Status, Risks and Recommendations of the Asian Currency Market from 2022 to Mid-2023
I. Overview
In response to high inflation, most economies entered a cycle of interest rate hikes in 2022, shifting the monetary environment from previously accommodative to tight. In terms of absolute levels, broad monetary supply in 11 representative Asian economies grew by an average of 5.8% year on year at the end of June 2023, with India and China, which have more abundant money supply, growing at 13.4% and 11.3% year on year, respectively.
In terms of changes, currency supply growth declined in most economies after the shift in monetary policy. Broad monetary growth in the representative economies at the end of June 2023 declined by an average of 1.9 percentage points from the end of June 2022. Among them, monetary supply in South Korea, Vietnam, Indonesia, and Thailand declined faster, by 6.6, 6.2, 4.6, and 4.5 percentage points, respectively. Although India is continuing to raise interest rates, but supported by strong domestic demand, the growth rate of monetary supply increased instead of declining, M3 improved by 5.5 percentage points year on year. Saudi Arabia's M2 year-on-year first declined to 5.7% at the end of 2022 before recovering to 8.3% at the end of June 2023. China and Japan's monetary supply growth rates are little changed, mainly due to the fact that monetary policy in both countries has not tightened and the monetary environment has been accommodative.
Table 1 Year-on-year Growth Rate and Change in Broad Monetary Supply in Asian Representative Economies (%)
Source:
Wind
Note 1: To improve comparability, M3 is used for Japan and India, while M2 is used for all others;
Note 2: The latest year-on-year M2 data for Vietnam is only disclosed until the end of April 2023, and the latest disclosure for the Philippines is until the end of May 2023, and the change in growth rate is the latest value minus the value at the end of June 2022.
With respect to short-term interest rates, in terms of absolute levels, short-term interest rates in most of the representative economies were at historically high levels in June 2023. For example, Saudi Arabia's 3-month interbank lending rate reached a monthly average of 5.9%, the highest since 2010. And the Philippines, Singapore, and South Korea's interest rate levels were at the top of the 95% quartile since 2010.
In terms of change, short-term interest rates increased in all representative economies except Japan. Among them, interest rates in the Philippines rose the most, by 3.9 percentage points, while those in Indonesia, Saudi Arabia, Singapore, and India also moved up by 3.0, 2.8, 2.2, and 2.0 percentage points respectively, and those in South Korea, Vietnam, and Thailand all moved up by 1.5 percentage points. However, China's interest rates moved modestly, up by only 0.2 percentage points.
Table 2 Short-term Interest Rates and
Changes in Representative Economies (%)
Source: CEIC (The Philippines uses a weighted average of interbank lending rates, while the rest use monthly averages of three-month interbank lending rates.)
II. Developments and underlying forces
Changes in short-term interest rates in the monetary market depend largely on the country's monetary policy. Until October 2022, the direction of monetary policy in representative economies other than China and Japan is relatively consistent, following Europe and the United States into the interest rate hiking cycle. This is because of the high dependence on import and export trade for the development of most Asian economies, especially Singapore, whose foreign trade dependence (total imports and exports as a share of GDP) is 337% in 2022, and Vietnam, Malaysia, Thailand and South Korea, whose foreign trade dependence is also very high, at 186%, 141%, 134%, and 97%, respectively. Thus, the imported inflationary pressures from the U.S. and Europe have made the central banks of these countries had to tighten monetary policy.
Figure 1 Representative Economies Imports and Exports as a Share of GDP in 2022
Source: World Bank (2021 data for Vietnam and Japan).
However, since November 2022, there has been a shift in monetary policy in some countries. South Korea, India, Indonesia, Malaysia, and the Philippines have all pressed the pause button on interest rate hikes one after another, and Vietnam started to cut interest rates in March 2023 after the last policy rate hike in October 2022.
On the one hand, as imported inflationary pressures diminished, the need for countries to follow the Fed's rate hike was reduced, with CPI year-on-year growth rates at the time of the announcement of the pause in tightening in India, South Korea, and Singapore coming down by 1.2, 1.0, and 2.3 percentage points from June 2022, respectively. On the other hand, more importantly, consumption growth in developed countries such as Europe and the United States has slowed, and the decline in external demand has exacerbated the pressure on economic growth in export-oriented countries, at which point a sustained interest rate hike would unduly dampen domestic demand. Unlike most developed economies in Europe, which have a single target for inflation, and unlike the United States, which has a dual target for inflation and employment, the ultimate goal of monetary policy in most Asian countries is multifaceted, including economic growth, price stability, full employment, balance of payments, exchange rate stability, etc., and the core of monetary policy will be shifted in line with the changes in the economic situation.
