two key risks, says AMRO.
First, a shortage in US dollar funding heightens stability risks for financial markets and intermediaries.
“Previous episodes of funding stress, triggered by global economic and financial shocks, created difficulties for Asean+3 financial intermediaries to secure liquidity,” reads the report. “Empirical studies show cross-border lending decreases during tighter funding conditions, affecting domestic banking stability, increasing financial market volatility and weakening Asean+3 assets.”
Second, the US dollar acts as a transmission channel for shocks from US monetary policy, geopolitical tensions, and other global events. Spillovers from US monetary policies have affected Asean+3’s financial markets significantly both during prolonged periods of easy conditions and short periods of sharp tightening. The US dollar’s status as a safe asset also transmits global shocks to Asean+3 as investors seek safe assets during times of heightened uncertainty, AMRO adds.
Overall risks lower in 2024
To this end, the overall financial stability risk across the region in 2024 is lower compared to last year, says AMRO.
With this in mind, the authorities can use this period to build policy space while remaining vigilant of emerging risks.
“The environment of robust growth and disinflation can provide an opportunity for Asean+3 governments to reduce debt and create more fiscal room to react to shocks. They may also rebuild foreign reserves during periods of capital inflows, to boost market confidence and create policy buffers against extreme market volatility,” AMRO adds.
