Overall Credit Quality in Asia-Pacific to Remain Resilient Beyond Federal Reserve Tapering

The overall credit quality in Asia Pacific will remain resilient beyond the end of Federal Reserve tapering, despite the residual risk of a larger-than-expected market reaction, says Moody's Investors Service.

Moody's expects the Fed to complete its tapering program in the final quarter of 2014, absent any unexpected shocks to the US economy. At this point, attention will turn towards potential increases in policy rates and the unwinding of quantitative easing.

"We expect the credit quality of Asian sovereigns, financial institutions and non-financial corporates to remain resilient to changes in US monetary policy, as the narrative shifts from Fed tapering to increases in policy interest rates in 2015," says Michael Taylor, a Moody's Managing Director and Chief Credit Officer.

"Asia's low reliance on external funding, policy space to deal with external shocks, and export orientation towards a strengthening US economy will all be credit positive," says Taylor.

Based on Moody's latest global macroeconomic outlook -- which assumes a sustained (if modest) recovery in the US economy -- the first increase in the Fed funds rate could materialize around mid-2015, with further tightening likely to take place at a moderate pace thereafter.

Under Moody's baseline scenario, the Fed completes tapering and enacts interest rate hikes in a manner that leads to a smooth adjustment in US asset markets and the real economy in 2015.

Asia's overall sovereign creditworthiness should remain resilient to US interest rate tightening under Moody's baseline scenario, largely for the same reasons displayed during the tapering process.

Structural factors, such as a low reliance on external funding and policy credibility, should be sufficient to safeguard against a region-wide credit or macroeconomic shock.

Asia Pacific's banking systems should also remain resilient, owing to their generally strong capitalization and limited exposure to offshore funding.

Most corporates should be able to weather the second-round effects of Fed tapering, including tighter domestic credit conditions and FX volatility.

However, a few non-financial corporates that have amassed high levels of offshore debt will be more exposed as US dollar rates increase and domestic liquidity conditions tighten.

But Moody's cautions that the potential remains for a larger-than-expected market reaction.

"Although not our baseline scenario, there is a risk of renewed market turbulence in Asia next year if the withdrawal of US monetary stimulus were to have larger effects on capital flows than currently anticipated," says Rahul Ghosh, a Moody's Vice President and Senior Research Analyst.

This risk is particularly pertinent given that portfolio inflows into Asia have rebounded strongly since the 2008-09 global financial crisis and global market volatility is historically low.


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