We expect a stronger recovery in capital flows to Asia relative to other EMs in 2021. FDI remains an important driver, with India and Indonesia as the largest recipients. Relatively robust inflows and c/a adjustments in ‘20 allow for reserve accumulation. A reemergence of COVID-19 and geopolitical factors are the key risks to the outlook.

Many EM central banks started QE-like programs at the height of the COVID-19 crisis. This coincided with questions arising with respect to the financing of widening deficits. However, actual government bond purchases remain limited so far, including in Asia. Domestic investors appear to have stepped in to buy up additional sovereign issuance.

We analyze external adjustments in EM Asia following the COVID-19 shock. Cross-border flows are shifting considerably in many countries in the region. The global recession weighs on exports and weak domestic demand on imports. Other sources of FX inflows have come under significant pressure as well in H1. This includes both international tourism revenues and workers’ remittances.

We downgrade our forecast and now expect an output contraction of 3.2%. The collapse in tourism has had the most immediate impact on the region. Shutdowns weakened domestic demand and exports declined markedly. Monetary and fiscal countermeasures will only partially offset this effect.

Strong investment growth is a prerequisite for Indonesia to grow faster than 6% per annum. The global commodity cycle, competitive external investment environment, and limited policy stimulus are potential headwinds to a meaningful pick-up in investment. 

High import content in export production and investment is evident across the region. Recent import compression should support current account positions amid weak exports. However, the multiplier effects of import plunge on investment will likely depress GDP growth.

External imbalances are headwinds facing the fast-growing economies of Indonesia and the Philippines. We have a constructive view of the CADs in these economies as investment has been an important contributor. Reliance on portfolio and other foreign inflows is the key risk. 

We recently argued systemic risk in EM Asia is contained, "¦ but concentration risk exists in countries like Indonesia. Positioning is heavy in rupiah

The EM sell-off was quite intense in recent months, with major currencies in Asia depreciating significantly. We assess if this is a signal of systemic risk in the region, comparing external risk metrics in the 1997 crisis vs. now. Vulnerability is an order of magnitude lower today. Financing needs are much lower and reserves higher.