TOKYO – Global markets are trying to discern whether the US-Iran ceasefire is real talk or happy talk. However, emerging market governments in Asia do not have that luxury as capital outflows accelerate.
Already, the exits so far place emerging economies in the center of the collateral damage zone between war in the middle east. In March alone, foreign investors pulled $70.3 billion from emerging market assets. It is the biggest outflow since the pandemic chaos in March 2020, according to the Institute of International Finance.
Asia is taking the lion’s share of sales. This is partly thanks to the region’s heavy reliance on oil from the Middle East, much of it through the Strait of Hormuz. It marks an “extraordinarily large” entry for January and also February flows still positivenotes IIF economist Jonathan Fortun, representing a “sharp regime break following a major geopolitical upheaval.”
The outflows continue despite claims that the US and Iran have agreed to a ceasefire in the six-week conflict. This vague framework – neither side has detailed it – already seems to be breaking down.
Tehran claims, for example, that Israeli attacks on Lebanon violate the agreement, despite planned talks. And among the things US and Iranian officials are at odds over is Tehran’s plan to charge a toll on every tanker that passes through the Strait of Hormuz.
The uncertainty factor hardly helps. Six months from now, governments from South Korea to Indonesia aren’t sure whether oil will cost $75 a barrel or $150.
“The unfolding shock echoes the crisis of 1973-74, when coordinated output cuts by Arab countries and a quadrupling of crude oil prices rocked energy-intensive, import-dependent Asian economies – only this time it’s much worse,” says Priyanka Kishore, chief economist at Asia Decoded.
Looking ahead, notes IIF’s Fortun, the duration of the Iran war is now the key variable for emerging markets portfolio flows. “If the conflict proves short-lived and the disruption in energy markets begins to ease, March could end up being the peak month for liquidation, with the damage remaining concentrated in equities and particularly in Asia,” he says.
If, however, the conflict “continues and the shock moves from an initial oil repricing to a more stable energy and input cost regime, the implications for EM become more serious,” notes Fortun.
Higher inflation, a delayed easing in global financial conditions, a stronger dollar and reduced policy flexibility in vulnerable EMs would make it difficult to stabilize flows quickly, Fortun adds.
In that environment, the next phase of differentiation among economies is likely to be shaped less by the initial market response itself and more by how countries maintain the monetary credibility, fiscal space, and external buffers needed to absorb a longer conflict.
An added concern: the extent to which Asia’s growing reliance on non-bank financiers, such as hedge funds, could put the region at even greater risk of massive capital flight.
This week, the International Monetary Fund noted that since the 2007-2008 global financial crisis, portfolio flows to emerging markets have increased eightfold, reaching about $4 trillion in cumulative terms. This compares with a more modest increase in bank flows.
Most of these inflows take the form of debt, notes IMF economist Salih Fendoglu. Portfolio debt obligations now average about 15% of gross domestic product emerging marketsup from about 9% in 2006. Roughly 80% of this capital is provided by non-banks, including investment funds, hedge funds, pension funds and insurance companies, a share twice as large as 20 years ago.
For borrowers in emerging markets, Fendoglu notes, such capital can make sense. It can lower financing costs, supporting higher investment and stronger productivity growth. It can also help deepen domestic financial systems and support long-term financial development.
However, portfolio flows in emerging markets “tend to be more volatile than bank flows and are increasingly sensitive to global risk conditions, as our analysis shows,” adds Fendoglu. “Immediate cuts could intensify external financing pressures, raise borrowing costs and trigger sharp currency devaluations, leading to financial strains that weigh on economic growth.”
These risks, says Fendoglu, “have come to the fore in the context of the war in the Middle East, as some emerging markets are experiencing a reversal of capital flows from non-resident non-bank investors.”
This has a variety of Asian economies on the front lines of global inflation. “India, Indonesia, Malaysia and Thailand, among others, face fiscal pressures as fuel subsidies help protect consumers and businesses from the brunt of higher global oil and gas prices,” says Christian de Guzman, economist at Moody’s Ratings.
India, for example, is among the world’s largest net energy importers. That leaves Asia’s third-largest economy to balance rising oil and gas costs and fiscal pressures that are already undermining the rupee.
In 2025, the rupee was Asia’s worst performing currency, down 5%. India’s currency is getting a new pace this year, losing another 3.1% since January 1.
India’s chief economic adviser Venkatramanan Anantha Naageswaran argues that the nation faces “Considerable downside” risk due to rising energy costs and supply chain disruptions. New Delhi’s trade deficit, he adds, is likely to “increase significantly” and lead to a “widening of the current account deficit”.
