Asia faces a perpetual cycle of credit booms and busts unless the US Federal Reserve looks beyond its employment-inflation mandate and considers the impact of its monetary stance on emerging markets (EMs), Tharman Shanmugaratnam, finance minister of Singapore, has warned.
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| Tharman Shanmugaratnam, Singapore finance minister |
He said the Fed had a self-interest in factoring in the negative feedback loop from its policies. “The world is becoming more interconnected and aggregate demand from emerging markets increasingly matters for the US,” he said.
“If the emerging world goes through a significant retrenchment [in part, triggered by Fed-induced unsustainable credit stimulus], it will rebound on the US exports and global growth,” he added, without calling on the Fed to delay tapering. The basic conclusion – emerging economies can solve this [capital-cycle challenge] alone – is wrong.”
Greater regulatory vigilance in the region in recent years failed to avert the Asian market sell-off – from the Philippines and India to Indonesia – ostensibly sparked by Fed-tapering fears, which underscores how the US central bank shouldn’t conduct policy in isolation to international challenges given the correlation of global credit cycles, said the minister.
Meanwhile, a volatile domestic monetary policy to address swings in capital flows would exact a heavy toll on the real economy in EMs, added Shanmugaratnam, who also serves as the first Asian head of the International Monetary and Financial Committee (IMFC) of the IMF, which reports to the global lender’s board of governors.
The market tremors from Fed chairman Ben Bernanke’s flirtation in May with tapering reverberated from São Paulo to Johannesburg, wiping off $1 trillion in EM stocks between May 22 and end-August, while a basket of 20 EM currencies fell to 2009 lows, amid fears that tighter global monetary conditions would trigger a slowdown in developing economies and capital outflows.
Bernanke in his latest press conference on September 18 said post-crisis US monetary policy had been beneficial for the US economy and, thereby, for EMs. He delivered these comments after the committee unexpectedly announced no change in the US central bank’s $85 billion monthly asset-purchase programme, triggering an EM equity rally to highs seen in early May.
“What we’re trying to do with our monetary policy here, I think, my colleagues in the emerging markets recognize, is trying to create a stronger US economy,” he said. “And a stronger US economy is one of the most important things that could happen to help the economies of emerging markets.
“It is true that changes in longer-term interest rates in the US – but also in other advanced economies – does have some effect on emerging markets, particularly those who are trying to peg their exchange rate, and can lead to some capital inflows or outflows.
“But there are also other factors that affect inflows and outflows – those include changes in risk preference by investors, changes in growth expectations [and] different perceptions of institutional strength within emerging markets across different countries.”
Mark Williams, Capital Economics’ chief Asia economist, said: “The Fed does not see itself as the world’s central bank. It has a clear mandate from Congress to focus on employment and inflation. In the recent press conference, Bernanke essentially made clear to emerging markets: you will never matter to the Fed.”
Presumptive Fed chair nominee Janet Yellen, and current vice-chair, made clear she backed Bernanke’s stance last October during the IMF annual meeting, stating although “interest-rate differentials” played a role in driving capital flows to emerging economies, investor appetite for risk and exposure to growing economies largely accounts for the strong demand for EM assets.
Yellen, addressing global currency-war fears that raged in 2012, added: “On balance, stronger US growth [thanks to a loose US monetary stimulus] is beneficial for the entire global economy.
“Interest rate differentials do drive capital flows and [this] undoubtedly puts pressure on exchange rates [but] it is not the Fed’s intention to make things more difficult.”
A January 2013 research paper by the Federal Reserve Bank of New York concluded a 10-basis-point reduction in long-term US Treasury yields results in a 0.4-percentage-point increase in the foreign ownership share of EM debt, in turn reducing local government yields by 1.7%, across the board.
While Fed policies drive the global monetary cycle and shape EMs’ export-led growth prospects, a slowdown in developing nations has a more limited impact on the US real economy, even amid greater globalization, says Williams at Capital Economics, buttressing Bernanke and Yellen’s argument the Fed should follow its dual domestic employment-inflation mandate, rather than expand its remit to consider emerging economies.
According to Yardeni Research, given the typically consumption-driven nature of US growth, at 70% of GDP, the beta between US and EM GDP is low.
“Tightening global credit conditions and weakening commodity prices threaten to depress emerging economies,” it stated. “How important are they to the US? More so than in the past, but not enough to hurt the US economy much at all.”
