Emerging economies closely watching capital outflows

Monetary authorities in emerging economies are closely watching the impact of the capital outflows amid market expectation that the Federal Reserve's exit from the quantitative easing may be close, though analysts say it is most likely a short-term adjustment.

It is estimated that at least 2.5 billion U.S. dollars have moved out of the Indian equities market since mid-May, leading to a significant softening of the rupee, said Tommy Xie, an economist with Singapore-based OCBC Bank.

The capital outflow from Thailand is estimated to total over 2 billion U.S. dollars since mid-May. Indonesia is believed to have seen an outflow of 500 million dollars from the stock market and 300 million dollars from the rupiah-denominated bonds market in the first week of June.

The benchmark Straits Times Index of the Singapore stock market shed a total of 8.7 percent over the past three weeks, while Indonesian stock market lost 9.9 percent and the Thai market lost 12.8 percent, respectively.

The yields of the local currency bonds are going up, too.

The weakness of both the stock markets and the bond markets leads to depreciation pressure on the currencies of emerging economies, with the Indian rupee down 7.5 percent since early May.

The Singapore dollar has been moving up and down, too, albeit within a managed range of about 3 percentage points.

Analysts said they expect the capital outflow to be "a short period of adjustment," though further weakness in the local currencies of some of the economies may be expected in the short term.

The adjustment in the equities markets in Southeast Asia is more likely a correction triggered by the expectation on the exit of the Fed from its quantitative easing, said Chang Chiou Yi, regional strategist at CIMB Research.

Xie also said that it is partly attributable to profit taking around the middle of the year following significant gains.

"My opinion is that it's most likely to be a short-term outflow, (resulting from) adjustment of their positions. I don't think it will last long," he said.

The stock markets in Southeast Asia have accumulated significant gains over the past months prior to the current adjustment. The STI index still has a 16 percent gain over the past 12 months despite the correction, while the Thai stock market still has a gain of 27 percent.

There had been capital inflows to the regional bonds market that were somewhat beyond the support of the fundamentals, too, Chang said.

Despite the market talks of the Fed's exit from QE, the analysts said the unwinding is most likely to be gradual. The sudden repricing of the U.S. Treasury bonds is only a trigger.

"There are no crises or liquidity crunch kind of concern such as what we are seeing in Europe. This is pretty much led by the Fed thinking that because my growth is improving, I think I am willing to let my bond yields rise a little," Chang said.

The annual yields of the ten-year Treasury bonds has moved up to around 2.2 percent recently, but Chang said it would harm the U. S. economic recovery if it moves to anywhere near 4 percent.

"They cannot afford to let it go up too much. So I don't think it will lead to a crisis. I think it is just a period of adjustment," she said.

Xie said he did not expect the Fed to raise the interest rates before 2015.

"I don't think there will be a crisis," he said. "The inter- bank lending market does not seem to be affected much, either."

Both Xie and Zhang cited the sound fundamentals of the emerging economies. They shall be able to absorb higher bond yields once their economic outlook improves with the major economies such as the United States as well as China, which is still showing signs of weakness.

Nevertheless, Chang said she expects to see further weakness in the currencies of the emerging economies in the near term.

"If the swings are really so wild, leading to risks of a monetary crisis, authorities should indeed step in to intervene when it's necessary," Xie said.

Indonesia's central bank stepped in to intervene on Tuesday by raising the interest rates and increasing the supply of U.S. dollars.

Xie said there used to be a wave of capital outflows from the emerging markets in 2011 when the sovereign debt risks broke out in Europe, forcing the banks to reduce their leverage.

The current outflow is seen as substantially different from the monetary crisis in 1997. Xie said the countries in Southeast Asia now have more foreign exchange reserves, better political environment and, more importantly, local currency bond markets that provide an alternative financing channel to the U.S. dollar debt market.