Asia is feasting on a massive monetary stimulus. This made sense when the world was dangling over the precipice. But, this is no longer the case.
The central banks in Asia most attuned to US growth risks are in Korea, China, Taiwan, Singapore, and Thailand, “but, the needle needs to be pushed back to neutral everywhere, quickly,” said Frederic Neumann, co-head of Asian economics at HSBC.
Interest rates in the region are on average 150bp to 200bp below neutral, he told FinanceAsia. China, India and Indonesia, in particular, need to act rapidly, and the time for small, incremental rate hikes has ended.
The willingness of policymakers to act should have been given a boost by recent US economic data.
The December ADP employment change report released on January 5 showed that US private employers added a staggering 297,000 jobs, compared with the revised estimate of 92,000 added jobs back in November and much higher than median estimates of 100,000 jobs.
Asian “officials should now be more comfortable to do what's right and tighten up around here. They've played on the defensive for too long out of fear the US might buckle,” but Wednesday’s “labour market data should dispel that worry”, said Neumann.
Prolonged monetary accommodation can cause damage in at least three ways: inflation, asset bubbles, and excessive investment. If money is kept cheap for too long then “financial instability invariably ensues”.
Although Neumann acknowledged that low interest rates and printing money doesn’t always lead to inflation – such as when banking systems are bust and loans are hard to get as seen in the West recently and in Japan for two decades – those mitigating factors aren’t present in emerging Asia. Here, banks are healthy and credit growth is picking up. “So, easy money should have its usual effects,” he said.
On the other hand, the current global output gap could continue to restrain price pressures, so that “Asia gets away with it” for a while. But, it is likely to be temporary, not least because there is little slack in agricultural production, which determines a third of Asia’s CPI basket.
The second concern is asset bubbles. “Give people cheap money, and they'll do silly things; give them free money, and they'll do even sillier things,” said Neumann. Leverage is gradually starting to build, and the narrative that Asia's rise is making things ‘different this time’ is sneaking up on investors. As he pointed out, Asia has been here before.
Neumann argued that “throwing in some regulatory sand” in an attempt to curb any incipient bubbles is “not terribly reassuring”. But, higher interest rates would force an answer to the question of when a healthy rally ends and a bubble begins. Besides, bubbles never grow the same way and new avenues are frequently found to exploit the returns that cheap money offers.
“Regulators can only chase the obvious ones; everyone else will be hiding in the thicket quietly making their buck until duly exposed when interest rates eventually do begin to rise,” he said.
Finally, there is the third concern – and one which central bankers tend to be less vigilant about. This is the danger of excessive public and private investment prompted by a low cost of funding. Simply, “cheap money spurs investment”.
Of course, as Neumann pointed out, this is an intended effect of monetary loosening. But, if rates are kept low too far into the recovery, investment will keep rising at an unreasonable pace. Asia, he said, is especially vulnerable because cheap money “encourages local firms to build empires and governments to race their countries towards the future”, rather than channelling the focus into private consumption.
The result might be excess capacity which undermines returns and can shake the financial foundation of an economy.
“Whatever combination occurs, it is clear that the consequences could be dire if monetary accommodation persists on this scale. Rates need to go up,” concluded Neumann. Fortunately the strong US payroll data means that policymakers in the region can feel more confident about acting decisively.