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Opinion

Asia's central banks finally take a welcome lead

India's rate hike is the latest of several timely moves in volatile conditions

The Reserve Bank of India Gov. Urjit Patel has shown he is ready to act fast on economic rather than political logic.   © Reuters

Urjit Patel's wish may be Jerome Powell's command. Last week, the Reserve Bank of India (RBI) governor pleaded with his U.S. counterpart to scale back planned interest rate hikes.

As Patel wrote in a Financial Times op-ed, emerging economies are in a state of "upheaval" amid a "double whammy" from Washington. One threat: a borrowing binge related to President Donald Trump's $1.5 trillion tax cut. The other: how the Fed's shrinking balance sheet is threatening to squeeze Asian markets.

If Chairman Powell's team is not careful, Patel warned, "Treasuries will absorb such a large share of dollar liquidity that a crisis" in related markets is "inevitable." The good news for Patel is that traders are scaling back on Fed tightening bets. While U.S. growth is plenty strong enough, renewed turmoil in Europe as well as economies from Argentina to Turkey to Indonesia has Powell's team throttling back on rate hikes.

The even better news: Patel is picking up some of the slack. The RBI's 25 basis-point tightening last week -- boosting the benchmark repo rate to 6.25% -- was the first in more than four years and a bold move. With national elections planned for 2019, Prime Minister Narendra Modi is probably none too happy to see Patel yanking away the proverbial punchbowl.

In 2016, after all, Modi dispatched with globally respected then RBI head Raghuram Rajan for, in Modi's view, being too hawkish. Last week, Patel won new credibility for leading financial markets, not merely following them. Coming on the heels of two recent tightening steps by Bank Indonesia, his actions offer hope that Asia's central bankers are finally doing their jobs.

Bank of Korea got things rolling last November, when it became the first major Asian central bank to hit the brakes since 2011. Gov. Lee Ju-yeol signaled that Asia no longer needed the liquidity pumped out after the 2008 global financial crisis. In other words, Asia is ready to do without monetary life support.

Indonesia's two rate boosts -- one last month, one this month -- were partly aimed at safeguarding the rupiah. While Jakarta's 2.15% current-account deficit seems modest, it is enough to have speculators smelling blood in the water. Yet Bank Indonesia is acting despite slowing growth and modest inflation -- proof it is sending the right long-term signals regardless of short-term consequences.

Even the Bank of Japan is experimenting with a touch of austerity. On June 1, it scaled back on government bond purchases. Far from a tightening step, but a sign BOJ Gov. Haruhiko Kuroda may be done being Tokyo's ATM. Since 2013, Kuroda's team has been filling and refilling the monetary fuel tanks. Even so, inflation is perhaps halfway to the 2% target and wage gains continue to disappoint. The message: It is Prime Minister Shinzo Abe's turn to rekindle Japan's animal spirits with structural reforms.

There is a big limit, though, to how much central banks can tighten. Emerging-market debt has quadrupled since the dark days of 2008, putting governments at risk. Both Harvard University's Carmen Reinhart and Nobel laureate Paul Krugman argue emerging markets face bigger perils than in 2013 amid the Fed "taper tantrum."

Corporate default risks are indeed rising. Experts on insolvency and restructuring like David Kidd of Linklaters says "defaults will pick up in Asia." Between now and 2020, a record $282 billion of ex-Japan Asia dollar bonds come due. Potential pressure points come as yields on 10-year U.S. Treasuries approach 3%.

Brace for selective defaults in Southeast Asia going forward as debt-servicing costs rise, warns S&P Global. The culprit: aggressive mergers and acquisitions activities on the part of conglomerates.

In some cases, currency rates also pose escalating risks. In China's case, a weaker yuan would make dollar-denominated loans hard to repay. Default fears have driven mainland credit spreads to two-year highs. It does not help that over the next two years, Chinese industrial companies have at least $124 billion of debt maturing. In the case of Indonesia, meantime, the rupiah falling to, say, 15,000 versus the dollar would slam weaker companies, making debt repayments harder.

There is a silver lining here: key Asian economies like China are displaying a greater willingness to let defaults happen. China has experienced 19 corporate defaults this year. That is a sign of financial maturity, a signal that the economy can withstand significant shocks. India's efforts to revamp bankruptcy laws, meantime, is nudging delinquent borrowers into court arbitration.

Still, uncertainties are closing in. That includes Trump tossing grenades at the global trading system. The chaotic market reaction to Italy's recent political drama suggests Europe's debt woes are flaring up anew. The uncertainty is throwing Asia's junk-bond spreads out of whack. Investors are seeking average yields of between 7% and 8% on China's junk-rated dollar bonds, up from 5% in January. All the more reason for the Fed to tread carefully.

"Rising borrowing costs could substantially increase the burden of debt servicing, which was compressed in recent years by low global interest rates and risk premiums," the World Bank warned last week. "In turn, rising debt service costs could weaken investment and lower medium-term growth. A reversal in capital inflows and sharp currency depreciations could also increase default risks and raise financial stability concerns among economies with external vulnerabilities."

India is a case in point. Its vulnerabilities have sent the rupee tumbling more than 5% versus the dollar this year, making it Asia's second-worst performer after the Philippine peso. Patel and his team have spent about $14 billion this year worth of foreign-exchange reserves to support the currency. Hence last week's rate boost and hints more may follow.

With growth expected to average 7.4% in the fiscal year ending in March 2019, India can take a hit or two from an economic point of view, even if Modi won't like it.

Yet aggressive Fed action would complicate things for Asia's third-biggest economy. Hopefully, Powell will grant Patel his wish for a gentler tightening cycle. In the meantime, though, it is heartening to see that rather than refill the punchbowl and enable market excesses, Asia's central bankers are preparing to take it away in good time instead of waiting until it is too late.

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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