For example, the Bank of Korea in February this year announced a moratorium on interest rate hikes, said the future of monetary policy needs to take into account economic growth, at this time South Korea is facing a decline in external demand and the pressure of a single industrial structure, in 2023 the first two months of the semiconductor export value fell sharply by 43.5% year on year. China and Japan, on the other hand, have maintained an accommodative stance with interest rates kept at low levels for the sake of promoting domestic economic growth. Saudi Arabia, on the other hand, has followed the Federal Reserve in raising its benchmark interest rate, mainly because of the fixed exchange rate system between the Saudi Riyal and the US dollar. Saudi Arabia's economic development is highly dependent on oil exports, from the 1970s the dollar became the currency of oil, in order to stabilize economic growth, so the implementation of the monetary policy of pegged to the dollar.
Table 3 Divergence in Monetary Policy in Representative Economies
Figure 2 Changes of Selected Policy Rates in Representative Asian Economies
Source: CEIC
III. Possible risks
(i) Global economic and trade cycle downward
Although the U.S. interest rate hike cycle is nearing its end, the overall performance of the European and American economies is also better than expected, but the lag effect of interest rate hikes is continuing to affect the world economy. In the overseas interest rate hike cycle, the residents of consumption and business investment is inhibited, the global manufacturing and merchandise trade boom downward. In July, U.S. and Eurozone manufacturing PMI index recorded 46.4% and 42.7%, continued to be located in the low level; U.S. Red Book commercial retail sales year-on-year growth rate of the average of -0.04%, which is the first time since September 2020 to turn negative, consumer confidence index of 20 countries in Eurozone was as low as -15.1%. Malaysia, Thailand, South Korea and other countries with a high degree of external dependence, compared with external demand, its pulling force of domestic demand for economic growth is weak, so in the context of the global economic and trade cycle in a downward trend, the impact of the global economic fluctuations is also greater. From January to July, in Vietnam, South Korea, the year-on-year decline of the export value is respectively 10.6% and 13%, Malaysia's first half of the year exports declined by 14%. China's export growth in the first seven months also slipped to -5%, the drag effect of the fall in foreign demand on the economy aggravated in the context of the slow repair of domestic demand. Looking ahead to the second half of the year, with the slowdown in labor payroll growth, the excess savings accumulated during the epidemic will be gradually consumed and the probability that the growth rate of service consumption in developed countries will continue to slow down. And weak external demand will continue to bring downward pressure on exports in the Asian region, and economic growth is under pressure.
(ii) Cross-border capital ups and downs
In 2022, the Fed's aggressive interest rate hikes pushed the dollar index to a new high since October 2022. Before this, cross-border capital that had been aggressively flooding into Asia returned sharply. In 2023, as monetary policy in Asian economies shifted and expectations of a pause in Fed interest rate hikes heated up, more and more overseas capital returned to emerging Asian markets. For example, in 2022 September, net capital outflows from Japanese equity securities amounted to 3 trillion yen, the Nikkei 225 index monthly average fell 3.3% year on year, while in April 2023, when major foreign investors on Japanese equity securities net buying reached 4.98 trillion yen, a record high since 2005, the subsequent two months of net buying also continued to be located in the high level. The Nikkei 225 index rose from 28,041 points at the end of March all the way to 33,189 points at the end of June, an increase of 18.4%. The ups and downs of cross-border capital flows will affect the independence of monetary policy in Asian countries, which is not conducive to maintaining the sound operation of financial markets, and also poses a serious challenge to the management of cross-border capital flows in these countries. For example, in India, the domestic economy and the expected loose monetary environment to attract foreign capital inflows, the stock market has repeatedly hit record highs. At the end of June this year, Mumbai Sensitive 30 index rose 22.1% over the same period last year. However, as developing countries are generally weaker than developed countries in terms of financial system perfection, economic development and currency competitiveness, they tend to be passive risk carriers in the free flow of capital. Asian economies are mostly developing countries, and large fluctuations in cross-border capital pose potential risks to these economies.