This, in turn, could send 10-year Indian yields higher level 6.9%. and the rupee towards 100 to the dollar from 93 now.
Economist Sonal Bandhan at Bank of Baroda says “ongoing geopolitical conflict has brought added volatility to financial markets. Given the challenging global environment, we expect the rupee to trade in the 93-95 range to the dollar in the near term, with downside risks. We also expect India’s trade rates of 10.7 to 9% in the 0.7% to 0.7% range in the near term, with a growing prejudice.”
Indonesia also finds itself in trouble, as evidenced by the slide of the rupiah. While Southeast Asia’s largest economy has some relative advantages over its neighbors, its reliance on imported fuel, especially with rising energy prices, threatens economic growth and the inflation outlook.
In recent days, Bank Indonesia has intervened to maintain currency stability and avoid excessive volatility after the rupiah hit a record low against the dollar.
As Senior Deputy Governor of BI, Destry Damayanti says Reuters: “Stabilizing the rupiah is certainly a top priority for us now. We will use every tool and policy at our disposal, we will be all out,” she says, noting that the pressure on the currency was largely global in nature amid the US-Israeli war against Iran.
Malaysia, on the other hand, recently raised its GDP forecasts despite trade disruptions and higher fuel prices caused by the conflict in the Middle East. The central bank now expects economic growth of between 4% and 5% this year, revising its forecast slightly upward from 4% to 4.5%, driven by robust household spending.
However, the risks are many. As Wilder scholar Alejandro Sanchez wrote in a Geopolitical Monitor op-ed“Malaysia has vast energy resources and is a net exporter of liquefied natural gas, but the country imports up to 70% of crude oil from the Gulf region. Specifically, the Asian nation imports gasoline, diesel, liquefied petroleum gas and jet fuel.
“In other words,” argues Sanchez, “Malaysia needs those energy imports to keep its economy running. So it’s no surprise that in addition to domestic measures, Malaysia’s diplomatic corps swung into action to secure oil supplies.”
Bank Negara Malaysia Governor Abdul Rasheed Ghaffour warns that a protracted war would pose major risks to the outlook. “If things really go bad… of course we will look at that and if there is a need (to) revise the growth forecast,” Ghaffour adds.
In Bangkok, Thailand’s new government is rising response efforts to limit the economic consequences for the country’s 71 million inhabitants. This week, Prime Minister Anutin Charnvirakul announced plans to restructure energy prices, set up public funds to support the public and issue a new round of cash assistance and low-interest loans to small businesses and farmers.
“We are facing a global crisis,” says Anutin, “We must accept the reality and adapt together to overcome this crisis.”
IN a report This week, S&P Global notes that Thai banks “face prolonged asset quality pressure amid an uneven recovery. High exposure to vulnerable borrower segments makes the sector vulnerable to weaker macro conditions.”
S&P’s base case assumes that while credit costs are set to remain high, the sector will remain resilient supported by strong capital, earnings and buffers. But under a severe stress scenario, where Thailand sees its NPL ratio rise to 10%, “the sector remains broadly resilient, with most institutions holding capital above regulatory requirements.”
Although the impact would vary, with some Thai banks more exposed to tougher conditions, S&P concludes, “geopolitical risks could further weigh on borrowers’ repayment capacity. If the war in Iran drags on, we predict Thailand will be among the hardest hit countries due to higher input costs, weaker demand and supply disruptions.”
The bad news for Asia is that even good news on the Iran war front means a prolonged period of economic pain. As Louise Loo, head of Asia research at Oxford Economics, explains, backlogs of shipping and transit times mean shipments are weeks away even if the US-Israel-Iran ceasefire holds.
“The most enduring constraints,” says Loos, “are infrastructure and behavior. The damage to Qatar’s Ras Laffan LNG facilities is said to carry a repair horizon of three to five years, while governments collection of supplies against the risk of renewed conflict will keep demand tight.”
Also, Loo notes, the policy response across developing Asia has tilted toward energy rationing and administrative controls: price caps, mobility restrictions, shortened work weeks.
“This is not appropriate for economies using this policy book,” warns Loo. “High labor market informality results in lost work days and reduced mobility, translating almost immediately into lower cash income and household consumption. Energy conservation may not come from efficiency gains, but from demand destruction.”
As economic costs rise, so do the risks that capital will continue to leave Asia.
Follow William Pesek on X at @WilliamPesek
