Do you ever find that when you meet someone important - their presence seems to stay with you, dominate your thoughts for the next few days to come? This is what recently happened to David Fernandez, a Singapore-based economist with JPMorgan who specialises in emerging markets.
He chatted with Finance Asia a day after he listened to Robert Mundell, who won the 1999 Nobel Prize in economics for his groundbreaking 1960s analysis of exchange rates that helped lay the intellectual groundwork for Europe's common currency. But, in the 1960s Mundell also espoused the notion that a unified currency for Asia could work. Not likely anytime soon, but it does get you thinking (about more than just the comforting notion that even Nobel laureates can get things wrong). Mundell got Fernandez thinking and talking about the role of central bankers in Asia's emerging markets.
Do you think a unified Asian currency is possible?
Fernandez: In 1969 Mundell published a paper entitled, "Plan for a European Currency". It took 30 years for that dream to be realised. Yes, I think a unified currency is possible, but 30 years would be an optimistic forecast, in my opinion.
But central bankers in the region are trying to work together more, aren't they?
I just think that over time we're going to continue to hear more and more about central bank cooperation in Asia. What do we have concrete so far? We've got the Chiang Mai initiative and the swap lines. We've got Asian Bond Fund I and now ABFII. And yes, I think all of these things the market should roll its eyes at and say, 'What does it all mean? Does it have any impact?'
That's because the details of all these initiatives make them pretty unimpressive on their own. But what is impressive is July 21 (the fact that central banks across the region were ready for, and responded to China's slight adjustment of its monetary policy.) And that's what happens when you talk to each other all the time.
That's what ABF and these types of initiatives actually did. It takes a dozen central bankers, meeting on a regular basis to set up what people characterize as unimpressive swap agreements and unimpressive ABFs, but they've all been flying back and forth meeting each other on a regular basis and they have a conference call system set up between them and talk to each other on breaking issues. And that means going forward you have a building of trust and infrastructure that's going to facilitate the proper initiatives. This is how it begins.
Let's look at the regional central banks. Do you think the central bank in Indonesia should have raised interest rates faster?
I think the central bank waited too long. It was clear that inflation was going to keep drifting higher even absent the removal of the fuel subsidies. But if you look back to even the elections a year ago, central bank policy had already loosened then. And that carried on for such a long time that by the time the headline inflation started to really move up, the central bank was well behind the curve. So it was very worrying and not surprising then that the currency came under such severe pressure as it did just a few months ago.
But what they've done since then is pretty impressive in terms of how quick and how hard they are responding with rate increases.
We're at 12.5% now, yes inflation is about 18% on the headline but in part that's because October was the perfect storm of inflation pressures with the subsidy lift and increases in prices of food right before a holiday. If you look at the month-to-month number it is about 8%... but much of that was due to transportation, food and other month-specific inflation increases. If you look at the non-core inflation it was up 2.5%, which is still high but perhaps not as bad as it looks initially.
So while 12.5% doesn't quite match up with 18% inflation what the central bank seems to be saying is, "Yes, current inflation is high but there are lots of one-off factors and we think it's going to come down.' And that's a bet that I think is a fairly sound one for them to make. I think you could see inflation come down to about 15% in the middle of the year and then down toward where rates are now by later in the year. I think they will still have to hike rates again, to maybe 13% before year end, but what I'm increasingly more positive on about Indonesia is that if you look at the currency it stayed very well contained after that big spike. So what I think BI is very close to achieving is recovering that credibility it lost during that big period of inactivity.
How long will Indonesiahave to continue to hike rates?
I think when we get to 2006 you might start seeing interest rates fall. BI won't have to pause for that long. As long as the currency stays stable, I think they can be confident enough to cut rates. Right now, I think that after peaking out at about 13%, you could be in single digits next year - so we could be seeing about 300bp to 400bp of rate cuts in Indonesia.
This would be in the face of everywhere else adding to their interest rate hike calls. We see the Fed going to 5%. We see ECB doing 100bp next year. Korea, India everyone else is going to be adding some interest rate hikes next year. Indonesia has just packed it all in, in a short time period - they've had the worst of an inflation hike, but now they're poised to go in the right direction.
What about Malaysia's economy?
Let's start with China. The market shouldn't be yawning about July 21 and only pricing in very small moves in the next few months. I think you could still see 12-13% appreciation from where we stand now, to end of next year.
So on the back of that China call we see the ringgit going to M$3.5 to the US dollar next year. So there could be some interest rate moves in Malaysia, but it's going to be primarily in the currency appreciation where you're going to see monetary policy tightening.
As for foreign investors, what they should be focussing on, and are, is getting more involved in the fixed income markets. I think people should realise that Malaysia isn't just a currency play, as interest rates go up elsewhere, Malaysia is going to be a relatively safe haven, they are just not going to move their interest rates up very much and at the same time you have the possibility of local currency appreciation.
On a fundamental basis, the key thing is this is an economy whose growth potential is rising - I can't say that about a lot of countries that I follow. And because it's built on human capital, it's a sustainable story and one with jobs.
The great thing is that Indians believe their own story. And so that's why you have non-resident inflows continuing to bring money back. You have locals who have never participated in equity markets, slowly accumulating stock holdings. And I think this is going to continue on a sustainable level for many years.
And at the same time, the political problems and noise that one historically gets from New Delhi is increasingly unimportant to the markets. It's not that government necessarily has cleaned up its act - you still have consolidated deficits that are in the high single digits - it's that the private sector firms are the story in India and they can operate even if there are problems at the government level.
BI are hiking rates slowly - they are gradualists to the extreme - but by doing so very incrementally they are letting the markets run, and I think they have good reason. I really like the India story.