FX and equity markets in Asia are being increasingly affected by volatile economic conditions in China, according to a wide-ranging study from the International Monetary Fund (IMF).
In an annual outlook report for the region, published on 3 May, the IMF says that it has identified 14 episodes since July 2005 – when China announced the adoption of a managed floating exchange-rate regime – in which the onshore renminbi-to-dollar exchange rate moved by more than 0.5% in a given day.
“The average impact on regional FX markets was relatively muted until June 2015,” the report notes, “but has become substantial since then. Moreover, markets with strong trade links with China were affected more.
“These findings suggest that financial spillovers from China to regional markets are on the rise – both in equity and FX markets.”
Overall, the report notes, the sensitivity of regional markets to China has increased, while the influence of Japan has declined. At the same time, the region has also become more susceptible to the effects of US economic trends, “highlighting the steady integration of Asia with the rest of the world”.
In the IMF’s view, the region’s high level of vulnerability to China illustrates its significant exposure to the country – particularly its final investment demand.
“It also reflects the fact that China’s impact on regional markets is likely to grow further with the ongoing process of internationalisation of the renminbi, the country’s gradual capital account opening and further regional trade integration.”
For the IMF, the climate of vulnerability is concerning at a time when debt levels are high across most of the region, stemming from several years of buoyant credit growth and the increased importance of corporate bond issuance.
Indeed, the report points out: “Corporate-debt-to-GDP ratios have increased faster in Asia than in other major parts of the global economy since 2009, and are particularly high in China, Hong Kong, the Southeast Asian Region and Korea. In addition, there are pockets of high leverage (in less profitable firms) across the region.”
With that in mind, the report advises, China must prioritise clarity in the way it communicates policy shifts to regional trading partners. That, it says, will be “essential” for managing the country’s transition to an economic model “increasingly driven by consumption and services”.
“It will also help moderate the perceived uncertainty for neighbouring countries, especially when combined with clarity on the exchange-rate regime and consistency in its implementation.”
On a broader scale, the report urges regulators across the region to introduce “structural reforms” to help “rebalance demand and supply, reduce vulnerabilities, and increase economic efficiency and potential growth”.
It notes: “Past reforms have shown themselves to have been highly effective, including by fostering economic and trade diversification and facilitating Asia’s entry into global markets – but a new wave of high-impact reforms is needed, ranging from state-owned enterprise reform in China to labour and product market reforms in Japan.”