Emerging Asia’s Efforts to Deal with Increasing Debt

By Paul Tierno

Asian economies have been borrowing more in recent years. Despite concerns that increased external and specifically dollar-denominated debt may leave Asia susceptible to destabilizing outflows, other key economic and financial metrics depict a region more resilient than when it experienced the Asian Financial Crisis (AFC) 20 years ago. Prudential policy and regulation have played an important role in improving the region’s financial resilience, though some efforts to increase resilience may run counter to the goal of developing deep local bond markets.

Cautious Governments Act

Foreign debt gives borrowers access to global financial capital, but too much debt often has unwanted consequences. Significant foreign ownership of local debt often creates instability when slower growth, rising political risk, or a tightening of international financial conditions triggers currency depreciation and capital flight, as repeatedly demonstrated by past emerging market debt crises. Asian economies’ external debt levels have grown over the past decade, but still appear manageable at present (see Figure 1). Moreover, the increase in external borrowing in recent years is driven by local currency debt, which is less detrimental than US dollar borrowings at times of financial market turbulence.

Figure 1: External Debt-to-GDP in Asia

External Debt-to-GDP in Asia
Source: BIS and World Bank and author’s calculation.

Since the “taper tantrum” in 2013, several Asian central banks have taken steps to insulate domestic borrowers’ large external debt loads from currency shocks. Such measures include promoting onshore hedging, prohibiting offshore currency hedging/speculation, and encouraging the broader use of domestic currency. Indonesia and Malaysia specifically have taken a number of macroprudential and capital flow management measures to address financial stability concerns associated with foreign-held debt.

Indonesia Mandates Hedging, Discourages Dollarization

The Indonesian central bank, Bank Indonesia (BI), imposed three requirements since 2015 that attempted to mitigate risks associated with elevated external debt levels, including a hedging requirement, local currency mandate, and tax amnesty/repatriation scheme. 

Private sector borrowing has driven much of the recent increase in Indonesia’s external debt, as BI explained, “even exceeding the current level of public external debt.” In response, authorities required that domestic corporates hedge 20% of their short-term borrowings not covered by foreign currency assets in 2015, and increased the minimum hedging requirement to 25% in 2016. The hedging requirement was a prudential measure meant to ensure that corporates were insulated against excessive foreign leverage. Subsequently, a surge in hedging demand deterred foreign borrowing due to higher hedging costs.

Not long after issuing the hedging requirement, BI established another rule, aptly titled “Mandatory Use of Rupiah in Indonesia,” requiring the use of the Indonesian rupiah for all transactions unless one party is domiciled overseas or there are some other exceptions. This measure sought to prevent informal dollarization—the use of the dollar by domestic businesses in lieu of the local currency—and the stress it places on a domestic currency.

Even Indonesia’s recently concluded tax amnesty scheme was aimed at bolstering the country’s external position. The scheme’s primary goal was to raise tax revenue and the country’s low tax-to-GDP ratio by encouraging residents to register previously undocumented onshore assets and to repatriate offshore funds at lower tax rates. However, the plan also has been credited with shoring up the country’s foreign reserves, as previously held foreign assets were repatriated and converted back to rupiah.

Figure 2: Indonesia’s Foreign Currency Reserves (US$ billions)

Indonesia’s Foreign Currency Reserves (US$ billions)
Source: Bank Indonesia

Malaysia Moves Hedging Onshore

Bank Negara Malaysia (BNM), Malaysia’s central bank, took similar steps by prohibiting the use of non-deliverable forwards (NDFs) and mandating local currency conversion of most export proceeds. BNM issued a directive late last year reinforcing rules that prohibited offshore ringgit NDFs and required domestic banks to certify that clients were not participating in offshore markets.

NDFs operate like deliverable forwards but for illiquid or non-internationalized currencies. Transactions take place in offshore financial centers and counterparties settle with each other in dollars for the shift in value between the two currencies rather than delivering the underlying currency. To offset the restriction on NDFs, BNM expanded domestic hedging options.1 However, onshore alternatives are only imperfect alternatives, as NDFs are typically insulated from onshore risks and capital control concerns.

A case for more restrictions on NDFs is that they put downward pressure on onshore spot exchange rates when the local currency is already weakening, as a study by India’s central bank shows. Therefore, NDFs may affect a country’s international reserves indirectly if central banks intervene to defend a currency.

At around the same time, BNM issued a notice that required exporters to convert most of their export proceeds to ringgit. The regulation limited the amount of export proceeds an exporter could retain in foreign currency to 25% of the total transaction. Both moves were launched in November 2016, just as the Malaysian ringgit hit its lowest point against the dollar in more than five years.

So Far, Mixed Results

These measures seem to have improved Indonesia’s and Malaysia’s external positions. While tax revenue from repatriated funds under Indonesia’s tax amnesty program was underwhelming, repatriated funds have bolstered the country’s foreign reserves, as some foreign capital held overseas was converted back to rupiah. At $118.5 billion, Indonesia’s foreign exchange reserves hit their highest level in two years in May, shortly after the program concluded (Figure 2).

In Malaysia, it appears that BNM’s NDF prohibition stemmed the ringgit’s depreciation, as not long afterward the currency did bottom out to a record low against the dollar (see Figure 3), but has steadily strengthened since. Conversely, foreign holdings of Malaysia’s sovereign bonds dropped to 28.7% in February 2017, down from 2016’s highs of 34.7%, as a large number of non-resident sovereign debt holders decided to liquidate their holdings rather than retain insufficiently hedged exposure.

Figure 3: Path of the Ringgit

Path of the Ringgit
Source: Bloomberg

However, these measures limit investor-prized flexibility and may have unwanted consequences. In particular, prohibiting the use of NDFs may lead to slower development of local currency bond markets as investors lose an important tool to hedge currency risks and may shun the debt altogether. When foreign investors retreat, local bond markets suffer from a narrower investor base, less liquidity, and fewer sources for corporate and public financing, a tradeoff that emerging economies will need to consider.


1. BNM expanded onshore hedging by allowing residents (including fund managers) to hedge up to MYR 6m per client per bank of USD and CNY exposure. BNM allowed resident and non-resident fund managers to hedge up to 25% of their investments. Those using these instruments had to certify that they would not speculate on the currency.


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