Asia's emerging markets face a risk of financial instability, amid rising trade tensions and concerns about rising inflation, the Asean+3 Macroeconomic Research Office (Amro) highlighted in a note on July 11.
In 2017, Asian emerging markets gained from robust trade growth, against a backdrop of ample global liquidity and subdued global market volatility, said Amro. In the Asean+3 region, real GDP growth exceeded expectations at 5.6 per cent.
But in 2018, concerns about trade tensions and inflation, especially in the United States, have increased global financial market volatility.
Asian emerging markets have benefited from foreign capital inflows, which have helped to ease the rebalancing from export-led to domestic-led demand growth. However, the region is vulnerable to the risk of large capital flow reversals and spikes in volatility, said Amro.
Global stock markets, including in Asia, have fallen since February 2018 -- though Asian emerging markets have fared better than Latin American ones.
Bond markets in Asian markets also remain resilient, with continuing foreign capital inflows. Said Amro: "This also suggests that despite the rising risk aversion, the region remains attractive to foreign investors given the sustained macroeconomic outlook."
On the exchange rate front, Asian currencies are set on a depreciating and more volatile path in 2018, as foreign investors trim their exposure to riskier assets amid an uncertain global environment.
Highlighting the dangers posed by ongoing trade battles between the United States and its major trading partners, as well as pressure from US Federal Bank policy, Amro said: "The interactions between trade tensions and Fed policy could prompt a much more cautious investor stance, weighing on asset markets and capital flows into Asian EMEs (emerging market economies)."
Amro recommended vigilance on the part of policymakers, though the specific mix of fiscal, monetary and macroprudential policies would depend on where each economy is in its business and credit cycle.
Even though most regional economies are in the early- to mid-business cycle, given the build-up of credit over the past years, the objective of financial stability should be prioritized over economic growth for the near future, Amro added.