Emerging Asia to lean on $255 bln China-Japan liquidity wall against Fed fallout

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By Vidya Ranganathan

SINGAPORE, Dec 16 (Reuters) - As investors brace for this week's historic U.S. interest rate decision, central banks in Asia's emerging markets will be standing by a quarter of a trillion dollars in emergency liquidity lines with China and Japan to prevent routs in their currencies.

For vulnerable Asian countries with heavy dollar borrowings and modest foreign reserves, central bank swap agreements with the region's two largest economies are a key defence against the kinds of market swings that have created past liquidity crises.

Central banks across Asia have on tap $215 billion in yuan swap lines with the People's Bank of China and $40 billion in lines with the Bank of Japan. Most of these agreements were established after the global financial crisis of 2008.

"Policymakers need the big bazooka when investors get jittery and any official complementary measures they can draw on will be very beneficial," says Frederic Neumann, co-head of Asian economics research at HSBC in Hong Kong.

"I would expect China and even Japan to be much more proactive should financial uncertainty revisit Southeast Asia," said Neumann.

Asian economies have $6.75 trillion in combined foreign exchange reserves, though China and Japan account for about 70 percent of these assets. http://link.reuters.com/qek63v

Other economies, particularly the emerging markets of South and Southeast Asia, have thinner currency reserve cushions and central bank lines provide an additional layer of protection.

Malaysia's 180 billion yuan swap line, for example, could bolster its meagre $94.6 billion in reserves by almost a third, while Indonesia's $100.2 billion reserves will rise by a further $38 billion if it draws down on swaps with China and Japan.

China has more and larger swap lines with emerging Asian markets than it does with countries in other emerging markets blocs, such as Eastern Europe and Latin America. http://link.reuters.com/fuf67v

Additionally, Asia's network of swap lines to the region's two largest central banks is more extensive than the liquidity backstops countries in other emerging market blocs have with the Federal Reserve of European Central Bank.

"Asian emerging markets might be in a better position relative to other emerging markets due to the larger swap agreements in place," said Bernard Aw, market strategist at IG in Singapore.

"Bilateral swap lines are seldom used, but they prove useful in the event of financial turmoil."

While Japan's swap lines are unequivocally earmarked for use in a crisis only, there are questions over what circumstances swap lines with China could be used.

The yuan bilateral swap agreements stipulate the funds can be used to facilitate trade payments and direct investments, or anything else the two parties agree on.

"But when push comes to shove, is this money really available? That's going to be the question," said HSBC's Neumann.

OUTFLOW RISKS

The key concerns for markets about a widely expected Fed rate hike this week - the first in almost a decade - is the possibility that hundreds of billions of dollars in Asian investments could move to higher-yielding U.S. markets.

That risk is magnified by the fragile external balance-sheet positions of Asia's smaller economies. Their currencies are weak, foreign exchange reserves have shrunk over the past couple of years and current account surpluses have been deflated by feeble global demand and a collapse in commodity prices.

"The risk of some reversal is certainly a real prospect," ANZ's Asia strategist, Khoon Goh, wrote in a recent note.

He estimates about $700 billion in portfolio inflows have moved into emerging Asian markets over the past decade.

"While we do not expect to see the kind of outflow experienced during the global financial crisis, even a tailing off of inflows will be sufficient to put downward pressure on Asian currencies."

In addition to the central bank swap lines, the region is also backstopped by the $240 billion Chiang Mai Initiative Multilateralisation emergency fund, which can be used by countries that have signed up to a reform and loan program with the International Monetary Fund.

So far, it looks like none of these facilities will need to be tapped.

While markets may take a hit if the Fed lifts rates as widely expected, most analysts expect the pain will be short-lived, particularly if the central bank flags a gradual approach to policy tightening.

And recent history also provides investors with some confidence - although Asian markets were hit during the 2011 eurozone debt crisis, the Fed's 2013 "taper tantrum", and heavy emerging market selloffs in September, they were able to get through the routs without requiring too much additional liquidity support.

(Additional reporting by Christine Kim in Seoul and Nichola Saminather in Singapore; Editing by Nachum Kaplan and Sam Holmes)