According to the research shop, total exports of goods and services account for 14% of US GDP. Of this, US merchandise exports to emerging economies account for 67% of total exports, up from about 50% in 1990.
Although US corporate profitability, often tied to global growth, would suffer in the event of a prolonged EM downturn, cheaper US commodity imports could help partially offset this impact, say analysts.
In any case, the EM sell-off underscores the structural challenge of ever-volatile capital-flow cycles, given macro-prudential arbitrage and limited EM policymakers’ tools to control domestic credit conditions, said Michael Spencer, head of research, Asia Pacific, at Deutsche Bank.
“The message that policymakers can draw [from the EM rout] is that, put simply, international capital flows can be incredibly disruptive,” he said. “How can emerging market sovereigns absorb capital flows from a large global financial system?
“Even if these flows have been absorbed within the local government bond market, this depresses local interest rates. And when the tide begins to turn and there are relatively modest dollar outflows, you have seen some exchange rates down as much as 17% year-to-mid-September against the dollar.”
Hélène Rey, economics professor at the London Business School, presented a paper at the Jackson Hole summit in early September – the annual economic policy symposium for central bankers – arguing EMs should use capital controls, such as stress tests and greater leverage caps for banking systems, to smooth capital-flow cycles, rather than rely on global monetary policy co-ordination.
Shanmugaratnam said Asia could stage a cyclical rebound while the US monetary cycle normalizes, “unorthodox” policies – such as stamp duties, as used in Singapore – could help ease real-estate bubble fears, while EM policymakers should embark on supply-side and capital-market reforms to boost the quantum of investable assets, such as long-dated renminbi-denominated infrastructure bonds, to sate foreign appetite for Asian exposure.
However, greater monetary policy co-ordination, led by the Fed, is key to global stability, Shanmugaratnam – a G30 member, who has earned regional acclaim for his pronouncements on global fiscal and monetary affairs – said.
The IMFC chair, who also serves as deputy prime minister of Singapore, called on the IMF to provide more practical guidelines, or a code of practice, on how and when emerging central banks should implement capital controls to boost market expectations.
“Rather than search for a grand new paradigm [in the global monetary architecture], we should talk about greater predictability in macro-prudential measures, so markets can build this into their expectations,” he said.
Yellen’s likely Fed nomination would spell modest relief for EMs, during the current risk-off environment, given her dovish stance, but her views on the Fed’s domestically focused mandate suggests tensions ahead between policymakers from high-yield regions about the negative international feedback loops caused by Fed policy.
Yellen served as chief economic adviser to president Bill Clinton during the Asia crisis of 1997, worked at the Fed’s international economics division, and, as befits her position, has met with central banking executives across the emerging world in recent years.
She has modest experience of regulating global banks with EM exposure in her six-year stint as president of the Federal Reserve Bank of San Francisco, where the largest lender she oversaw, Wells Fargo, has 97% of its business in the US.
The market volatility, which raised the spectre of balance-of-payments crises in Indonesia and India, also highlights the limitations of the Chiang Mai Initiative Multilateralization (CMIM), a 13-year-old monetary support framework for Asia, says Spencer at Deutsche Bank.
“The Asian market sell-off underscored how it is fundamentally flawed to have a region-specific support package because precisely when you need to borrow, the ability of neighbouring economies to lend is, to a significant extent, constrained because they are also feeling the pressure,” he said.
“This period of market volatility will prove quite damaging to the so-called Asian alternative to the IMF [CMIM].”
The new Brics reserve fund also largely suffers from this “problem of contagion”, while bilateral swap lines from Japan and China to liquidity-hungry emerging economies would prove more effective than a multilateral effort, consisting of correlated risk, akin to the CMIM, whose resources were doubled to $240 billion last year, in a bid to increase the region’s financial safety net.
Given the huge pool of global financial capital looking for returns in a world of deficient demand, and the trend among US and EU pension funds to allocate a greater proportion of their capital from a low base to Asia, the high-growth region, in particular, could be held hostage to the bubbles and financial imbalances for years to come.
While the IMF is playing a heightened surveillance role, the jury is out on whether prudential measures, counter-cyclical fiscal and monetary policies, and regional support packages are enough to stabilize markets during violent bouts of capital outflows, given the lack of political appetite for greater global monetary co-ordination.
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| Source: Yardeni Research |