The past decade has repeatedly demonstrated that the ASEAN+3 economies have weak immunity against shocks that originate from major economies. Specifically, smaller and more open economies in the region have struggled to address those vulnerabilities, despite keeping their houses in order and maintaining strong economic foundations.
The effects of unconventional monetary policies implemented by major economies following the global financial crisis were not limited within home countries. They have also triggered fluctuations in capital flows and currency values across several continents.
Around March 2022, several ASEAN+3 economies experienced significant capital outflows from their stock and bond markets as foreign investors panicked and reversed earlier investments in emerging markets, following the surge in US treasury yields. The “U-turns” were rather sudden and dramatic, leading to financial volatilities, including currency depreciation pressures on the regional economies.
Alongside capital flows, interest rates in the regional economies are often forced to mirror the footsteps of interest rates in major economies, such as the US. The cost of borrowing is expected to stay elevated for the region, given that foreign rates are expected to remain high to dampen the stubborn inflationary pressures in those countries.
The triple evils of volatile exchange rate, elevated interest rate, and unstable capital flow, which appear to stay for good, will have adverse implications for various stakeholders in the ASEAN+3 region, such as corporates and banks.
As key creators of wealth in modern societies, corporates are naturally hard hit as all major decisions hinge on interest rate and exchange rate movements. With pre-existing vulnerabilities, the resilience of ASEAN+3 corporates could be put to the test in a few ways.
First, ASEAN+3 corporates tend to be highly leveraged and have one of the highest debt-to-GDP ratios in the world. The higher cost of borrowing would make it more difficult for corporates to repay their debts.
Second, many firms, especially smaller ones, have balance sheets which are not sound. In 2022, 40 percent of ASEAN+3 firms have Interest Coverage Ratio (ICR) below 1.25 times, equivalent to S&P’s “CCC” rating and below. According to AMRO’s assessment, a 100bps increase in interest rates would lead to an additional 5 percent of firms facing financial difficulties.
Third, corporates in some economies carry substantial liabilities, which are denominated in foreign currencies, for example USD. A sharp depreciation of domestic currencies against foreign currencies could exacerbate currency mismatch risk, especially if revenues received are in domestic currencies and hedging practices are not widely practiced.
Such a deterioration of corporate balance sheets could worsen the asset quality of ASEAN+3 banking sectors. Amid weaker growth trajectory, geopolitical tensions, and global fragmentation, more customers could face difficulties in meeting their obligations.
Bank liabilities might not be completely secured either, with 22 percent—and increasing—of the banks’ funding originating from the more volatile interbank and wholesale funding. Furthermore, cross-border financing is non-negligible, accounting for more than 5-10 percent of banking sector assets. To further compound matters, most of the cross-border foreign-currency borrowings are denominated in USD.
That said, one positive outcome in the current environment is that banks may benefit from higher interest rates. Higher borrowing rates and relatively stable deposit rates have led to an improvement in net interest margins (NIMs) of banks.
Another saving grace is that banks in the region are holding higher capital buffers following the painful global financial crisis experience.
In a highly connected world, problems arising in an individual systemically important corporate or bank, or disruptions within a group of smaller entities, could quickly spread to the broader macroeconomy and financial system. Hence, there is a need to take measures to prevent the outbreak of financial crises.
A two-pronged approach to enhance the overall corporate sector health could help to pre-empt and prevent tail risk events.
On one hand, macroprudential policies should be extended to corporates. The current set of macroprudential policies are mostly targeted at banks or the property sector. There might be benefits from imposing leverage ratios on corporates, such as amount of debt versus earnings or assets, to minimize the risks of excessive debts taken up within any sectors.
Second, corporates should adopt diversification and embrace financial prudence, where applicable. Financial derivatives are strongly recommended to hedge against interest rate and currency risks. As a rule-of-thumb, firms should build cash reserves.
For the banking sector, while the side effects of interest rates might be less evident with offsetting effects, exchange rate risks remain the primary concern. Mitigating volatilities stemming from fluctuations of the local currencies against the USD is necessary, considering its significance within banking portfolios.
USD swap lines–which some central banks have already set up with the Federal Reserve–are a great second line of defense after foreign exchange reserves, and provide emergency USD liquidity support in times of stress.
Banks should reinforce their liquidity positions, with efforts at both the entity- and economy-levels, especially due to the increased dependence on short-term funding.
Individual banks should align the maturity profiles of both their assets and liabilities, while central banks and supervisory authorities should regularly conduct stress tests to assess the impact of adverse liquidity scenarios and establish standby lending facilities that could be readily provided.
Economies should advocate intra-regional liquidity support for baseline and stress scenario. Regional financing arrangements that pledge multilateral financial support such as the Chiang Mai Initiative Multilateralisation (CMIM), could be put in place to address short-term liquidity challenges.
Li Kouqing, AMRO Director, said at the second ASEAN+3 Economic Cooperation and Financial Stability Forum, “In an increasingly interconnected world, safeguarding growth and stability calls for regional solutions and collective efforts.” ASEAN+3 economies have close economic and financial ties with each other and a more resilient corporate and financial sector would translate to a stronger region.