Question

Why have Asian countries attracted short-term capital flows in recent years and why have they been very volatile? What are the risks that Asian firms face when they borrow in foreign currencies at low-interest rates?

Answer 1

Why have Asian countries attracted short-term capital flows in recent years and why have they been very volatile?

Asian countries emerged from the post-GFC faster and recovered to maintain relatively good growth (though slower than before GFC) – in contrast, the post-GFC period has seen poor growth performance in the developed economies of North America, EU, and Japan. Further, because of monetary expansion (QE and other unconventional monetary policies) interest rates and bond yields in these latter countries have been extremely low – creating interest differentials that favor capital flows into Asian countries where rates/yields are higher. These have been very volatile because of continually shifting investor sentiment that is looking for signals that the cheap money policies in the EU and US are about to end, and often reading all kinds of things into statements from the US Fed Reserve officials and then changing these interpretations quite often – also they worry about the stability of emerging market economies, whose economies, after initially growing quite well in the post-GFC period have also been affected by the slowdown and recession in developed country markets (as reflected at the end of the commodity boom, etc.).

What are the risks that Asian firms face when they borrow in foreign currencies at low-interest rates?

They can be exposed to currency movements caused by capital flow reversals: capital outflows depreciate their currencies, so they have to pay back more (in a stronger currency) than when they borrowed