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Why Fed Won't Trigger Messy Rerun of 1994 in Asia

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The prospect of the U.S. Federal Reserve cutting back on its massive bond buying program has put global financial markets on tenterhooks in recent months.

In Asia, in particular, there have been fears of a repeat of 1994, when the Fed embarked on an aggressive tightening campaign, which saw U.S. interest rates spike 300 basis points. That in turn pushed up the yields of Asia's sovereign debt, and, together with a strengthening dollar which made Asia's exchange-rate pegs unsustainable, contributed to the onset of the Asian financial crisis in 1997.

But one economist says concerns of a replay of that scenario are unfounded, because the Asian region is in a much better position now than it was nearly two decades ago.

Daniel Martin, Asia economist at research firm Capital Economics said the Fed's tightening cycle in 1994, when it raised interest rates by 300 basis points within a year, is unlikely to happen at the same pace this time around.

"We don't expect emerging Asian bond yields to rise in earnest until the Fed starts to increase the Fed funds rate and that's unlikely until mid-2015. It won't even stop its QE program entirely until mid-2014," Martin told CNBC. "These things will be an anchor on bond yields in Asia, at least on U.S. dollar bond yields, and then low interest rates in the region will act as an anchor on local bond yields as well."

On Friday, U.S. Treasurys steadied in Asia with the benchmark 10-year yield at 2.433 percent, holding below a nearly two-year high hit earlier this week after Fed Chairman Ben Bernanke hinted that the central bank could start scaling back its monthly $85 billion bond-buying program later this year, Reuters reported.

Martin, however, points out that the recent rise in U.S. dollar-denominated government bond yields in Asia is much smaller than it was back in 1994.

"Its yield has risen by almost 70 basis points since the end of May, which is far smaller than the increase in 1994. And at 4.2 percent, the yield is still very low. The story is similar for local-currency bond yields," Martin said.

The Fed's stimulus program has led to a steady stream of cash into emerging markets in recent years. But speculation over the potential tapering of the program in recent months has led to a spike in risk aversion and heavy outflows from such markets.

(Read More: Emerging Market Allocations Lowest Since 2008)

Last week, Indonesia's central bank was the first in the region to hike interest rates in an effort to shore up its battered local currency - the rupiah - against the U.S. dollar and stem capital outflows.

(Read More: Rate Hike a Pre-Emptive Strike: Indonesia Official)

Martin said money flowing out of Asia has been the result of initial panic by investors, but the outflows will eventually ease.

"We don't expect money to keep flowing out of Asia - it's been a feature of June, but up until then money had generally been coming into Asia," Martin said. "That in a way will mean that bond yields will again remain quite low."

A stronger U.S. dollar, which has been on a rally since the Fed outlined that it might begin tapering at the end of this year, also won't necessarily be a bad thing for Asian currencies, according to Martin.

"The implications for Asia of a strong U.S. dollar are much better from a trade perspective than they were in 1994," Martin said. "Back then, most Asian currencies were pegged to the U.S. dollar. In 2013, most economies have floating exchange rates, so U.S. dollar appreciation would give their exporters a boost to competitiveness."

(Read More: Is the US Dollar Now Unstoppable?)

The dollar index, which measures the currency's value against a basket of other major currencies in terms of trade, stood at 81.85 on Friday, up almost 2 percent from a low hit earlier this week.

Martin does, however, add a note of caution, pointing out that those countries with higher foreign-currency debt like India could face headwinds if the U.S. dollar rises sharply.

"India is one we're looking at. They're going to have to erase a lot of debt over the next couple of years," Martin said. "High borrowing costs for them could be a bigger issue."

(Read More: Diving Rupee - Here's How Bad It Can Get for India)

- By CNBC.com's Rajeshni Naidu-Ghelani; Follow her on Twitter @RajeshniNaidu

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