Capital outflow predicted to trigger higher finance costs, exchange rate volatility

But most sovereigns could weather disruptions, says S&P.

According to Standard & Poor's Ratings Services, the normalization of global monetary policy could lead to a sharp outflow of capital from Asia-Pacific, triggering higher financing costs and exchange rate volatility. But the report suggests that most sovereigns can weather the disruption without a sharp slowdown in economic growth or prolonged financial volatility.

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"Most sovereigns are likely to see economic growth weighed down somewhat by modest-to-moderate increases in funding costs," said Standard & Poor's credit analyst Kim Eng Tan. "The strain is likely to be greater in economies that run sizable current account deficits or have inflexible exchange rates."

The report says that capital flows into Asia-Pacific have lifted external liabilities or have kept them elevated in recent years. In some economies, it has helped to sustain relatively high investment rates. But improved conditions in the eurozone and the U.S. could lead to slower capital inflows or outright outflows.

"If capital inflows slow much more than we expect, the cost of financing may unpleasantly surprise borrowers," said Mr. Tan.

Policy responses or political developments that negatively surprise investors could spread the impact beyond an economic slowdown. In such cases, the negative impact on economic growth and financial system stability may exceed what we currently expect to be the case. For some sovereigns, this scenario could undermine their creditworthiness.