Interest rate rises off the table as Asian economies try to curb speculation and asset prices

Since the US Federal Reserve is unlikely to raise policy rates soon, Asian central banks’ ability to take the lead in raising interest rates is limited
Instead, macroprudential policies that target credit growth and build buffers to protect the banking sector and borrowers can help prevent overheating

Tai Hui

Published: 4:45pm, 26 Feb 2021

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The global Covid-19 pandemic has led to another round of ultra-loose monetary policy from central banks in developed economies, flooding the markets with cheap money. Although the global economy needs a lot of support to recover from the Covid-19 pandemic, there is a rising concern that a prolonged period of low interest rates could lead to asset inflation or excessive credit growth.

Several Asian central banks – such as the People’s Bank of China (PBOC), the Bank of Korea and the Reserve Bank of New Zealand (RBNZ) – have voiced concerns about the rapid rise in asset prices. Some have even taken action to withdraw policy support.

Earlier this month, the PBOC took the unusual step of withdrawing 80 billion yuan (US$12 billion) from the banking system right before the Lunar New Year. The RBNZ tightened mortgage lending in its February meeting to cool down its property market.

Since the US Federal Reserve is unlikely to raise policy rates in the next one or two years, Asian central banks’ ability to take the lead in raising interest rates is limited. High policy rates could limit lending growth and prevent Asia’s domestic economies from overheating.

At the same time, higher interest rates could also attract more international capital inflows into these markets when investors look to take advantage of the interest rate differential. Therefore, Asian central banks and governments will need to look for a different set of tools to attract this possible inflow of liquidity.

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Beyond raising interest rates, Asian central banks have some other tools for coping with the seemingly never-ending zero interest rate policy environment. After all, this is not a new problem for Asian monetary authorities.

Since a similar episode of ultra-loose monetary policy after the 2008 global financial crisis, Asian policymakers have focused more on macroprudential policies. These include setting higher reserve and capital requirements for banks, loan-to-value ratios for mortgages and debt-to-income ratios for consumer loans.

Some measures are also aimed at managing foreign capital inflows, although these are harder to implement for many Asian economies with relatively free cross-border flow of capital. Some governments, such as Hong Kong and Singapore, have introduced stamp duties to curb speculation in the residential property market.

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These type of measures are not directly aimed at curtailing increases in asset prices. Instead, they target credit growth and seek to build buffers to protect the banking sector and borrowers.

For example, a more stringent loan-to-value ratio would protect both banks and mortgage borrowers in case property prices fall. Central banks that set a higher reserve requirement are aiming to limit how much lending banks can make to households and companies. This also allows policymakers to be more targeted towards specific sectors that are at risk of overheating or excessive borrowing.

Policymakers have prioritised controlling price increases in local real estate markets over financial assets such as equities or fixed income. This is because a strong surge in housing prices would undermine affordability, which in turn can lead to social tension.

For financial assets, policymakers’ general attitude is that investors should be responsible for their own investment decisions. Therefore, in the spirit of free markets, central banks tend to intervene less. Having said that, one way for policymakers to curb equity market momentum and cool speculation could be to require investors to put down higher deposits for margin trading.

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A study by the International Monetary Fund shows that housing-related measures have the most significant impact on credit growth in Asia, while the effect from changes in reserve requirements and capital regulation have been more limited.

Macroprudential policies and capital flow management measures do not discourage portfolio equity inflow and do not have any significant impact on debt inflows. These macroprudential policies tend to be aimed at strengthening the financial system, both for the lenders and borrowers, rather than supporting direct asset prices.

Hence, we could still see episodes of irrational and volatile market moves if the low-yield environment persists and global liquidity remains abundant for an extended period of time while the global economy charts a path of gradual recovery from the pandemic.

Tai Hui is chief market strategist for the Asia-Pacific at JP Morgan Asset Management

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