Central banks in Korea, Malaysia and Thailand raised interest rates in the past two weeks, joining other recent tightening by central banks in India, Taiwan and Australia. We view this as a vote of confidence that Asian economies will continue to pace the global rebound, weathering any drag from the European debt crisis.
Conspicuous in their absence are Japan and China, the two largest economies in the region, which have yet to raise rates. The Bank of Japan is widely expected to maintain its overnight rate at near-zero indefinitely in the face of lingering deflation.
The People’s Bank of China represents perhaps the biggest question mark, having refrained a little longer than originally expected from tightening rates, but taking other steps to rein in money and credit growth. On another front, last month opened the door for gradual FX appreciation of their currency. We see China as likely to begin raising interest rates sometime during the second half of this year.
Asia has paced the global turnaround, with most nations swinging to positive quarter-on-quarter GDP growth in the second quarter of 2009, continuing into the first quarter of this year. Monthly data suggest that second quarter GDP reports will show healthy growth sustained through mid-2010. Singapore has just reported a 19.3% year-on-year GDP growth in the three months to June, while China said its GDP expanded 10.3% in the same period.
The reversal of the run-up in commodity prices, together with the ballooning in excess capacity in the face of the economic slowdown, initially provided considerable relief on the inflation front. Inflation typically slowed to multi-year lows during 2009, with many economies posting year-on-year declines for at least a few months, even if understating the underlying sequential pace of inflation.
Although by late-2009 inflation was generally swinging positive year-on-year, as the year-ago comparisons became less flattering, inflation generally remains fairly well contained.
The exception on the inflation front has been India, where the wholesale price index (WPI), utilised by the central bank as the broadest inflation gauge, rose to +11.0% year-on-year in April. That’s the highest since October 2008 and sharply up from -1.0% year-on-year in June 2009.
In addition to the base effect in comparison with the swing in global commodity prices a year earlier, the WPI has been boosted by food prices rising nearly 20% year-on-year in early December (though easing to 12.6% year-on-year through 26 June), under pressure from shortages as dry monsoons cut farm output.
But Indian economic growth has been impressive, with GDP bouncing +8.6% year-on-year in the first quarter after annual growth of +6.8% year-on-year in calendar 2009. Growth is projected at +8.5% year-on-year in 2010, trailing only China among the major economies. In this environment, the Reserve Bank of India has hiked its repo rate by 25 basis points three times beginning in March.
Also hiking three times beginning in March 2010 has been Bank Negara Malaysia. It has raised its target overnight interest rate a cumulative 75 basis points to 2.75%, after holding steady at a record-low 2% from February 2009, following cuts by a cumulative 150 basis points to counter the global downturn.
Governor Zeti Akhtar Aziz has emphasised that this represents a “normalisation” from the accommodative policy, as economic growth recovers. Inflation has picked up to +1.6% year-on-year in May from -2.4% year-on-year in July-August 2009, the lowest in nearly 30 years of data, but it remains moderate, projected to average +1.8% year-on-year in 2010.
We expect that this will allow the central bank to pause after their latest tightening, perhaps holding steady through year-end.
The Bank of Korea tightened its repo rate to 2.25% on 9 July from the record-low 2% in place since February 2009. We look for them to hike by another 0.5% by year-end. The Korean economy has rebounded strongly following the collapse of exports at the end of 2008, back to +8.1% year-on-year in the first quarter of 2010, though exaggerated by comparison with -4.3% year-on-year in first quarter 2009.
The BoK has revised up its annual growth forecast for 2010 to 5.9% year-on-year from the previous 5.2%, while raising their projection for annual CPI to 2.8% year-on-year from the previous 2.6%.
Amid evidence of stronger economic growth, a noteworthy 21 June report from the Ministry of Strategy and Finance cited the government’s aim to “normalise” macroeconomic policies, apparently opening the door for monetary tightening. Central bank officials had appeared to hold back during the first half of 2010 in the face of government opposition, including the unusual episode of the vice finance minister attending the BoK policy meeting on 8 January.
The Bank of Thailand has raised by 25 basis points its overnight repo rate from the record-low 1.25% level prevailing since last April, after cutting rates a cumulative 2.5% beginning in December 2008. Officials have expressed satisfaction with the export-led rebound in economic activity, highlighted by GDP climbing +12% year-on-year in first quarter 2010, from -7.1% year-on-year a year earlier.
