India, Philippines most vulnerable in a taper tantrum-like scenario: S&P

One mitigating factor for both countries is that current accounts are stronger relative to normal levels, notes S&P

Asian economies are better prepared to face a taper tantrum-like incident, but countries like India and the Philippines stand “the most vulnerable at the current juncture,” global rating agency S&P said in a report on Wednesday.  

“Both economies have seen inflation rise in recent months. Real policy rates are below long-run average levels, eroding the return buffers. Capital may be quicker to leave and the central banks may have to by raising policy rates,” the rating agency said. However, it noted, "one mitigating factor for both countries is that current accounts are stronger relative to normal levels".

The Reserve Bank of India (RBI) has lowered policy rates by 250 basis points since January 2019, of which 115 basis points were done after the nation went into a lockdown due to the pandemic. Given the weak economic recovery, analysts expect the rates to remain soft at least in the current year.  

Inflation has remained high, and for most of 2020 out of the RBI’s target zone of 6 per cent. In February, the CPI inflation came at 5.03 per cent, rising for the first time in three months. A rising inflation will force the RBI to tighten its liquidity and rate stance. If the US yields rise, this could lead to outflow of capital, which would prompt the central bank to hike its own interest rate to maintain parity.  

In 2013, US yields leaped after the US Federal Reserve indicated it would begin unwinding its quantitative easing program. The resulting panic over rising credit costs led to sharp outflow from emerging markets, including Asia's, and forced central banks to hike interest rates, S&P noted. 

A similar trend could be seen now, as the US yields rise in response to hopes that better economic growth will lift inflation.  

“Asia is usually a prime beneficiary of improving global growth. We also believe that Asian economies are better cushioned against external shocks than during the taper tantrum of 2013. Initial conditions are bolstered by current account surpluses, low inflation (for the most part), higher real interest rates, and fatter foreign-exchange reserve buffers,” S&P said.  

"The recovery across Asia's emerging economies should withstand rising U.S. yields so long as this reflects an improving growth outlook and reflation rather than a monetary shock," said Shaun Roache, Asia-Pacific Chief Economist at S&P Global Ratings. 

However, if the markets decided the US Fed underestimated inflation risk, and would need to hike policy rates to combat the threat, then Asia's recovery could be endangered. 

"The U.S. treasury market remains important for financial conditions in Asia. Markets can react in a non-linear way if yields rise very quickly, especially if real yields (rather than inflation expectations) jump and the U.S. dollar appreciates at the same time," said Roache. 

If that happens, it would be challenging for both India and the Philippines, S&P noted.