The US Federal Reserve has begun tapering its quantitative easing policy. The Fed started "tapering" or paring its bond buying in December and cut its monthly bond purchases further in January to $65 billion.

Thus far, emerging economies in Asia have taken the QE tapering in their stride. Financial markets in Asia reacted much more negatively to the fears of tapering in mid-2013 compared to the actual start of tapering. [Company Formation | Offshore Company | Company Incorporation]The impact of the summer "taper tantrum" was particularly acute for India and Indonesia, leading to a fall in asset prices and dampening the growth outlook in those two economies. Nevertheless, neither country - nor any other emerging economy in Asia - had a systemic crisis.

This is due not least to the fact that the fundamentals of Asia's emerging economies are now much healthier that they were in the 1990s. Debt denominated in local currencies is more common today, thus foreign exchange depreciation causes less harm to domestic balance sheets. Most economies have large foreign exchange reserves and overall comfortable foreign exchange liquidity to serve their external financing needs. External debts are better structured and less vulnerable to external shocks. And bilateral as well as multilateral agreements for currency swap facilities are in place, mitigating risks.

Since the tapering of QE began, currencies of Asia's emerging economies have held up and some stock markets (in Southeast Asia and Shanghai) have even chalked up gains from the end of 2013. Despite the benign start, vulnerabilities in Asia's emerging markets remain and potential pitfalls should be recognized and avoided.

The most crucial factor in meeting the QE tapering challenge will be preserving investor confidence in Asia's emerging markets by striking a balance between growth and macroeconomic stability with consistent policies and clear market communication. Experts seem to agree that the Fed stimulus is likely to remain substantial and the QE tapering will progress at a moderate pace in 2014, with global interest rates staying low for a while longer.

In such a situation, emerging economies in Asia on the whole should be able to cope with the QE tapering without major disruptions. However, any signal that tapering could be faster than anticipated could stoke another round of rapid and large capital outflows from emerging markets, raising risks for financial asset prices and exchange rates in Asia's emerging markets with wider impact on the economy and creditworthiness of borrowers.

As tapering of QE will tighten liquidity and raise the cost of funds, Asia's emerging markets with twin deficits - India, Indonesia, Thailand, Pakistan and Sri Lanka - could be the most challenged from the prospect of higher borrowing costs. Those that have a higher percentage of foreign investors in their capital markets - Malaysia, Indonesia, [Company Incorporation USA]Thailand and the Republic of Korea - will be more vulnerable to a sudden change in portfolio fund flows, raising risks to financial stability in terms of exchange rate and interest rate volatility.

Since consistent policy and clear market communication is essential, domestic capital markets that can efficiently intermediate between domestic savings and investment needs will play an even more significant role. Therefore, steps to improve transparency and good governance will be essential to enhance investors' confidence.

In addition, as liquidity becomes less abundant, QE tapering will in effect expose existing domestic challenges, which were hidden in a low interest rate environment. Thus, emerging markets in Asia need to make up for any missed reforms and look harder for ways to secure long-term funding as the easy and cheap credit brought by QE fades. Investor-friendly reforms are especially necessary in countries with a larger current account deficit than net foreign direct investment inflows such as India.

Abundant global liquidity has led to a build-up of private debt in Asia's emerging markets. Rapid credit growth was observed in several emerging markets in Asia in the past few years. In 2013, several economies, including Singapore, China, the Philippines and Indonesia, saw double-digit credit growth. Household debt as a percentage of GDP increased substantially between 2009 and 2013, especially in Indonesia, China, Thailand and Malaysia. True, the ROK and Singapore did not see a large increase, but the two economies already had a high level of household debt, with ratios of household debt to GDP being above 70 percent.

The eventual rise in domestic interest rates could potentially challenge the repayment capacity of some borrowers and consequently lead to an increase in non-performing loans and a decline in profitability in the domestic banking sector.

And closely related to credit growth is the rapid rise in asset prices during the QE years. Property markets have risen sharply in many emerging economies in Asia despite several rounds of price-curbing measures. Tapering-induced consolidation and correction of property prices will pose challenges to the banking sector with large exposure to property-related loans, including those in Hong Kong and Singapore. But prudential measures have been in place in many countries and regions to mitigate risks of a property market correction, thus Asia's emerging economies should be able to avoid a major crisis, similar to the sub-prime meltdown in the US.

As the "taper tantrum" episode shows, investors do distinguish between emerging markets that embrace reform and those slower to do so. Fed tightening has preceded a few emerging market crises in the past. Emerging markets in Asia should therefore not be complacent.