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Opinion

Argentina should set alarm bells ringing in Asia

Indonesia's interest rate rise highlights need for urgent defensive action

Indonesia's central bank was quick to take a defensive action.   © Reuters

Argentina's return to financial chaos might seem remote to Indonesia's Joko Widodo, but the rupiah's decline tells a different, and more troubling, story. And not just for Jakarta, but New Delhi and perhaps Beijing as well.

Rising U.S. yields combined with President Donald Trump's trade war antics have investors turning away from emerging markets. Indonesia is taking the biggest knocks in Asia, with the rupiah plunging below the psychologically key level of 14,000 to the dollar, falling 3.7% this year to its lowest level since October 2015.

Global punters dumped more than $3 billion of Indonesian bonds and stocks in 2018. The central bank sold more than $7 billion of reserves since early February. And on May 17, it hiked interest rates for the first time since 2014 to defend the currency.

Jakarta's current account puts President Widodo's economy on the frontline of turbulence emanating from Buenos Aires. While the gap of 2.15% is smaller than the U.S.'s much-publicised deficit (2.4% last year), emerging economies can have much bigger difficulties financing their shortfalls, especially when, as now, markets get rough.

Argentina, as analysts at Seeking Alpha point out, is often the "canary in the coal mine" for emerging markets. The International Finance Institute says "Argentina may be the tip of the iceberg" of disorder to come. Turmoil is already sinking Turkey, turning attention to the so-called Fragile Five.

In 2013, when the Federal Reserve "taper tantrum" was slamming the developing world, Morgan Stanley put out a list no nation wanted to be on. Its "Fragile Five" included India and Indonesia, as well as Brazil, South Africa and Turkey.

What of India and Indonesia, as markets quake anew? One could add the Philippines to the list, given its current-account imbalance of almost 1% of GDP and President Rodrigo Duterte's neglect of economic reforms. What's more, China could find itself in harm's way should speculators target its swelling debt load.

Let us take Indonesia and India first. The good news is that both economies are healthier than in 2013. Since then, Indonesian voters elected Widodo who is working to strengthen the national balance sheet, upgrade infrastructure, improve education and tame economic nationalism in the world's biggest Muslim-majority nation.

One reason is that Indonesia is an easy target: nearly 40% of government debt is held overseas, among the highest ratios in emerging Asia. Last week's terror attack in Surabaya, Indonesia's second-biggest city, also hit investor sentiment. The worst attack in a decade killed at least 13. Still, Finance Minister Mulyani Indrawati is right that the economy is on the mend. Last month, Moody's Investors Service upgraded Jakarta, citing reduced vulnerability to global shocks.

In India, Prime Minister Narendra Modi and the Reserve Bank of India have since 2014 added flexibility to the capital account, boosted tax collections, increased transparency and addressed bad loans in the financial sector. A work in progress, for sure, but India is not in as fragile a state as Morgan Stanley surmised five years ago.

Others, in fact, argue for a new "Fragile" list. Both Goldman Sachs and S&P Global separately think the new unlucky five are Argentina, Egypt, Pakistan, Qatar and Turkey. So Asia is largely spared.

But complacency is an emerging-market government's worst enemy. Emerging economies should be importing capital for long-term investment, not to manage balance-of-payments shortfalls. And odds are, the volatility spreading from Argentina to Turkey to Indonesia will get worse before things calm down. Harvard economist Carmen Reinhart says emerging economies may be in a tougher spot than during the 2008 crisis. The problem, as Fitch Ratings points out, is that debt quadrupled since then.

At the same time, 10-year U.S. Treasury yields are now above 3%, the highest since 2011. That is reducing appetites for emerging-market assets. A big part of their appeal is higher yields relative to more developed markets. Indonesia's 7.18% yields on local currency 10-year debt and India's 7.88% are losing their allure as U.S. rates top 3.10%.

Officials in Jakarta and India should brace for increased turmoil as Trump and China's Xi Jinping come to blows on trade. Governments should act immediately to narrow current-account and fiscal deficits, hone macroprudential tools to tame outflows and telegraph confidence in institutions to markets. Central banks should be at the ready with defensive measures if needed.

For Bank Indonesia, that meant hiking the benchmark rate by 25 basis points to 4.5%. In doing so, Governor Agus Martowardojo put long-term stability over short-term growth. Though Indonesia's 5% growth rate may take a modest hit, delaying action would have graver consequences if the rupiah's drop accelerates. The central bank pledged to continue acting "pre-emptively" to tame markets despite subdued inflation.

Asia's other weak links need to batten down the hatches, too. The Philippine peso has consistently been among Asia's worst-performing currencies over the last 12 months. So far this year, it is down nearly 5% versus the dollar as investors lose faith in Duterte's stewardship. His war on drugs is distracting Manila from strengthening the national balance sheet, attacking graft and creating new jobs. Manila might, too, find itself on the frontlines of renewed market chaos.

Malaysia's new leader Mahathir Mohamad should mind the victory lap. His shock election victory on May 9, when he ended the 61-year reign of Najib Razak's Barisan Nasional, was a boon for democracy. Yet Mahathir must prove he has evolved since the late 1990s. During his earlier stint as prime minister, the firebrand called currency trading "unnecessary, unproductive and totally immoral." Mahathir must waste no time devising a clear plan to restore competitiveness.

China's President Xi also needs to tread carefully. Granted, investors do not make much money betting on a mainland debt reckoning, what economists call a "Minsky moment." Its total debt, though, is 260% of gross domestic product before average incomes reach $10,000 annually - in other words disturbingly early in its economic development and well before China achieves rich-country status.

Economist David Dollar at the Brookings Institution warns mainland government and corporate debt ratios "are flashing yellow lights." Question is, might the color turn red if Trump's trade tariffs threaten China's export engine?

There is increasing focus, too, on Beijing exporting imbalances to the developing world. A new report from Harvard University scholars raises red flags about the side effects of Xi's Belt and Road initiative: billions of dollars in loans to "acquire strategic assets or political influence over debtor nations." China's "check diplomacy," the report says, is rapidly being supplanted by "debtbook diplomacy."

Gareth Evans, Australia's former foreign minister, goes so far as to call Laos and Cambodia, both of which borrowed more than $5 billion, "wholly owned subsidiaries of China." For Phnom Penh this is nearly a quarter of annual GDP. For Ventiane, almost a third. Beijing risks spreading its international wings too widely before its domestic foundations are ready.

So, do not cry for Indonesia, India or other Asian economies just yet. But fragilities remain, and governments need to act boldly as Argentina burns, sending flames their way.

William Pesek is a Tokyo-based journalist and author of "Japanization: What the world can learn from Japan`s lost decades." He is a former columnist for Bloomberg and Barron's.

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