IV. Recommendations
(i) Cultivating endogenous economic growth momentum
Most Asian economies are characterized by a high degree of external dependence, a single economic structure, an incomplete manufacturing industry chain, and an imperfect and unsound financial system, making them vulnerable to fluctuations in the global economic and financial cycles. In this regard, countries should focus on the weak links to strengthen the economic foundation and better resist external shocks. Firstly, accelerate industrial upgrading and transformation, reduce overdependence on export industries. Encourage domestic enterprises to actively innovate and increase R&D investment by providing tax breaks, low-interest loans and technical support. Improve product quality and competitiveness, and develop high-end manufacturing and service industries, so as to promote industrial transformation and upgrading, and increase the share of the distribution of global benefits. Secondly, actively implement the strategy of expanding domestic demand, expanding government investment, stabilizing employment, raising the level of national income, enhancing the vitality of micro-entrepreneurs, and improving the driving force of commodity consumption and service consumption on economic development. Thirdly, it is to increase investment in infrastructure construction, improve deficiencies in communications, transportation and energy, improve the efficiency of industrial chains, provide low-priced land and preferential tax rates to reduce enterprise costs, optimize the business environment, enhance the attractiveness of foreign investment, and improve the ability to undertake industrial transfers from developed countries. Fourthly, reduce the scale of external debt, optimize the structure of external debt, and reduce the risk of debt servicing. In addition, the World Bank, the International Monetary Fund and other international organizations should increase their support for developing countries and maintain the economic and financial stability of developing countries in Asia.
(ii) Enhancing regional economic and financial integration exchanges and cooperation
By strengthening economic and financial connectivity in the Asian region, enhance the level of specialized division of labor in the Asian region and jointly address the uncertainties and challenges of the global economy. Firstly, further optimize and strengthen RCEP, Belt and Road and other types of regional trade agreements, smooth communication channels among countries, strengthen cooperation mechanisms, expand the intra-Asian cycle, and promote the high-quality development of international trade. Secondly, encourage financial institutions of all countries to actively participate in cross-border business such as trade finance, supply chain finance, cross-border mergers and acquisitions, etc., so as to open up the blockages in the regional economic cycle. Thirdly, give full play to the risk hedging and mitigation functions of financial instruments, promote intra-regional resource sharing and risk sharing, and enhance the resilience of the industrial chain. Fourthly, strengthen Asian monetary cooperation, such as simplifying RMB cross-border settlement procedures, realizing the interconnection of international financial cross-border infrastructure, and promoting trade and investment facilitation. Fifthly, increase the scale of issuance of RMB products, expand the scope and scale of application of RMB products, further promote the internationalization of the RMB, and weaken the hegemonic position of the US dollar as the world currency.
(iii) Improving macro-prudential management of cross-border capital flows
The opening up of financial markets should be matched with the capacity of macro-prudential management of cross-border capital. Against the backdrop of frequent fluctuations in the global financial cycle, the macro-prudential management of cross-border capital flows should be strengthened to enhance the independence of monetary policy in Asian economies. Firstly, China and other countries can take the lead in establishing a sound policy system for responding to abnormal cross-border capital flow shocks under the impact of the global financial cycle in collaboration with Asian countries. Secondly, the role of big data and financial technology in monitoring, early warning and regulation of cross-border capital flows should be brought into play, micro-regulation should be strengthened, and the capacity of macro-prudential management of cross-border capital flows should be enhanced. Thirdly, it will improve the functions of the capital market, perfect the regulatory system, deepen the reform and opening-up in the field of foreign exchange, and enhance the ability of the financial market to open up at a high level.
Expert Biography
Li Qilin, Fellow of the Asian Financial Cooperation Association Think Tankers Committee, Member of the Central Committee, Deputy Director of the Economic Committee of China Democratic League, Director and Chief Economist of Hongta Securities Research Institute, member of the Chief Economist Committee of the Securities Industry Association, member of the Chief Economist Forum, Distinguished Senior researcher of the National Finance and Development Research Office. He is an adjunct professor of Fudan University, Central University of Finance and Economics and Wuhan University.
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