Hong Kong: The global fallout from Greece’s debt crisis is likely to put monetary policy tightening in Asia on hold, at least until central banks see clear signs that European demand for exports will not be affected.
Asia’s central banks have led the world in raising policy rates as the region recovered faster than elsewhere from the global economic downturn.
But those prospects, combined with the region’s relative fiscal health compared with a debt-heavy developed world, raises the risk of a pick up in portfolio investment that could provoke policymakers into imposing more capital controls before the end of 2010.
A $1 trillion emergency package hatched by EU finance ministers, central bankers and the IMF to calm financial markets and ensure the stability of the euro, will help prevent a repeat of 2008’s mad rush for US dollar funding after the collapse of Lehman Brothers.
Still, Asia’s policymakers have consistently erred on the side of high-speed growth. So in the face of nagging uncertainty about the solvency of countries like Greece and Portugal, they will maintain a loose stance, even if it means higher inflation and asset prices.
“Central banks that haven’t started their tightening cycle by now are unlikely to start it in the near future, probably the rest of the year,” said Glenn Maguire, chief Asia economist with Societe Generale in Hong Kong.
“There will be extreme caution displayed by Asian central banks in terms of removing emergency settings of policy that were put in place during the subprime-Lehman crisis,” he said.
The Malaysian central bank will be first test case when it reviews policy on Thursday. After it surprised markets in March by raising rates for the first time since the global downturn, some money had bet on another rate rise this month.
Those expectations have been whittled down and some economists said the chances Bank Negara Malaysia will carry out a second interest rate increase in the current cycle have fallen significantly.
Rate hikes are off the table for now in China, which has raised bank reserves requirements three times this year, and a shift in yuan policy is likely delayed.
India, which raised policy rates twice this year, may have to tolerate higher inflation and South Korea, on hold since February last year, is unlikely to move at all this year.
A policy freeze will keep the average GDP-weighted policy rate in emerging Asia around 4.1%, or 261 basis points below pre-Lehman levels, JPMorgan data showed. The ECB rate is 1.0%.
The nagging worry for emerging Asia’s policymakers is that Europe’s export demand could take a hit if fiscal spending has to be significantly cut as euro zone governments try to get their budget deficits back to the bloc’s 3% limit.
China’s exports to Greece, Ireland, Italy, Portugal and Spain only account for 3.5% of total exports. However, shipments to the European Union make up 20% of the total for China, 13% for New Zealand and 12% for both South Korea and Japan.
“It’s early days, but the risk is that there could be more contagion and it could cause slower growth in Europe. We know that even with good fundamentals Asia is very much inter-linked with Europe and the United States,” said Rob Subbaraman, chief Asia economist at Nomura in Hong Kong.
Indeed, for all the talk of regional integration, Asia is still highly dependent on external demand and economic activity. In every Asia ex-Japan economy, the value of goods and services imported from outside of the region for export production exceeds the OECD average, a paper from the IMF said in April.
Haven in Asia
Once the dust settles on the series of policies set in place in the past week to support Europe and the euro, portfolio flows may resume in earnest to emerging Asia, which is unencumbered by heavy borrowing and whose long-term growth prospects are bright.
Indeed, rather than running public deficits as a ratio of GDP, Asia ex-Japan economies ran an average surplus of 4.1% in 2009 and are expected to have a healthy surplus of 2.9% this year.
Economists at Bank of America-Merrill Lynch found that emerging Asia’s vulnerability to financial shock has declined in the last year.
South Korea, Indonesia and Malaysia are the three most susceptible to external macro shocks, on the basis of foreign exchange reserves-to-short term debt.
However, all three have seen their reserves rise and debt shrink since the credit crunch began in 2007.
Commercial banks in Europe are also unlikely to cut their credit flows to the Asia Pacific region if the Greek debt crisis escalates.
As of last year, European lenders had increased their lending to emerging markets, including Asia, by double digits compared with the five-year average, but cut lending to developed countries, Bank for International Settlements data showed.
Asia will continue to behave more like a low beta, or haven for assets, in the wake of the Greek debt crisis, analysts said.
As a result, Manu Bhaskaran, chief executive of consultancy Centennial Asia Advisors in Singapore, believes Taiwan, India and China will add to existing measures to control the flow of incoming capital.
The deflected money flows may then try to head to other Asian countries, pressuring policymakers to enact more administrative measures to prevent overheating in assets like property.
“You hope to deter capital by having restrictions in favoured asset classes,” said Bhaskaran, who has advised the Singaporean government on economic matters.
Such controls are finding some acceptance globally. The International Monetary Fund said in a report in April that capital controls or tighter fiscal policy were options to curb capital inflows.
Robert Prior-Wandesforde, senior Asian economist with HSBC in Hong Kong, said after the exchange rate volatility of the past week, policymakers may allow their currencies to gain several percentage points against the dollar before intervening to curb the strength.
Intervention would be just to ease the pain on exporters, though.
“It’s a wall of money that they face. They can’t in my view stop appreciation through intervention, they can only slow it,” he said.