KUALA LUMPUR (Feb 1): Strong but moderating economic growth rates in Asia Pacific (APAC) will support the region's credit conditions for 2023, though its growth trajectory will partly hinge on China's recovery, according to Moody’s Investor Service.

"Economic activity will normalise closer to potential levels in most of the region's major economies, while we expect an acceleration in activity in China as authorities lift Covid-related mobility restrictions. However, China's troubled property sector and weaker global demand pose risks to regional growth, with the potential for further geopolitical shocks to ripple through to the supply and prices of key commodities," said Moody's in a statement.

Meanwhile, monetary tightening could slow as inflation peaks, it noted, but external financial conditions will challenge high-yield issuers.

"APAC has largely weathered the inflation shocks emanating from the military conflict between Russia and Ukraine, while central banks have gradually narrowed their policy rate differentials with the US Federal Reserve. Nevertheless, higher dollar financing costs and tighter liquidity will be a strain for Asian high-yield issuers facing maturities in 2023-24, including some frontier sovereigns and Chinese property developers."

Currency weakness in APAC has been pronounced amid the US dollar’s broad strength, it noted, but slowing policy-rate tightening in the US and Europe will alleviate currency pressures for both higher-rated sovereigns and lower-rated ones.

Currency depreciation poses minimal risks, it said, but will still challenge APAC issuers dependent on foreign-currency debt or local-currency revenue. 

"Most APAC companies are well protected from recent dollar strength through foreign-currency-linked revenue, while increased local-currency financing provides buffers for some sovereigns. Issuers dependent on local-currency revenue in weaker currencies are the most exposed," it said.

Advanced economies such as Australia, Japan, South Korea and New Zealand, which experienced depreciation pressures in the second half of 2022, benefit from free-floating currencies and tend to have highly stable local-currency funding bases or large external buffers.

In a downside scenario in which growth prospects in China weaken further, depreciation pressures on the renminbi risk will create competitive disadvantages for other exporters in the region such as Malaysia, Thailand and Vietnam, it noted.

"Most APAC governments have reduced their exposure to foreign-currency-denominated borrowings since before the global financial crisis, although several frontier market sovereigns maintain very high levels of foreign currency debt, including Cambodia, Laos and Mongolia. For stronger-rated sovereigns, the development of deep local-currency bond markets and more flexible exchange rates following the 1997 Asian financial crisis are mitigating factors to bouts of currency depreciation. The prevalence of highly concessional foreign-currency lending by multilateral and bilateral lenders is another mitigating factor.

"However, there will be wide differences between economies in their abilities to smooth currency volatility. Most large emerging economies with current account deficits, such as India and Indonesia, continue to hold robust foreign-exchange buffers while reserves adequacy is at critically low levels relative to short-term external liabilities in Laos, Mongolia, Pakistan and, to a lesser degree, Maldives," it noted.

Rising geopolitical tensions in APAC against the backdrop of rising competition between China and the US and its allies in the region will create what Moody's has termed as “fault lines”.

"These fractures will reflect the formation and evolution of geopolitical alliances and the reconfiguration of APAC’s established economic, trade and financial relationships, with the potential for long-lasting credit effects. These fault lines will pressure international companies, investors and financial institutions to reshape or build redundancy into their operations and relocate supply chains closer to their home markets as geopolitical relations increasingly influence economic and financial connectivity. This is likely to increase operational costs to businesses and drive higher inflation.

US-China tensions will be among the most significant sources of fault line formation in the region, which was illustrated by new US restrictions on China’s access to semiconductor technology and tools, Moody's said.

"These restrictions will have broad consequences for companies based in Japan, [South] Korea, Malaysia and Taiwan, among others," it added.