Financial Chronicle - - DEEP -

Tighter global fi­nanc­ing con­di­tions raise debt af­ford­abil­ity and govern­ment liq­uid­ity risks, par­tic­u­larly for some fron­tier mar­kets. Global fi­nanc­ing con­di­tions will tighten fur­ther, as with­drawal of mon­e­tary pol­icy ac­com­mo­da­tion con­tin­ues in the US and com­mences in the euro area. Fron­tier mar­kets in APAC are par­tic­u­larly vulnerable to any re­sult­ing de­cline in cap­i­tal in­flows or out­right out­flows, weak­en­ing of lo­cal cur­ren­cies, and/or in­crease in bor­row­ing costs. Debt af­ford­abil­ity will weaken as ex­ter­nal fund­ing costs mount, and the value of for­eign debt will in­crease, inflated by de­pre­ci­at­ing lo­cal cur­ren­cies. Pro­nounced cur­rency weak­en­ing would also raise in­fla­tion and prompt do­mes­tic rate hikes, which would push up lo­cal cur­rency bor­row­ing costs and fur­ther weaken govern­ments' fis­cal po­si­tions.

As a re­gion, APAC will be rel­a­tively re­silient. Gen­er­ally large ex­ter­nal buf­fers and a grad­ual re­duc­tion in re­liance on ex­ter­nal fi­nanc­ing, driven by the in­crease in do­mes­tic sav­ings and deep­en­ing of do­mes­tic mar­kets, will sup­port emerg­ing and fron­tier mar­kets in APAC in gen­eral, com­pared with other re­gions and rel­a­tive to 2008, ahead of the global fi­nan­cial cri­sis. Govern­ment ex­ter­nal debt to GDP has de­clined in APAC and, on av­er­age, is the low­est among emerg­ing and fron­tier economies glob­ally, while ex­ter­nal buf­fers – mea­sured by for­eign re­serves cover­age of to­tal goods and ser­vices im­ports – have in­creased and are higher than in other re­gions. There is also a gen­eral ab­sence of macroe­co­nomic im­bal­ances for most coun­tries in the re­gion, with a few ex­cep­tions.


Economies with size­able twin cur­rent ac­count and fis­cal deficits and/or with a sig­nif­i­cant re­liance on ex­ter­nal fi­nanc­ing are es­pe­cially vulnerable to the shift in global fund­ing con­di­tions. The risk is par­tic­u­larly el­e­vated for those with cur­rent ac­count deficits that are not fully fi­nanced by sta­ble, long-term cap­i­tal in­flows, that have large gross bor­row­ing re­quire­ments, and/or that bor­row heav­ily from ex­ter­nal sources on com­mer­cial terms. Mal­dives' cur­rent ac­count deficit is par­tic­u­larly wide, and not fully funded

by sta­ble for­eign di­rect in­vest­ment (FDI), rais­ing the coun­try's sus­cep­ti­bil­ity to cap­i­tal flow volatil­ity.

Cur­rent ac­count deficit is likely to widen to 16 per cent in 2019, only half of which will be funded by FDI in­flows. This puts pres­sure on for­eign re­serves given the coun­try's fixed ex­change rate regime. That said, the share of for­eign cur­rency debt is not par­tic­u­larly high and is largely owed to mul­ti­lat­eral or bi­lat­eral lenders on con­ces­sional terms. Cur­rent ac­count deficits are also very wide in Cam­bo­dia and Mongolia, at around 8-9 per cent of GDP, but fully funded by FDI in­flows.

For­eign ex­change re­serves are low, and gross bor­row­ing re­quire­ments are large in Pak­istan and Sri Lanka, threat­en­ing the abil­ity of these govern­ments to re­fi­nance debt and fund deficits af­ford­ably. For­eign ex­change re­serves have de­clined ow­ing to per­sis­tent cur­rent ac­count deficits, which have widened over the past two years. Moody’s ex­ter­nal vul­ner­a­bil­ity in­di­ca­tor (EVI)5 read­ing for both coun­tries ex­ceeds 160 per cent for 2019, in­di­cat­ing that to­tal pub­lic and pri­vate ex­ter­nal debt due over the next year is larger than for­eign ex­change re­serves. The re­serves cover­age of im­ports has also fallen, par­tic­u­larly in Pak­istan, where re­serves are now worth less than two months of goods and ser­vices im­ports.

Tighter global fund­ing con­di­tions re­sult­ing in higher credit risk pre­mia and/or do­mes­tic in­ter­est rates would quickly trans­mit to govern­ment fi­nances in both coun­tries – where debt af­ford­abil­ity is al­ready weak – ow­ing to large gross bor­row­ing re­quire­ments. For Sri Lanka, fur­ther po­lit­i­cal ten­sion could also spark cap­i­tal out­flows and raise the coun­try's risk pre­mia, ex­ac­er­bat­ing tight fi­nanc­ing con­di­tions.

Sta­ble sources of ex­ter­nal fund­ing, large do­mes­tic sav­ings lower ex­ter­nal vul­ner­a­bil­ity in other APAC economies with twin deficits. Among the other emerg­ing and fron­tier mar­ket economies, lim­ited de­pen­dence on short-term cap­i­tal flows to fund cur­rent ac­count deficits, low com­mer­cial for­eign cur­rency debt, and/or large pools of do­mes­tic sav­ings that govern­ments can rely upon to fund deficits pro­vide re­silience to global fi­nanc­ing shocks. In In­dia and Fiji, large do­mes­tic sav­ings in banks and the na­tional prov­i­dent fund, re­spec­tively, cou­pled with am­ple for­eign ex­change re­serves limit ex­ter­nal vul­ner­a­bil­ity risks. Ex­ter­nal debt in In­dia is also very low.

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