Here’s How QE Tapering Could Hurt Asia

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The tapering of quantitative easing (QE) in the U.S. will likely have a destabilizing impact in Asia, a region that has been a target of hot money inflows in recent years, according to Nomura.

"Strong capital inflows to emerging Asia, coupled with a prolonged period of low real policy rates have led to a worsening of emerging Asia's economic fundamentals," the bank, which expects the U.S. Federal Reserve to start scaling back its bond buying program at the end of September, wrote in a report on Tuesday.

With interest rates remaining low, domestic private debt – including loans by financial institutions to households and companies and corporate bonds - in the region has surged, particularly in countries such as Hong Kong and Singapore that now face risks of property bubbles.

(Read More: Fed Minutes: Participants Mull Tapering as Soon as June )

Furthermore, there has been an increase in foreign currency denominated external borrowing which increases the risk of a "currency mismatch" if Asian currencies depreciate sharply, the bank said.

"Potential large foreign equity and/or bond-related outflows are a significant risk for Asia currencies," the bank said. Currencies most at risk are those from countries that are running current account deficits or small current account surpluses such as the Indian rupee and Indonesian rupiah.

Who's Most Vulnerable

According to Nomura, Hong Kong, Singapore, India and Indonesia will be the most vulnerable to a winding down of QE.

With its currency pegged to the greenback, Hong Kong has imported the U.S.'s loose monetary policy which has in turn stoked an unprecedented boom in its housing market. Property prices have risen by 128 percent since December 2008 and a tapering of QE could trigger a major correction in the market as interest rates rise and liquidity tightens, Nomura said.

"The 1997 [Asian financial] crisis in Hong Kong was also to a large extent driven by housing wealth, and the property bubble bursting eventually led to a sharp decline in consumption, which plunged the economy into a deep recession and deflation," Nomura analysts wrote.

Singapore, a country in which a sizable sum of household assets are concentrated in property, would be subject to similar risks.

"Domestic interest rates could rise sharply and lead to balance sheet problems for households which increased leveraged on the assumption that property prices would remain buoyant," the bank said.

Indonesia and India are also at major risk, but for another reason. They both face large current account deficits and have hence become more reliant on portfolio flows to finance them.

(Read More: Flood of Easy Money Putting This Region at Risk )

In Indonesia, a reversal of portfolio flows could exert heavy pressure on the balance of payments, causing the Indonesian rupiah to depreciate substantially, the bank said.

"Given the potential size of the outflows, this could force the Bank of Indonesia to implement significant policy rate hikes, which would in turn dampen consumer and investment spending," the bank said.

Similarly, in India, a reversal of capital inflows would "wreak havoc" on the rupee and the country's equity market. Net capital inflows into Asia's third largest economy totaled $88 billion in 2012, spurred by global quantitative easing.

"Asset price volatility and a slowdown in capital inflows would hurt investment, as uncertainty further delayed a revival of the capex cycle," the bank said.