22 October 2016
US rate hikes may have a stronger impact on Hong Kong than on other Asian economies. Photo: Bloomberg Intelligence
US rate hikes may have a stronger impact on Hong Kong than on other Asian economies. Photo: Bloomberg Intelligence

Hong Kong seen hardest hit by US rate hikes

Federal Reserve Chair Janet Yellen has put the first US interest rate rise since 2006 firmly on the agenda for this year. History suggests the consequences of such a move on Asia’s economies could be far-reaching.

To assess where the region’s vulnerabilities to the Fed’s looming rate lift-off are greatest, Bloomberg Economics examined 10 indicators of growth, inflation and financial risks for a cross-section of emerging Asian nations.

The results suggest Hong Kong may be hit hardest by an increase in US interest rates. The economy is heavily leveraged, with domestic credit reaching about 220 percent of GDP as of the end of 2013.

This has fueled rapid rises in equities and housing prices. External debt amounted to 446 percent of GDP as of end-2014.

The city ranked low in eight out of our 10 metrics, with its weaknesses both domestic and external. Hong Kong’s distinct profile as a mature economy with a large financial sector would account for some of its rankings.

Next in the line of fire is Thailand. In contrast to Hong Kong, the country’s vulnerabilities are mainly domestic. Private credit is high at about 154 percent of GDP as of end-2013 and has fueled a boom in the property market.

Indeed, housing prices have risen about 15 percent in real terms in the past year. Negative inflation is also a drag on the Southeast Asian economy.

At the other end of the spectrum are the Philippines and India, which appear relatively resilient. The Philippines has solid growth, stable capital flows and low external debt.

The economy is also the least leveraged among the 10 countries we examined. Its main weakness stems from the public sector, which had about one-third of total debt held by foreigners as of 2014.

India may also be less vulnerable to external shocks, as GDP growth remains solid, external debt is low and the economy is not heavily leveraged.

The South Asian nation’s risks are mostly due to its current account deficit, possible asset bubbles in the stock market and a hot housing sector.

It’s worth noting that China, the region’s largest economy and main growth engine, may not be as vulnerable as some expect.

High foreign reserves, low external debt and low foreign-held public debt all buffer the economy from external shocks. Still, slowing growth, heavy leverage and potential asset bubbles mean the economy has its fair share of homegrown problems.

The results of our assessment appear to have been partially priced in by the markets. Currencies of Asian countries have fallen across the board against the US dollar in the past year, with China being the only exception.

The currencies of countries with greater external fragilities, based on our assessment, fell most; Indonesia and Malaysia, ranked seventh and eighth, saw the greatest depreciation against the dollar during the past year.

Sovereign bond yields, dropping across the board in the region during the past year because of interest rate cuts, nevertheless have not priced in external vulnerabilities.

This data also allows a comparison of vulnerabilities today versus the “taper tantrum” of the second half of 2013. Compared with that period, Asian nations generally are growing more slowly and have greater financial stress.

Still, lower inflation provides more room for policy easing to buffer the region from external shocks, while strong current accounts in most countries would help them to weather the Fed’s rate normalization cycle.

The views expressed in this article are those of Fielding Chen, Asia economist at Bloomberg Intelligence.

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