The central bank has expressed relief as the recent political turmoil appears to have calmed after widespread protests came to a head in May. It should now begin tightening to keep up with CPI, which stood at +3.3% year-on-year in June, with the core a more modest +1.1% year-on-year. Incoming central bank Gov Prasarn Trairatvorakul, nominated to take office in October, told reporters he expected the benchmark policy rate to rise gradually to 2% by the end of the year – and who are we to argue?
In contrast, the Philippines held rates steady at a record low of 4% for a ninth consecutive month at its 15 July meeting. Bangko Sentral ng Pilipinas Governor Armando Tetangco has described inflation as remaining manageable, falling to a seven-month low of 3.9% year-on-year in June, even as the domestic economy gains steam, with GDP growth picking up to +7.3% year-on-year in first quarter 2010.
Along with firmness in the peso, which finished April at its strongest in two years versus the US dollar before pulling back amid the heightened risk aversion during May-June, economic growth has allowed the central bank to remain patient on rates. Nevertheless, we expect interest rates to rise to 4.25% in August and 4.5% by year-end, though it will be a close call, dependent upon developments on the inflation and foreign exchange fronts.
Bank Indonesia appears relatively patient, too. It maintained its one-month central bank paper rate at 6.5% at its 5 July policy meeting, having held steady after trimming by a cumulative 300 bps through Aug 2009. In their statements, officials have reiterated that the central bank sees no need to change interest rates in 2010 because inflation would be within its target band of 4-6% this year and next.
We suspect that Indonesia might still see the need for a 25 bps hike to 6.75% in the fourth quarter, in line with our projection for CPI to pick up from 5% year-on-year in June to 6% year-on-year by year-end, though officials continue to sound more optimistic. It might be noted that even 6.75% would remain a full 125 basis points below the low of 8% in first half 2008 during the previous easing cycle.
China is perhaps the biggest question mark, having refrained a little longer than originally expected from tightening rates, but taking other steps to rein in money and credit growth. The Chinese economy has rebounded strongly, supported by an aggressive stimulus policy adopted in late 2008 in a successful effort to counter the global financial crisis..
The strong GDP data, along with CPI inflation picking up to a 19-month high of 3.1% year-on-year in May, suggest that it is time to begin to withdraw some of this stimulus. Together with concerns about over-investment and the quality of bank assets, these would appear to set the stage for monetary tightening.
However, like the statements from other Chinese government policymakers, the PBoC is prone to emphasise the need for gradualism, talking of the need for “appropriately accommodative” monetary policy to maintain economic growth in the face of threatened global slowdown.
So far the People’s Bank of China has refrained from hiking interest rates, holding its benchmark one-year lending rate steady at 5.31% since December 2008. However, the PBoC has taken steps on several fronts to curtail the abundant liquidity in China's markets, including raising reserve requirements in May for a third time this year, though this has been complicated by continued foreign exchange reserve accumulation.
The mid-June announcement that Beijing would allow gradually greater exchange rate flexibility for the CNY opened the door for renewed appreciation. It has been allowed to appreciate by a cumulative 0.8% during the first three weeks, to near 6.77 versus USD after having been pegged at around 6.83 since July 2008. China had generally been expected to allow renewed appreciation as a tool for helping contain reemerging inflation pressure. Our projection is for them to tolerate appreciation versus USD at a 5-8% annual pace, not that different from the period before July 2008.
It remains to be seen when the PBoC will proceed to round out its efforts at restraint by increasing interest rates. Markets had been expecting them to begin raising rates around mid−2010, though forecasts have been pushed back, at least a few months, partly in the face of the additional global uncertainty surrounding the euro zone woes. We now look for the PBoC to begin raising the one-year lending rate from 5.31% to 5.58% at year-end, though like other central banks they will be watching the trajectory of inflation and GDP growth.
About the Author
David L. Cohen is the Director of Asian Economic Forecasting for Action Economics, LLC. He was previously Asian Regional Director of Economic Forecasting at MMS International, and an economist at the Federal Reserve Board of Governors in Washington DC. He obtained his B.A. in Economics from University of Pennsylvania, M.S. in finance from Massachusetts Institute of Technology, and M.A. in economics from the Ph.D. program at Stanford University.