Central banks in many Asian economies have considered interest rate cuts or other forms of monetary easing in response to the lacklustre performance of the global economy, says the Economist Intelligence Unit Limited.
While growth in Asia will be higher in 2013 than it was in 2012, growth prospects in many Asian economies are being revised downwards.
Over the last quarter, six major economies in Asia have cut interest rates, with three of those being in the first half of May. Following many months of loose monetary policy in other regions, monetary stimulus is spreading across Asia.
The major scene of monetary loosening in Asia is in Japan. The recently elected Liberal Democratic Party (LDP) government is determined to end deflation and boost the economy.
"Many of the measures that the new administration of the prime minister, Shinzo Abe, is promoting—such as steps to boost private consumption, and monetary easing—have been tried unsuccessfully before, but the key differences this time are the strength of Abe's electoral mandate and personnel changes at the Bank of Japan (BOJ, Japan's central bank)," says the EIU.
The BOJ is aiming to double the size of the monetary base between end-2012 and end-2014. This is a major change and its prospect is already having an impact in the financial economy, such as through a rising stockmarket and depreciating currency, but it is far from certain that it will have the intended effect on the real economy.
The challenge of microeconomic reform in an environment of powerful vested interests, along with the underlying trends of the country's shrinking working-age population, rising government debt and persistent fiscal deficits, will continue to exert a significant drag on economic activity.
Meanwhile, Japan's growing legions of working poor will not be happy to see the inflation that Abe and Haruhiko Kuroda, the BOJ's new governor, have committed to achieve.
Rate cuts everywhere
According to the EIU, many countries in Asia—including small economies such as Mongolia and Vanuatu—have been responding to the slow global recovery by extending the use of loose monetary policy.
A number of recent rate cuts were driven by slowing economic growth in the first quarter of 2013, combined with appreciating currencies and subdued inflation. These characteristics are shared, for example, by Australia, Papua New Guinea (PNG) and South Korea.
The Bank of PNG cut 50 basis points from its main policy rate in March, with a pause in growth being induced by the timing of a large investment project.
In Australia and South Korea, where rates were cut in April and May, respectively, lower than expected export demand (mainly owing to the slowdown in China) alongside highly indebted consumers, who have been reluctant to spend, were also factors at play.
Rate cuts have also been widespread in South Asia. The Reserve Bank of India (RBI) has cut rates three times since the beginning of 2013, with the latest cut in the main policy rate occurring in early May.
Although consumer price inflation is still relatively high, producer price inflation is low and real GDP growth is also slowing. The Economist Intelligence Unit believes, however, that rates will now remain on hold in India. The RBI is worried that the government is doing too little to curb the current-account deficit, and so is wary of further interest rate cuts leading to an outflow of cash deposits. The Central Bank of Sri Lanka (CBSL) announced a 50-basis-point cut to its main policy interest rate in early May.
"While economic growth is still fairly fast—we forecast 6.9% in 2013—merchandise exports are falling in year-on-year terms, and the CBSL has long held a bias towards supporting growth, rather than curbing inflation, and this cut will lead to accelerating inflation in the second half of 2013," notes the EIU.
Some central banks would like to cut rates, but are otherwise restricted.
Pakistan's economy is slowing, with growth forecast this year at 3.7% as compared with 4.2% in 2012, and consumer price inflation is also decelerating. However, the State Bank of Pakistan (SBP, the central bank) is constrained from cutting interest rates by the difficulty the country is having in meeting its balance of payments obligations and by the wide fiscal deficit, which means that government borrowing from commercial banks is crowding out the private sector.
Rates on hold in ASEAN
Monetary loosening has been less of a feature in South-east Asia. The one country where rates have been cut this year is Vietnam, where monetary policy is firmly tilted towards supporting economic growth, rather than taming inflation.
Consumer price inflation in the first quarter of 2013 was 6.9%, as compared to 9.1% in 2012, and the State Bank of Vietnam (SBV, the central bank) took the chance to reduce interest rates, despite problems in the banking sector.
Monetary policy is loose in Indonesia, where the main policy rate has been at a record low of 5.75% for over a year. However, rising inflationary pressures—in part caused by import restrictions on agricultural products—mean that the next rate move there is likely to be up.
Rates are also on hold in Malaysia and the Philippines. The Bank of Thailand (BoT, the central bank) has said that it could cut interest rates at its next policy meeting, although we believe that it is unlikely to do so and that this statement is aimed at calming relations with the government, which is agitating over the rapidly appreciating currency.
Monetary stimulus or currency wars?
Monetary stimulus, and particularly that of Japan, is also focusing attention on exchange rates. Japan's yen remains at the centre of global currency markets as the country's central bank takes ever more aggressive steps to reflate the economy.
The yen, which has been weakening for months as the BOJ has been under pressure to ease policy, fell by around 25% against the US dollar between November 2012 and May 2013. But the recent behaviour of the yen is an exception.
Many currencies in Asia have appreciated markedly over the last few years, the Thai baht, the Australian and New Zealand dollars, the Papua New Guinea kina, Philippine peso and the South Korean won being notable examples.
The Japanese yen had also appreciated prior to the recent change in monetary policy; however, despite the recent bout of depreciation, the yen is no weaker than it was in 2008.
The net impact of monetary loosening is hard to gauge on a global scale. The evidence that unconventional policy in the US, UK and Japan and, to a lesser extent, in the Euro zone, is having an impact on the real economy is decidedly mixed. However, Japan aside, central banks in Asia are still very much operating within the bounds of conventional monetary policy, which is more likely to be effective. Nonetheless, the combined impacts of reduced export demand, appreciating currencies, as well as low consumer demand and investment in some economies, have induced many Asian economies to introduce additional liquidity.
The short-term impact has been depreciating currencies and rising stockmarkets, but Asian central bankers will be hoping for a more substantial impact on the real economy.