Countries like the Philippines should expect higher borrowing costs and tighter credit standards next year as the US Federal Reserve drains liquidity from emerging markets once its much-awaited scaling back of bond purchases finally takes place.
Debt watcher Fitch Ratings on Monday said that in extreme cases, some countries may see a higher rate of defaults among Asian companies as banks restrict their own lending to protect their portfolios from soured loans.
“Most investors believe that a significant liquidity drain will occur once tapering is officially confirmed as investors are likely to reduce their exposure to bonds in order to minimize mark-to-market losses as US treasury rates rise,” Fitch said in a statement.
The US Fed has been buying up $85 billion in mortgage-backed securities and US Treasuries every month since 2009 to spur the world’s largest economy by keeping interest rates low.
This has also helped push money into emerging markets, driving down interest rates and driving stock prices up.
Outgoing Fed Chair Ben Bernanke last June announced that monetary authorities would scale back their asset purchases as the US economic recovery gains traction.
Fitch based its observations on input from 20 fixed-income investors based in the Asian financial centers of Singapore and Hong Kong.
The rating firm, which upgraded the Philippines to “investment grade” earlier this year, said the tightness in liquidity would last until investors are confident that rates have stabilized.
However, Fitch said most investors said they were unlikely to exit their existing portfolio in a “fire sale” manner.
Instead, Fitch said once the tapering begins, investments will be subject to more stringent selection criteria and higher premiums will be required for issuers.
Fitch said the more cautious outlook would contribute to slower growth as banks tighten underwriting criteria. Banks would also be faced with higher ratios of non-performing loans, hampering the flow of new credit to corporations.
“Some investors suggested that the extent of the negative impact on the bond markets could have been mitigated if tapering had started in September when the market was originally anticipating it,” the rating firm said.