Asia faces complex political considerations

The battle against Covid-19 is by no means over, but Asia’s central banks must start to deal with post-pandemic considerations. China is already taking measures to reign over liquidity and credit, as well as measures to curb soaring house prices in parts of the country. The economic outperformance has been accompanied by a surge in capital inflows, a currency appreciation and a sharp rise in bond prices, which make macroeconomic management difficult.

For the rest of Asia, the political considerations are even more complex. Economic normalization is still far from over, but currencies and real estate markets have soared. When is the current level of interest rates considered too low? And when should monetary authorities take macroprudential action to stem the scum in the housing market and capital inflows fueling a credit boom?

Markets should be encouraged by the prompt and appropriate actions that policy makers have taken over the past year. As the pandemic began to rage in 2020, major central banks moved quickly to inject liquidity to lower rates to their lowest point, open or increase emergency credit facilities, and provide banks with a range of incentives. to continue to lend.

By the end of the year, the combined balance sheets of the central banks of the G4 economies (US, eurozone, UK and Japan) had jumped to 55% from 35% of gross domestic product. By imposing zero to negative short-term rates, buying a wide range of bonds (and stocks in some cases), and subscribing to money transfer programs, central banks in the industrial world have left little behind. intact in their political toolbox.

Asian central banks also responded in the first year of the pandemic, mainly by lowering key interest rates. South Korea and Thailand moved rates closer to the zero mark, while others cut rates by 100 to 200 basis points. These measures, which brought key rates to historically low levels, were not questioned by the markets as growth collapsed. With the exception of India, inflation rates were modest at the start of the pandemic.

While no central bank in emerging Asian markets has gone as far as the G4 central banks to expand their balance sheets, they have nonetheless taken a wide range of measures to supplement their rate cuts. Regulatory forbearance was exercised to help banks cope with rising credit risk, asset purchases were broadened to support the bond market (particularly in India and Indonesia), and loan guarantees were offered to keep the trade credit and payment system in good working order.

In the first quarter of 2020, the People’s Bank of China took action that was considered fairly measured at the time. In addition to cutting the key rate by 100bp, the central bank lowered the bank reserve rate, carried out major open market operations to inject liquidity and set up credit facilities. But these were carried out gradually over a few months, with less urgency than in other large economies.

There were two major factors at play here. First, China started 2020 with relatively easy monetary conditions. Second, significant progress has already been made in stemming the spread of the pandemic until the second quarter of 2020. As a result, as the pandemic worsened elsewhere in the world during the second half of the year, activity has resumed. vigorously in China, reducing the need for further central bank intervention.

A third factor at play may have been China’s already enormous debt burden and the resulting reluctance by authorities to overstimulate the economy in the face of what was seen as a temporary setback. On the eve of 2021, the PBoC began to withdraw some of its support measures, so much so that market watchers began to assess the extent of the ongoing “ tightening ”.

The combination of successful handling of the pandemic and a sharp rebound in exports made China’s political stance appropriate. But what about the rest of Asia?

Given the extremely difficult circumstances they faced, other central banks in Asia have done quite well. Exchange rates were allowed to act as shock absorbers during the period of acute risk aversion. No brutal measures have been taken to prevent foreign investors from withdrawing their capital, a measure which tends to tempt policymakers in times of crisis but which generally backfires. Little time was wasted in indecision and some regional central banks took advantage of the crisis to consolidate their external finances by obtaining swap lines with the Federal Reserve and by extending the maturity of their sovereign debt.

Some debt monetization has taken place (particularly in India and Indonesia), but given the scale of the crisis and the general lack of inflationary pressure, markets have not reacted negatively to these measures. By the end of the year, regional exchange rates had recovered much of the ground lost in March and April 2020, stock markets had rebounded, debt markets were buoyant, credit spreads were narrowing and liquidity was abundant.

As we move into the second quarter of 2021, it may make sense for regional central banks to be patient, so as not to jeopardize the nascent resumption of last year’s recession. But if global markets start to anticipate the take-off of key US interest rates earlier than expected, it will have a disproportionate impact on emerging markets, ranging from volatility in capital flows and exchange rates to the liquidity squeeze. Guarantees against this phase of market crisis must be put in place now.

Taimur Baig is Managing Director and Chief Economist at DBS Bank Ltd.

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