Slow on the uptake
Asia’s central banks are in danger of falling behind the yield curve. The region’s monetary authorities have so far failed to heed bond investors’ legitimate worries about disinflation. Their reticence could imperil both GDP growth and financial stability.
Investors have been pushing down interest rates across Asia. The average yield on 10-year sovereign bonds issued by the region’s ten major economies has fallen by almost 80 basis points over the past year. Yet short-term policy rates have barely budged. The narrowing gap shows that the growing sense of alarm over disinflation in the marketplace has yet to upset the relative calm in policymakers’ ivory towers. That could turn out to be an error of judgement.
Central banks may be worrying about a repeat of the mid-2013 “taper scare,” when the prospect of higher interest rates in the United States prompted foreign investors to flee Asian markets. If that’s the case, they are fighting yesterday’s battles. Yields on 10-year U.S. bonds have dipped below 2 percent; Japanese government debt of similar maturity yields 0.28 percent, a record low. Hot money will only flow out of the region if rates in advanced economies are much more attractive.
A more valid concern is that lower rates will drag down exchange rates, making foreign-currency debt more expensive to service. That might be especially problematic for China, which owes $1.1 trillion in cross-border claims, according to the Bank for International Settlements.
Some central bankers may be hoping that cheaper energy will reignite global and domestic growth. Such complacency is plain wrong. Inflation expectations in the region could slide further as companies receive lower prices for their goods and services and workers get lacklustre raises. If producer prices and wages don’t grow, the already-high real corporate debt burden in China and the household debt overhang in Malaysia, South Korea, Thailand and Singapore would worsen.
China, South Korea and Thailand cut rates last year. All three need to do so again. Australia and India would have to join in. Malaysia, Indonesia and the Philippines, which raised rates last year, should at least avoid further increases. The longer Asian central banks take to decode the disinflation risk, the farther they will fall behind the yield curve.