Asia’s Resilience in the Face of Reduced Capital Inflows due to the Normalization of U.S. Monetary Policy -COVID and the Ukraine Crisis Have the Potential to Increase Vulnerability-

Ever since the 2008 global financial crisis, capital inflows from advanced countries have supported economic growth in emerging nations. It is undeniable that massive monetary easing in the U.S., which provided ample liquidity to financial markets around the world, was a background factor. However, we are now seeing a reversal of that policy. Coming into 2022, the U.S. FRB began hiking interest rates and reducing the money supply, and since then has been accelerating the normalization of monetary policy. Going forward, a decline in capital inflows to emerging countries is unavoidable.

Estimating the impact on capital flows of major emerging countries, I found that the U.S. monetary easing in 2020-21 increased capital flows to these countries as a percentage of GDP by an annual average of 1.3 points, but that this up-push effect will dip to +0.8 points, marking a decline of 0.5 points, in 2022-23. This is equal to the down-push effect on capital flows that occurred during the five years from 2015-2019, the previous normalization phase, suggesting that heavy downward pressure will be exerted on capital flows in a short time.

However, resilience to capital inflow drops varies among emerging countries as a result of economic and financial structural differences, and the impact will likely differ from country to country, e.g., in the extent of currency depreciation. India, Indonesia, and the Philippines are saddled with chronic account deficits, and are therefore structurally vulnerable in that they are reliant on borrowing from abroad. That being said, their level of dependence on dollar-denominated short-term debt is low, so as things stand now, there is little likelihood of them experiencing a crisis of the like that occurred in Argentina and Turkey in 2018.

Attention needs to be paid to the fact that the recent COVID pandemic and Ukraine crisis have led to dramatic changes in the economic environment. Asia is especially affected, with the triple burden of current account deterioration, inflation acceleration, and government debt expansion gradually compounding to cause serious problems. If these problems get even worse, resilience to reduced capital inflows could wane, and vulnerability could increase, so there is a danger that the risk of instability in Asian financial and currency markets will increase.

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