Asian central banks brace for Fed's move, Indonesia seen most at risk

By Choonsik Yoo

SEOUL (Reuters) - As global markets tremble in anticipation that the U.S. Federal Reserve will decide next week to begin tapering its monetary stimulus, four central banks in the Asia-Pacific with very different comfort levels are likely to hold interest rates steady at policy meetings on Thursday.

Indonesia, the Philippines, South Korea and New Zealand have all been buffeted by stormy markets since May, when the Fed first hinted that it could finally begin calling time on the easy money go-round that has lasted almost five years.

As the shake-out in emerging markets progresses, investors have become more discriminating, sticking more easily with those economies that show good growth prospects, low inflation and healthy fiscal and external balances.

"Some markets were treated overly harshly during the latest sell-off," HSBC Global Research said in a note to clients on Monday. The reasons given for being more discerning included stabilizing growth in China, an upturn in the global industrial cycle, and some an expectation that the region will prove less sensitive to rising interest rates resulting from the Fed tapering than has been supposed.

"Amid all the talk about the end of the emerging market era....do you really expect the West to deliver growth rates beating these economies in the near future?" HSBC concluded.

Of the countries whose central banks meet on Thursday, only Indonesia has looked to be in serious danger from the investor exodus. Southeast Asia's largest economy needs capital inflows to support a current account deficit that was 4.4 percent of gross domestic product in the second quarter.

In contrast, the Philippines, South Korea and New Zealand have come through the past few months in far better shape. They have experienced outflows, but not on a scale to destabilize their markets or economies.

If the Fed does as expected by starting a gradual reduction in its bond buying program, higher U.S. Treasury yields could cause more pain for emerging markets.

But, it will also remove uncertainty, and give these central banks comfort to wait until early next year to begin raising interest rates, confident that the Fed won't be raising rates before them.

Indonesia's policymakers will await the Fed decision on September 18 with a far greater sense of trepidation.

To staunch the outflows and counter the inflationary effects of weak currency, Bank Indonesia raised its key interest rates by a cumulative 125 basis points since June.

The rupiah's troubles deepened on Tuesday as it slumped 3 percent to its weakest level against the dollar since April 2009. It has lost 16 percent since the start of the year.

But, as BI most recently put up its key rates at an emergency meeting on August 29, the majority of economists expect it to leave them unchanged at Thursday's meeting, a Reuters survey showed.

However, given the chances that the Fed will roil markets further, several economists see the Indonesian central bank being forced to raise rates again.

"We are expecting another 50 basis-point rate hike in the later BI meetings given our forecasts for a steeper inflation trajectory in the coming months," said Chua Hak Bin, economist at Bank of America Merrill Lynch in Singapore.

India has been the country in the region most badly hit by the great rotation out of emerging markets by investors eyeing higher U.S. Treasury yields, because, like Indonesia, Asia's third-largest economy is running an unsustainable current account deficit, and its fiscal deficit is also worryingly high.

Reluctant to raise interest rates that could exacerbate a worrying slowdown in economic growth and drive up the cost of government borrowing, the Reserve Bank of India has taken the precaution of delaying its policy meeting until two days after the Fed meets, so it has a better idea what to do next while it's rupee remains lodged near record lows.

OTHERS CAN WAIT

Those economies without pressing external deficit problems, like South Korea, and the Philippines, or healthy, sturdy economies like New Zealand have weathered the storm far more easily.

The Bangko Sentral ng Pilipinas has kept its benchmark interest rate at record-low 3.5 percent since late last year, and with the economy in a sweet spot of low inflation and strong growth it is under no pressure to change at this stage.

The retreat from emerging markets saw the peso fall by 7.0 percent so far this year, and the stock market's earlier gains have been wiped out. But the change of wind is not blowing the economy off course and it is expected to grow by 7 percent this year.

"The Philippines has a strong current account surplus, unlike some of its regional peers such as Indonesia, and as such will not find it necessary to raise rates in order to attract inflows to finance an external deficit," said Michael Wan, economist at Credit Suisse in Singapore.

Bank of Korea (BOK) made a token interest rate cut in May to support a fiscal stimulus program, and has not moved since, although economists reckon its easing cycle has ended.

"There's no reason for (the BOK) to cut the rates further because the economy won't get worse from here," said Kim Sang-hoon, a fixed-income analyst at Hana Daetoo Securities. "I expect a raise from late next year, when most central banks will have started to tighten up policy."

The Reserve Bank of New Zealand has kept its overnight cash rate at record-low 2.5 percent since early 2011, but rising property prices could push the broad consumer inflation up from current low levels over the coming months. Analysts expect RBNZ to begin raising rates early next year.

(Reporting by Reuters bureaux in SEOUL, JAKARTA, WELLINGTON and MANILA; Editing by Simon Cameron-Moore)