The battle against Covid-19 is by no means over, but Asia’s central banks must start confronting post-pandemic considerations. China is already taking steps to reign in liquidity and credit, along with measures to curb property price surges in some parts of the country. Economic outperformance has come with capital inflow surge, an appreciating currency and a marked rise in bond prices, all of which are making macroeconomic management challenging.
For the rest of Asia, policy considerations are even more complex. Economic normalisation is still a way off, but currencies and property markets have soared. At what point is the current level of interest rate deemed too low? And at what point should monetary authorities take macroprudential measures to stem property market froth and capital inflows fuelling a credit boom?
Markets should be encouraged by the prompt and appropriate actions policy-makers have implemented over the past year. As the pandemic began to rage in 2020, major central banks acted expeditiously to inject liquidity to bring rates to their floor, open or augment emergency credit facilities and provide banks with a range of incentives to keep lending.
By the end of the year, the combined balance sheets of the central banks of G4 economies (the US, euro area, UK and Japan) had jumped to 55% from 35% of gross domestic product. By imposing zero to negative short-term rates, purchasing a wide array of bonds (and stocks in some cases) and underwriting cash transfer programmes, central banks in the industrial world have left little untouched in their policy toolbox.
Asian central banks also reacted through the first year of the pandemic, primarily by cutting policy interest rates. South Korea and Thailand took rates towards the zero bound, while others cut rates by 100 to 200 basis points. These moves, which brought policy rates down to record-low levels, were not questioned by the markets as growth was collapsing. With the exception of India, inflation rates were modest coming into the pandemic.
While no central bank in Asian emerging markets went as far as the G4 central banks in expanding their balance sheets, they nevertheless took a wide array of actions to supplement their rate cuts. Regulatory forbearance was exercised to assist banks with dealing with rising credit risk, asset purchases were expanded to support the bond market (especially in India and Indonesia) and loan guarantees were offered to keep the system of trade credit and payments operating seamlessly.
In the first quarter of 2020, the People’s Bank of China took steps that were seen as fairly measured at the time. Besides cutting the policy rate by 100bp, the central bank cut the reserve ratio for banks, carried out large open market operations to inject liquidity and set up lending facilities. But these were done incrementally over a few months, with less urgency than in other major economies.
There were two major factors at play here. First, China began 2020 with relatively easy monetary conditions. Second, significant headway was already being made to stem the spread of the pandemic through the second quarter of 2020. Therefore, while the pandemic worsened elsewhere in the world during the second half of the year, activity resumed vigorously in China, reducing the need for further central bank intervention.
A third factor at play may have been China’s already formidable debt burden and a resulting reluctance on the part of the authorities to overstimulate the economy over what was seen as a temporary setback. As 2021 dawned, the PBoC began withdrawing some of its support measures, so much so that market observers began assessing the extent of ‘tightening’ taking place.
A combination of successful pandemic management and a roaring rebound in exports made China’s policy stance seem appropriate. But what about the rest of Asia?
Considering the extremely challenging circumstances they faced, other central banks in Asia did quite well. Exchange rates were allowed to act as shock absorbers during the period of acute risk aversion. No abrupt measures were taken to prevent foreign investors from withdrawing their capital, a measure that tends to tempt policy-makers during times of stress but typically backfires. Little time was wasted in indecision and some regional central banks used the crisis to shore up their external finances by securing swap lines with the Federal Reserve and extending the maturity of their sovereign debt.
Some degree of debt monetisation took place (especially in India and Indonesia), but given the size of the crisis and a general lack of inflationary pressure, markets did not react adversely to these measures. By the end of the year, regional exchange rates had recovered much of the ground lost in March and April 2020, equity markets had rebounded, debt markets were buoyant, credit spreads narrow and liquidity ample.
As we enter the second quarter of 2021, it may make sense for regional central banks to be patient, so that a nascent recovery from last year’s recession is not undermined. But if global markets begin to price in policy interest rate lift-off in the US earlier than expected, it will have an outsized impact on emerging markets, ranging from capital flow and exchange rate volatility to liquidity squeeze. Safeguards against that phase of market tantrum need to be built now.
Taimur Baig is Managing Director and Chief Economist at DBS Bank.