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Asia-Pacific central banks face delicate balancing act as economies stabilize

Asia-Pacific nations that resorted to quantitative easing as a once-in-a-century pandemic roiled the global economy will now have to tread carefully as economic conditions stabilize, with some analysts warning against tapering the unconventional measures too soon.

Many central banks across Asia-Pacific that launched various versions of quantitative easing for the first time in 2020 had not indicated when their programs would end despite their rebounding economies. Those programs were additions to aggressive rate cuts, many of which are still far above zero, and other measures such as cuts of banks' reserve requirements.

Australia, which has purchased A$122.3 billion worth of government bonds since March 2020, said recently it would extend the program by another A$100 billion. Indonesia's central bank, which has acquired long-term government bonds equivalent to 4.9% of GDP since 2020, said the program would remain in place for as long as the economy needs. The exception is South Korea, whose three-month unlimited liquidity support facility, a light version of easing, concluded in July 2020 as scheduled.

Central banks may begin to normalize policy in 2021 if economic recovery takes hold, though policy rates are unlikely to be hiked anytime soon, analysts said.

It is not all about policy easing now. "In fact, we may be reaching a transition point where financial market players are concerned about premature policy exit amid the vaccine-fueled recovery," Selena Ling, chief economist at Oversea-Chinese Banking Corp. in Singapore, said in comments emailed to S&P Global Market Intelligence.

The vaccines must make significant progress toward herd immunity and the global economic recovery story has to become sufficiently entrenched for one of the major central banks, possibly the U.S. Federal Reserve, to signal its intention to taper QE. That "could set the ball rolling for the other smaller central banks," she said.

Most central banks in Asia-Pacific "appear content to adopt a wait-and-see mode for now and preserve whatever little policy ammunition is left," Ling said.

Emerging markets in Asia "have clearly leaned on monetary policy to support their economies through the crisis and they will be careful, lest the recovery is derailed," said Priyanka Kishore, head of India and Southeast Asia, macro and investor services at Oxford Economics.

Measuring success

Asian nations may also be evaluating the effect some of these unconventional policy measures may have had in cushioning the impact to their economies.

"These programs appear to be a viable macroeconomic policy response to COVID-19 and government bond markets and foreign investors have responded quite favorably to these programs," said Alicia Garcia-Herrero, chief economist for Asia-Pacific at Natixis.

The measures helped countries with a credible institutional framework in which the central bank runs a floating exchange rate regime and the government issues debt in its local currency. "It has helped ease financial conditions, while minimizing the risks of large depreciation and spiraling inflation," Garcia-Herrero said. When they begin to unwind QE, global central banks will need to have "a coherent exit strategy and clearly communicate to the markets the conditions under which the programs would end," she said.

Central banks typically employ such unconventional monetary policy to increase the domestic money supply and to encourage lending and investment after interest rates approach zero. A common tool is to buy longer-term securities from the open market to add new money to the economy.

Some emerging economies in Asia were different as their interest rates were still above zero, unlike in developed countries such as Japan and Australia that hit the effective lower bound of interest rates, said Robert Gilhooly, senior emerging markets research economist at Aberdeen Standard Investments.

For central banks with policy rates above zero, Gilhooly said their aims and the constraints they operate under are quite different from their developed market counterparts. "These central banks could, if they wished to, impart more stimulus by cutting policy rates further, but the classic emerging market policy dilemma may bite: Lower rates risks capital flight and an overshooting of the exchange rate, in the extreme the economy can be worse off," he said.

Mixed results

The results of QE have been mixed for Asia-Pacific central banks.

For example, in Indonesia, QE probably helped to anchor sentiments during a critical period and funded some government spending, but it may not have translated into any real impact on GDP growth.

"Maybe a pass as a short-term market salve and confidence booster, but not necessarily a panacea," OCBC's Ling said. Neighbor Malaysia, too, is reliant on foreign fund inflows and has relatively high foreign bond ownership, but it did not turn to QE, she said.

The success of the programs also depends on which outcomes are considered. "It is true that money and credit growth have remained well supported in these economies through 2020. But the impact on long-term yields has been muted, as other factors have offset central bank support to a large degree," Kishore said.

Data in Indonesia and the Philippines suggest that the unconventional monetary policy did help depress bond yield, though it is difficult to know what would have happened in the absence of quantitative easing, said Robert Carnell, head of research in Asia-Pacific at ING Group. "Exactly how much we can attribute [it] to central banks' policies? Hard to say," Carnell said.

Gilhooly said that for Bank Indonesia, QE does seem to have been "a reasonably successful policy choice." Across emerging markets, "research points to significant falls in local-currency bond yields, with minimal changes in [foreign exchange rates]," he said.

In contrast, Bank of Japan, which has been engaged in QE since 2013, has only seen a small impact on re-anchoring its inflation and has fallen short of its 2% inflation target.

Side effects

Such unconventional policies "have the potential to be dangerous, are hard to backpedal from, arguably worsen inequality, are very weak in terms of real effects and distort market valuations in ways that may be unsustainable," Carnell said, adding: "It is not entirely obvious what these policies were designed to do, other than to fill a gap where conventional room for maneuver was looking strained or putting pressure on [forex] or bond markets."

A problem with unconventional policy measures is that they saddle the central bank with a balance sheet that it has to then manage. Bond purchases over a long period of time by a central bank can lead to debt monetization. Large liquidity injections by the central bank in the local currency may also destabilize the exchange rate and become inflationary.

QE is unlikely to stoke price increases as even before the COVID-19 pandemic, some major central banks in Asia were having problems hitting their inflation targets, said Shaun Roache, chief economist for Asia-Pacific at S&P Global Ratings.

"All of the jobs lost due to COVID-19 will have to be recovered, consumers need to regain confidence and spending will have to rise before we can be confident that inflation will eventually return to their targets," he said.