Finance ministers and central bank officials of the 10-member Association of Southeast Asian nations (Asean) and those of Japan, China and South Korea met this week in Chiangmai, Thailand, to discuss, among other things, the issue of managing the sizeable capital that continues to flow into Asian stocks and property from overseas. They achieved very little. One country that has perhaps done the most to handle the problem did not figure in the list of invitees—India. That is a shame. An initiative that has excluded India will remain incomplete (as it did this time around), for India’s most recent experience in dealing with credit and asset price bubbles would be valuable for the members of this self-styled group.
Notwithstanding criticisms of its recent actions by some economists, the Reserve Bank of India (RBI) has stuck to its mission of curbing speculation and the influence of excess liquidity on India’s credit growth and asset price bubbles. It should not matter if India’s asset markets achieved a hard landing via sharply lower prices. What matters is whether the Indian economy achieves a soft landing with growth slowing down to around 7%. If growth holds above 7% and inflation drops to a range of 4% to 5% in the next one year, then RBI would have pulled off a wonderful policy feat. It stuck to its guns even when the government did its best to undermine the efficacy of its policy. Now, the government has meekly fallen in line with the central bank. If, in the bargain, the animal spirits and new-found corporate resurgence were to fade away because of the recent credit tightening measures, then they were neither real nor sustainable anyway.
RBI is worthy of emulation by central banks in the developing and developed worlds. Most of them, notably the US Federal Reserve and the Bank of England, have failed to perform their basic duties of regulation. This is now becoming apparent as lending and borrowing excesses committed in the US mortgage industry come to light. The light-touch regulation of the hedge fund industry is another case in point. They have become ubiquitous and find their way into ordinary investors’ portfolios through retail banks. Yet, they are largely unregulated, their investment practices non-transparent and their systemic risk immeasurable. In the name of laissez-faire, regulators have abdicated their duty. In comparison, RBI has been more mindful of systemic risk.
When institutions such as the World Bank publish annual surveys of international countries on the business friendliness of their policy framework and institutions, they would do well to go beyond micro-definitions of investor protection and judging them solely through the prism of corporate governance and independence of the board of directors. A central bank that switches off the music when the dance floor is full protects investor value in the medium to long term, compared with those that have frozen in their tracks either wilfully or otherwise.
The best tribute to the macro management of RBI came when the People’s Bank of China (PBoC) took a leaf out of the book of RBI, and raised the reserve requirement to 10.5% on 5 April and pointedly announced that it would use multiple instruments to achieve its policy objectives—a phrase that RBI had employed recently. It was either indirect observation or direct policy consultation that had resulted in PBoC following the footprints of RBI.
Asean governments have been largely clueless about dealing with capital inflows. Thailand has now found out that its capital controls are largely ineffective while Vietnam made a lot of noises about restricting capital inflows and did nothing. The Philippines central bank governor acknowledged that the long-term interest rates were too low, but again, there was no follow-through. Perhaps, the seduction of asset price inflation is too strong to resist, even if it were fuelled by speculative inflows and, ultimately unsustainable.
These inflows continue to prop up Asian stock markets and real estate, despite the lack of domestic economic strength. The central banks continue to accumulate foreign exchange reserves. It is one thing to prepare for a new version of the 1997 crisis by accumulating forex reserves, and it is another thing to use macro-economic stability to strengthen the economy and deliver long-term growth. Most East Asian nations—small and medium—have failed to do that. In the process, they have rendered their economies more vulnerable to the next global economic downturn whose probability is increasing, by the day. When the tide goes out, it is not just the speculative investors in Asian stocks and real estate who will be found swimming naked.
V. Anantha Nageswaran is head, investment research, Bank Julius Baer (Singapore) Ltd. These are his personal views and do not represent those of his employer. Your comments are welcome at firstname.lastname@example.org