Asia Wants Better Communication from Fed when Rate Rises Come

Emerging Markets, May 2014. With Paolo Danese and Steven Gilmore

Asian policymakers and central bank governors, bruised from the market ructions last year after the Federal Reserve first raised the prospect of QE tapering, are demanding better communication from the Fed and other developed world institutions on the timing and nature of their monetary policy.

“There should be clear communication and calibrated announcements up front of how the sequencing will go of tapering and interest rate policies,” said Shamshad Akhtar, executive secretary of the United Nations Economic and Social Commission for Asia and the Pacific, and the former central bank governor of Pakistan.

Amando Tetangco Jr, governor of Bangko Sentral Ng Pilipinas, the Philippine central bank, told Emerging Markets: “We should see clearer communication from the Fed.” Although tapering is well underway, and the Fed has signaled that its low interest rates will continue for some time, “That’s still a source of uncertainty because we don’t know their timing as well as the speed of any tightening that they would implement,” he said. “To us, what is important is to make sure that our policy framework is well in place so we can assess the possible impact on our economies and decide on the appropriate course of action.”

Many Asian economies are still dealing with the aftermath of last May, when comments from the Fed triggered a sell-off in emerging market assets, widespread capital flight, and the deterioration of currencies, particularly in Asian markets with twin deficits such as Indonesia and India. They are very keen to avoid such a significant shock again. “Based on what we have seen, it’s the announcement that can have a significant impact,” Mr Tetangco said. “Particularly if there is a lack of convergence between what the Fed is trying to say and how the markets are interpreting the statements, like what happened in May and June.”

Dr Akhtar added: “The fact that it took everybody by surprise means that it was not necessarily something where people had been given a heads-up.” She added, though, that “fault lies on both sides in my view: to imagine that this would be a lifetime quantitative easing process was unrealistic to expect. As a former central bank governor I know there’s a time when you have to announce. You have to talk.”

The call was echoed by multilaterals outside Asia. “This communication [by the Fed] is not an easy exercise, but it needs to be clear enough as not to create unexpected volatility in the market,” said Naoyuki Shinohara, Deputy Managing Director of the IMF.

Also, with tapering now underway without a major impact on Asian economies, attention is turning to the next stage of US policy: the gradual rising of interest rates towards neutrality. This is likely to affect different nations than those who were hit last year. “Indonesia and India don’t have the debt issues, so the spotlight is going to shift from them to those that have built up debt,” said Paul Gruenwald, chief economist for Asia Pacific at Standard & Poor’s.  “The next chapter is rising interest rates and I think we’re looking at a very different group of countries. Now we need to focus on places that are running up a lot of debt – China, Hong Kong, Singapore, Thailand and Malaysia.”

There is an increasing sense that these rate rises now constitute a greater risk than tapering, which Asian markets now appear to have digested. “The effect of tapering is now relatively less: Asian countries are able to manage this,” said Muhamad Chatib Basri, Minister of Finance for Indonesia. “But next year there is a possibility of the US rising interest rates, which will have an impact on capital flows from emerging markets.”  Minister Basri also added his voice to calls for openness from the Fed and others, saying: “The issue of communication is very important.”

Rising rates will matter in Asia because of the widespread accumulation of debt at low rates which must inevitably rise when the US begins to tighten. “Lets assume that the Federal Reserve is going to move interest rates from zero to 4%, which is neutral, and that this is going to start some time next year,” said Mr Gruenwald. “There’s been a lot new debt issued in the region and a lot of households and firms borrowing at the short end on floating interest rates. Rather than paying 1% or so they’ll be paying 4%-5% in a few years.”

That said, many feel that Asia is better placed to deal with these external shocks now. Takehiko Nakao, President of the Asian Development Bank, said Asia “is much stronger than before. Risks are now easing instead of becoming more intense.” Dr Akhtar added that emerging markets have learned lessons from the past and have a better understanding of macroprudential regulation, exchange rate adjustments and reserves, though she would like to see greater development of regional safety nets.

But the fact that rising rates create a different challenge to the end of tapering suggests some may be unprepared. “Volatility is one thing, but generally global financial conditions will tighten and borrowing costs will eventually increase,” Mr Shinohara said. “For countries with debt sustainability issues it will be a big problem. It is important for countries in this area to build a buffer.”