Asian currency banknotes interspersed with US dollars. Photo: iStock/Getty Images.
TOKYO – After a year of scrambling to avoid another Great Recession, central bankers are now faced with a “be careful what you wish for” dilemma. Monetary officials may get the strong economic growth rebound for which they hoped. They may not like, however, how debt markets respond. If last week’s chaos in fixed-income circles is any guide, 2021 will be the year of what DBS Bank strategist Eugene Leow calls the “reflation tantrum” that imperils asset markets everywhere.  That could make 2013’s mini-crisis look tame. And this could be a particular problem for Asia in two respects – one short term, one longer. The first relates to the breathtaking amounts of debt developing Asia accumulated in the Covid-19 era, and
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TOKYO – After a year of scrambling to avoid another Great Recession, central bankers are now faced with a “be careful what you wish for” dilemma.

Monetary officials may get the strong economic growth rebound for which they hoped. They may not like, however, how debt markets respond.

If last week’s chaos in fixed-income circles is any guide, 2021 will be the year of what DBS Bank strategist Eugene Leow calls the “reflation tantrum” that imperils asset markets everywhere. 

That could make 2013’s mini-crisis look tame. And this could be a particular problem for Asia in two respects – one short term, one longer. The first relates to the breathtaking amounts of debt developing Asia accumulated in the Covid-19 era, and that’s just so far.

Globally, pandemic rescue moves added about US$24 trillion to the global debt mountain in 2020, pushing IOUs to a record $281 trillion. Overall, debt-to-gross-domestic-product (GDP) ratios among emerging economies topped 250%, up from 220% in 2019, according to the Institute of International Finance (IIF), a trade group for the global financial services industry.

In Asia, debt-to-GDP surged to nearly 300% from 266% in late 2019. China, South Korea and Thailand are among the five biggest offenders in developing circles, a dubious distinction considering that Covid-19 variants could lead to new waves of infections. India also saw a 17.3% jump in its public debt ratio.

This borrowing glut puts Asia in harm’s way, just as the 2013 Federal Reserve “taper tantrum” slammed markets. 

Last week’s spike in US Treasury debt yields could signal the beginning of market tremors to come. Investors are growing concerned about hints of rising inflation. The speed with which panic over a weak auction of seven-year US government debt spanned the globe spoke to investors’ fears about sudden credit-market stumbles.

Asia at risk

The magnitude of borrowing in Asia now comes into stark relief. As a region, says IIF economist Khadija Mahmood, “emerging market Asia saw larger increases in debt ratios across government, non-financial corporate and household sectors year-over-year in Q4 2020 compared to EMs overall.”

Another risk is the dollar’s still-central role in emerging Asian markets and trade. 

Since the region’s 1997-98 financial crisis, pledges to pivot away from the dollar took a backseat to moves to increase foreign-exchange reserves. Naturally, the vast majority of that currency stockpiling was in dollars.

Stacks of 100 US dollar banknotes. Photo: AFP/illustration

Asia also has been slow to wean economies off exports. Falling US growth has created its own troubles for the dollar, which boosted Asian currencies in 2020. It follows, then, that the Covid-19 era reduced the buying power of the biggest customers of US Treasury debt – China and Japan.

Strategist Lou Brien at DRW Trading Group observes that much of the dollar-buying Beijing and Tokyo do is reinvesting the profits of trade with US consumers. The coronavirus, though, “has curtailed a lot of trade” which, Brien notes, leaves “fewer profits to invest.”

Rising yields a pro or con?

But what if this becomes a pattern? If the next Treasury debt auctions suffer tepid demand, fixed-income markets could be in for a rough 2021. And central banks everywhere will be forced to act to restore calm, as best they can.

Last week, Philip Lane, chief economist at the European Central Bank, said “excessive” increases in yields “would be inconsistent with fighting the pandemic shock.” 

By sharp contrast, Esther George, president of the Federal Reserve Bank of Kansas City, argued rising debt yields are a good thing. “Much of this increase likely reflects growing optimism in the strength of the recovery and could be viewed as an encouraging sign of increasing growth expectations,” she said.

That’s little comfort for developing Asia if inflation worries seep into asset markets. International Monetary Fund (IMF) chief economist Gita Gopinath, for example, is still betting that the forces of globalization will tame consumer price surges.

