By V Anantha Nageswaran
For a while, at least, Asian currencies are caught between rocks and hard places. We struggle to construct realistic scenarios under which Asian currencies rally. Only a credible and reasonably aggressive policy response to the inflationary impulse washing through the region would do that. It would restore policy credibility, improve local currency returns for domestic savers, and slow import growth, thereby acting to restore trade surpluses. The actions of most regional central banks thus far, however, fall short of what is needed.
While exports in some countries have softened of late, the negative impulse from global slowdown remains modest. Policy, however, has for some time been set for a sharp growth slowdown and fears about imminent export slowdown have dominated policy announcements for quite some time. While more recently this has been joined by verbalized concern about inflation, the relative inaction of central banks suggests that concerns about future growth still dominate. The effects of this policy loosening were compounded by the food price shock, and the existence of price control regimes in a number of markets, which concentrated the adjustment in a way which did not occur in countries with freer pricing regimes.
Our economists, therefore, argue that not only is inflation in Asia generally likely to remain high over the next few months, and even increase further in a number of countries, but it is likely to be much slower to come down than most expect. It is no coincidence that Taiwan and Singapore have had the strongest performing currencies this year, and they are the only central banks that are tackling this issue reasonably proactively.
The key here is that it would be a mistake to argue that high commodity prices are the only reason policy settings have ended up being too loose. Policy was set for recoupling in almost all markets in Asia, and yet decoupling in exports and GDP growth has persisted. Chart 3 (see below) shows an average core CPI for Asia ex-Japan. Clearly, once we account for the contributions of food and energy price inflation, Asia’s inflation issues are not settled. Along with concerns about policy being too loose, growth decoupling has contributed to a surge in imports, which has been compounded by the rise in commodity prices, to result in sharply worse trade balances. Decoupling has ended up not being all that it cracked up to be.
Source: Emerging Markets: FX Road Map (June 2008), HSBC Global Research
Certainly, the independence of central banks is an issue. As well, the political environment in many countries is doing little to help central banks respond to the inflation threat in a way which is most prudent from a longer term perspective, but also most uncomfortable from a shorter-term perspective.
[All of the above capture our views on Asian macro-economic policy rather well and are excerpted from the following publication: “Emerging Markets: FX Road Map (June 2008)” from HSBC Global Research]
Realistic to have assumed no de-coupling
To be clear, it was realistic on the part of Asia not to have assumed de-coupling on the part of Asia from the ongoing troubles in America. But the mistake was in setting “no decoupling” policies proactively without waiting for slowdown to set in, in American consumer spending. American consumer is yet to flinch and, perhaps, is acting with even higher than usual optimism in visiting shopping malls. They are trying to drown their blues in shopping and, in the process, setting themselves up for deeper blues in the years ahead.
But, policy was set in anticipation of slowdown
The important point here is that consumer-spending weakness in the U.S. is yet to set in. But, global monetary policy is too loose already as this chart below from JP Morgan shows. The global policy rate is far below where it ought to be, according to the simple rule devised by a U.S. academic John Taylor teaching in Stanford University.
Source: Global Data Watch, Economic Research, JP Morgan Chase Bank, New York, June 20, 2008
Be prepared for deeper and longer downturn
The troubling message from the chart above is that there is not much room to ease policy (and we include fiscal policy too) when they are likely to be most needed in 2009 – when the consumer in the U.S. wakes up to the reality. The absence of policy lever should lead to the acceptance that the economic impact on Asian households and the earnings impact on Asian corporations would be deeper and longer.
Where is the floor for Asian asset prices? – lower than you think
What is clear is that the price for these policy errors has to be paid in the form of lower asset values. That means weaker currencies, higher bond yields and declining stocks. The process is currently under way. Most of the Asian stock markets have yet to breach the previous lows reached either in January/February 2008 or in July 2007. That has to happen first. Hence, prices must first reflect bad news. Second, the flow of bad news must stop. Since much of the bad news is in the form of policy errors, the turnaround must start there. That is, policymakers must acknowledge their mistakes, promise a credible timetable for reversing them and begin to implement a few steps. Frankly, we are far away from that in Asia as admitting mistakes in public is not very Asian. Therefore, the floor for Asian assets is probably lower than it is for other regions, particularly in the West.
(These are the author’s personal opinions and do not necessarily reflect those of his employer)