One risk to Asia’s recovery has been the fear that the US Federal Reserve Bank will soon begin cutting back on its monetary stimulus, potentially producing a repeat of the ‘taper tantrums’ that roiled Asian and other emerging markets in 2013.
At that time, an unexpected statement by the then Fed chairman, Ben Bernanke, signalling a reversal of the Bank’s monetary easing, had precipitated massive outflows from bonds and equities in emerging markets. That resulted in sharp currency devaluations and a loss of confidence in those economies.
The good news is that the Fed has learnt lessons from 2013 and is managing expectations better this time. The tapering risks to Asian emerging markets have been contained.
Easy money until 2022
In his opening speech at the recent Jackson Hole, Wyoming, conclave of the world’s central bankers, Fed chairman Jay Powell gave a strong hint that the Fed will begin tapering off its monetary easing policy by December. It will do so by reducing in stages the amount of bonds it purchases, with the process ending around the middle of 2022. It is likely that US monetary policymakers will then carefully assess the possible trajectory of the US economy before deciding when to start the process of raising their policy rates.
With the possibility diminished of abrupt capital outflows from an unexpected change of Fed policy, the risk appetites of global investors are likely to improve
The Fed has done a favour to emerging markets by providing an early indication of how it will shape policy. It also helped that Powell distinguished between tapering off bond purchases (probably soon and seen as relatively benign) and jacking up interest rates (still a long way away and seen as more threatening to emerging markets).
Consequently, Asian emerging markets are much less at risk from abrupt capital outflows caused by an unexpected change of Fed policy. With this downside possibility diminished, the risk appetites of global investors are likely to improve – which should help maintain the flow of external money needed to fund public sector deficits and corporate expansion projects in the region.
In addition, central banks and other financial supervisory agencies in Asia have a longer runway to prepare measures to mitigate the risks posed by the Fed’s tightening moves. For instance, they can use this time to pre-emptively mitigate vulnerabilities in the region, such as the high levels of foreign currency debt taken on by Asian corporate borrowers.
Monetary policy in Asia
There are other implications for Asia, in terms of how monetary policy is conducted. The first is that the tapering off of bond purchases by the Fed will over time result in less liquidity being pumped into financial markets around the world. As liquidity conditions tighten, the room for further easing by central banks in Asia could be constrained. That would be awkward because the regional economies are in need of more monetary support as new surges of Covid infections depress economic prospects.
Indeed, of late, growth forecasts have been downgraded in Thailand, Indonesia and the Philippines, leaving central banks in a quandary. Take Indonesia. Under pressure to provide more monetary stimulus but fearing pressures on its currency should it cut rates, Bank Indonesia has now extended the unconventional debt monetisation scheme with the government, under which the central bank helps to finance public sector deficits. Although financial markets are not comfortable with such a potentially inflationary policy, they have tolerated it as a one-off. More such unconventional policy approaches could, however, rattle markets.
On a more positive note, the second implication is that the Fed’s clear indication that it will not be in a hurry to raise rates gives Asian central banks flexibility in deciding when to normalise their monetary policies. Assuming that the Fed raises its policy rate some time in early 2023, we expect the regional central banks to begin normalising their monetary policies towards the end of 2022.
Watch out for Indonesia, Malaysia and the Philippines raising rates in the last quarter of 2022. Thailand is likely to move later given the more parlous state of its economy, which is dependent on a revival in tourism that we do not see materialising until well into 2023.
The much feared risk of another taper tantrum has now been reduced. Policymakers in Asia can use the breathing space gained to build defences against what could go wrong when liquidity is less plentiful and interest rates have to rise. All in all, this is a much better outcome for the Asian economies than we had expected.