Today, a number of emerging market currencies are in crisis territory and this is scary as it could also precipitate a debt crisis, especially in the corporate sector with high USD-denominated debts as they will struggle to service debts in local currency earnings once their currencies start to slide. So, it is time to review the size of global liquidity relative to the ability of stock and bond markets globally, especially those in emerging markets which are able to withstand the huge inflows and outflows without causing systemic failure at the national or global level.

Relative to the size of the GDP, the problem is acute in Turkey whose dollar-denominated debt-to-GDP ratio is 23.0%, with Mexico at 22.5%, Argentina 18.1%, S. Korea 15.1%, Malaysia 11.7%, S. Africa 10.8%, Thailand 9.5%, Indonesia 9.1% and India 7.7%. However, China is less vulnerable with its dollar-denominated debt-to-GDP ratio at 6.3%. Hence, we reiterate our view on the need to consider the possibility of introducing capital controls by countries experiencing growing market volatility as a pre-emptive measure to address any potential risk to the financial market stability. This is the view of the Malaysian central bank that was also supported by Thailand although not well received by the Philippines.

Focusing on Malaysia, among other factors, the level of reserves plays a crucial role in determining the need to peg a currency. Reserves is currently around US$103bil, which is sufficient to finance 7.4 months of retained imports, with the ringgit trading around 4.15 against the USD. About RM17.7bil was used for liquidity management via short position for forward and futures end-August. Our assessment suggests the currency peg pressure will kick in when the level of reserves approaches US$80bil or 6 months of retained imports, with our threshold around 5 months retained imports or about US$70bil for the currency to be pegged.

Clearly, a peg will reduce uncertainties regarding the value of the currency and improve our competitiveness thus benefitting the export-oriented sectors more. While it helps ease importers’ concerns on their currency strategy, the potential setback is that an undervalued ringgit makes imports of capital and intermediate goods more expensive and this has deleterious effects for the country’s medium- and long-term capacity expansion and growth. Besides, it will not augur well for short-term foreign players in the local bourse and global pension funds with restrictions to invest in markets with capital control.

• Today, we are again seeing a number of emerging market currencies in crisis territory – not least the Argentinian peso and the Turkish lira but also the Indonesian rupiah, while the Chinese renminbi is also coming under downward pressure. This turmoil is partly a collateral damage from the trade war between the US and China, and partly a result of rising interest rates in the US and the consequent desire of global investors to chase yields due to low global interest rates.

• What is scary about this new currency issue is that it could also precipitate a debt crisis, especially in Asian and other emerging markets and particularly in the corporate sector. Dollar-denominated debt will become harder to service in terms of local currency earnings once those currencies start to slide.

• And what is happening in corporate debt markets, mainly in emerging economies is worrying. Debt in emerging and developing economies has exceeded significantly to levels before the 2008 global financial crisis. It has jumped to US$4.5tril by end 2017 from US$8.3tril in 2008, as a result of huge quantitative easing exercises by the world’s leading central banks in response to the global financial crisis in 2008. This process is being reversed now, and with US interest rates rising – and set to rise further – more money will exit emerging markets.

• Total corporate borrowings in China is around 165% of GDP. While the bulk of this is in local currency, in South Korea it is 82% of GDP, Malaysia 51% of GDP and India 38% of GDP. Relative to the size of GDP, the problem is acute in other Asian countries. China’s dollar-denominated debt-to-GDP ratio is only 6.3% but the ratio in Turkey is 23.0%, Mexico 22.5%, Argentina 18.1%, S. Korea 15.1%, Malaysia 11.7%, S. Africa 10.8%, Thailand 9.5%, Indonesia 9.1% and India 7.7%.

• So, borrowing on the current scale is risky in itself because of the way a downturn in corporate revenues can damage its ability to repay. When the borrowings in foreign currencies are substantial, a squeeze can cause severity, especially when global investors pull money out of emerging market securities. Corporate access to credit can suffer and share prices fall, making it tough for firms to roll over even existing debt. Hence, a debt crisis can then ensue and that could happen as early as 2019.

• Besides, along with the trade war between the US and China, added with geopolitical noises, these could damage global momentum especially if business confidence and investment plunges. The contagion could spread to advanced economies via the banking sector.

• So, it is time to review the size of global liquidity relative to the ability of stock and bond markets globally, particularly those in emerging markets with the ability to withstand the huge inflows and outflows without causing systemic failure at the national or global level. However, Asian and other emerging markets have erected some defences against financial crises since 1997, not least by building up foreign exchange reserves and arranging currency swaps at the government level. At the corporate level, there is a better matching of debt maturity and currency risks. But even these defences could be washed away by the tide of global liquidity.

• Hence, we reiterate our view on the need to start considering the possibility of introducing capital controls by countries experiencing growing market volatility as a pre-emptive measure to address any potential risk to financial market stability. This view was brought about by the Malaysian central bank governor that was well supported by the Bank of Thailand but not the central bank of the Philippines.

Source: AmInvest Research - 18 Oct 2018