Granted, these are rather disorienting days for bond traders. As strategist Ivan Drazetic of InterCapital Group points out, the US was close to full employment back in 2019 and inflation was nowhere to be seen. “However,” he says, “the markets think this time it’s different.”

Surging yields would imperil exports, send stocks lower as price-to-earnings calculations deteriorate and increase debt repayment burdens at the worst possible moment. As remote as the chances seemed 12 months ago, developing Asia faces increased vulnerability to a repeat of 1997, which had its roots in excessive borrowing.

“Risks are amplified by existing vulnerabilities, including high and rising public and private debt levels,” says World Bank economist Ekaterine Vashakmadze.

A bank employee counts and stacks Thai baht notes. Photo: Facebook

Investment under threat

That gets at the longer-term challenge of how Asia’s debt glut leaves fewer resources to invest in more prosperous and competitive futures. More specifically, will the need to reduce Covid-era spending levels limit room for expenditures to ensure future generations don’t fall into the “middle-income trap” and/or face social unrest?

As debt-servicing costs surge, there are fewer financial resources left for building economic hardware – roads, airports, power grids, ports – and economic software – education, training, public health. This will limit competitiveness in the long run.

The region’s 1997-98 reckoning pushed about 65 million Asians into poverty, the World Bank says. The Covid-19 crisis has even greater potential for epic living-standard destruction.

Last month, the lending institution estimated the pandemic may have increased global poverty by between 119 million and 124 million. As Asia is home to the biggest proportion of the world’s poor, it’s safe to assume the region is bearing the brunt of this socioeconomic regression.

Chihoko Asada Miyakawa, assistant director-general at the International Labor Organization, or ILO, warns the fallout is still impossible to calculate.

“Covid-19 has inflicted a hammer-blow on the region’s labor markets, one that few governments in the region stood ready to handle,” she says. “Low levels of social security coverage and limited institutional capacity in many countries have made it difficult to help enterprises and workers back on their feet, a situation compounded when large numbers remain in the informal economy.”

The real problem, Miyakawa says, is that the coronavirus found developing Asia with serious pre-existing conditions and is exploiting them ruthlessly. “These pre-crisis weaknesses,” she says, “have left far too many exposed to the pain of economic insecurity when the pandemic hit and inflicted its toll on working hours and jobs.”

Women are the big losers across developing Asia. Photo: AFP/Tang Chhin Sothy

Female workers in particular. “Women are bearing the brunt of this fallout,” says Ash Kosiewicz at charity Oxfam, pointing to a United Nations report estimating the pandemic will push 18% more women than men between the ages of 25 and 34 out of jobs.

On the corporate front, there are concerns that excessive government debt issuances will crowd out the private sector’s ability to finance expansion efforts. IIF officials worry also about “corporate zombification” as government support warps incentives for companies to innovate and restructure.

Worse, says Lee Jong-wha at Korea University, it could lead to the broader zombification of entire economies. The specter of slow to moderate growth even as Covid risks abate will generate fiscal sustainability challenges.

Even as that happens, the fiscal positions of emerging and middle-income Asian economies, as the IMF has warned, will continue deteriorating. Related losses of income levels and gains in development will be hard to reverse.

“To achieve post-pandemic success, East Asian policymakers will have to navigate all of these risks while also managing profound economic and social transformations,” Lee says. “The pandemic has changed consumer behavior, accelerated digitization and upended industries. It has also exacerbated income inequality and social discontent. Calls for more equitable, sustainable systems are louder than ever.”

The bottom line, Lee says, is that “Covid-19 recovery is only the first step. Policymakers must also lay the foundations for better long-term growth, such as by increasing investment in social protection, digitalization, education and skills training and green energy. East Asian economies should take great pride in what they achieved in 2020.

“But they cannot rest on their laurels. The only way to ensure continued success, in 2021 and beyond, is to fortify their economies against risks they cannot control and mitigate those they can.”

Some of that fortification will, of course, require even more government borrowing in the short run. But longer-term, the IIF’s Mahmood says, “as a global recovery gathers pace, governments will be developing exit strategies from exceptional fiscal support measures.”