Are ASEAN Economies Resilient to Global Financial Shocks?

With a strong economic recovery from the temporary slowdown produced by various variants of the Covid-19 pandemic since the fourth quarter of 2020, some emerging markets (EM) in Asia are enjoying a “Great Asian Reopening”. However, the secondary effects of the Asian reopening may be offset by the secondary effects of the global economy, especially as commodity prices remain high and the main central banks continue to raise their key interest rates aggressively. Rising import bills and tighter international financial conditions often weigh on the external balances of vulnerable developing countries. It is therefore increasingly important to monitor and analyze the various measures of the developing countries’ external vulnerabilities.

We approach external vulnerability from two angles: the current account of the balance of payments and the overall level of official foreign reserves. Countries with a balance of payments deficit must either finance it with foreign capital or by drawing on their own foreign exchange reserves. In times of crisis, when global economic or financial conditions are difficult, capital flows can dry up or reverse, making it even more difficult to finance deficits without drawing on foreign currency. This is why current accounts are an important measure to assess countries’ exposure to capital flows and the concept of risk. The graph below shows the level of foreign exchange reserves in relation to the expected current account deficit or surplus for 2022.

Currency reserves and current items are expected in 2022

(USD billion)

Sources: Gardens, national central banks, QNB analysis

Official foreign exchange reserves can provide an important safety net to absorb external shocks. However, the level of foreign exchange reserves should be seen in context, as not only the need for short-term balance of payments financing is taken into account, but also other important macroeconomic parameters. Traditionally, a country’s foreign exchange reserves are considered adequate when they exceed three months of imports and are sufficient to cover 20% of the total amount of local currency held by the public, or at least one full year of external debt obligations. The International Monetary Fund (IMF) has created a useful composite indicator for these goals, called the IMF Reserve Adequacy Measure. Countries are considered to have adequate levels of foreign exchange reserves when they can cover the threshold of 100-150% of the IMF metric.

Our analysis focuses on the current account and foreign exchange reserves of the four major emerging economies of the Association of Southeast Asian Nations (ASEAN), namely Indonesia, Thailand, Malaysia and the Philippines, and draws conclusions about their resilience to potential global or regional shocks.

Targets for current items and reserves

(Estimate and forecasts for 2022)

Sources: Haver, IMF, QNB analysis

Despite high exposure to the global economic cycle (manufacturing exports and tourism) and a small current account deficit, Thailand is still in a good position to handle sudden changes in capital flows, although international tourism is still down more than 80% from pre-pandemic levels and if the terms of trade deteriorate due to rising commodity prices. The country has run huge current account surpluses for years and has accumulated $220 billion in official foreign exchange reserves, comfortably covering 249% of the IMF’s reserve adequacy criterion.

The Philippines is a clear external borrower, meaning it runs a current account deficit. With a large trade deficit currently only partially offset by remittances from the Filipino expatriate community, the country is projected to run a current account deficit of around 3% of GDP. While the deficits are partly due to a healthy increase in much-needed investment, high commodity prices weigh heavily on the country’s external accounts. So far, the deterioration of the external position has been significant. However, the monetary authorities control ample foreign exchange reserves. Official reserves of 99 billion USD, meets 230% of the IMF’s reserve adequacy criterion.

Malaysia, a major producer of manufactured goods and raw materials, is another strong ASEAN economy. Like Thailand, the country has also had persistent current account surpluses for years. As a net exporter of oil and light commodities, Malaysia benefited from the general strength of commodity markets, which translated into a larger current account surplus. Malaysia’s reserve adequacy parameters are much tighter than Thailand’s, with the central bank holding less than half of Thailand’s foreign exchange reserves, or $109 billion. However, Malaysia is still in the safe zone of the IMF’s reserve coverage measure at 122% coverage.

Indonesia, traditionally the major ASEAN country most exposed to potential external shocks, is now enjoying a commodities boom that has supported its external earnings despite weak tourism receipts. High coal, gas and palm oil prices are particularly supporting Indonesia, which is expected to run a current account surplus of around 4.5% of GDP this year, after last year and nine straight years of deficit. However, this surplus should not last more than two years, as the economic recovery and the realization of a significant number of investment projects will require additional imports. Indonesia’s official foreign exchange reserves are $132 billion, covering 111% of the IMF’s reserve adequacy criterion.

Overall, the major ASEAN economies are relatively resilient to sudden changes in risk conditions and capital flows. This resistance is an important source of support in a context of heightened uncertainty associated with global financial tightening and geopolitical conflicts.

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