Policies in Asia Becoming Less Accommodative
With the Greek debt drama occupying center stage at present, policy tightening in Asia has moved into the background. However, the issue hasn’t gone away. Chinese authorities have directed banks to slow down the rapid pace of credit growth, and the Malaysian central bank recently hiked rates for the first time in four years. Will policymakers in Asia tighten too much this year? Is the nascent global recovery in peril?
To understand what is happening now, we must return to the autumn of 2008 when the global economy was melting down. Because the outlook for most Asian economies was so grim at the time, governments in the region took emergency steps—directing banks to lend aggressively and cutting interest rates to extraordinary levels—to support growth. A year later, the global economy is starting to recover and economic growth in Asia has rebounded strongly. Asian governments are now removing some of the emergency measures that are no longer needed.
Will they tighten too much, thereby leading to renewed downturns in the region? Although credit growth will slow and rates will rise slowly, there are few reasons for monetary policy in most Asian economies to move into “restrictive” territory anytime soon. Core rates of inflation are benign at present and, as we argued in a recent special report, there is little evidence to support the popular notion that massive asset price bubbles are inflating in Asia at present.
What Are Central Bankers in Asia Thinking?
Policy tightening in Asia was the worry du jour in financial markets earlier this year before the Greek debt crisis burst on the scene. Although Greece continues to dominate the headlines, the issue of policy tightening in Asia has not disappeared. Indeed, the Malaysian central bank recently increased its main policy rate by 25 bps, the first rate hike in that country in nearly four years. Why are Asian central banks tightening policy at a time when the global economic outlook remains uncertain? Will rate hikes in Asia derail the budding global recovery?
To understand why Asian central banks are starting to tighten monetary policy now, we must consider why they eased policy in the first place. Flash back to the autumn of 2008 when global trade was collapsing in the wake of the failure of Lehman Brothers. Because exports are very important for many Asian countries, the outlook for these economies was rather grim at the time. In response, Asian governments moved to support growth via expansionary economic policies.
Start with China. Not only did the Chinese government accelerate infrastructure spending, but it also directed banks to start lending aggressively. And lend aggressively they did. By late last year, lending was up by more than 30 percent on a year-ago basis (see graph on front page). Due in part to strong credit growth and expansionary fiscal policy, real GDP growth in China bounced back sharply over the course of the year (chart below). Strong economic growth over the past few quarters has not been limited to China. For example, real GDP in Taiwan was up more than 9 percent in the fourth quarter on a year-ago basis. The Indian, Korean and Thai economies posted 6 percent growth rates in the fourth quarter.
In other words, the emergency policy measures that were put in place in late 2008/early 2009 are no longer appropriate now that the emergency has apparently passed. A year ago, when it appeared that the global economy was melting down, Chinese authorities directed banks to open the lending taps in order to support economic activity. Now that global economic activity is starting to recover, and the Chinese economy is humming along again, 30 percent loan growth is not needed anymore. Indeed, inflation—in both goods and asset prices—could become an issue if monetary policy remains extremely accommodative. Extraordinarily low interest rates in most other Asian economies are no longer needed either.
Does this mean that Asian central banks will tighten policy too much in the months ahead, thereby threatening to choke off the recovery in economic activity? Probably not, at least not in the foreseeable future. Although overall rates of CPI inflation have risen in recent months, core rates of inflation generally remain benign. For example, the overall rate of CPI inflation in Korea has moved up from less than 2 percent last summer to nearly 3 percent at present (chart below). However, the increase largely reflects the wild swing in energy prices over the past year or so. The core inflation rate, which excludes energy prices, continues to trend lower and is less than 2 percent at present. Similar stories about inflation can be told in most other Asian economies as well.
In addition, there is not much evidence, at least not in our view, to support the notion that massive bubbles are forming in Asian asset markets. (For further reading see “2010: Year of the Tiger or Asian Bubble?”, which is posted on our website.)
Will loan growth slow in China and interest rates rise in other Asian countries over the course of 2010? Yes. However, monetary policy settings will move from extremely accommodative back toward “neutral.” Most Asian governments have historically shown a preference for policies that support economic growth. With few inflationary pressures at present, policies in most Asian countries likely won’t become “tight” for a few more years.
Wachovia Corporation
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