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Signalling mistake

6 March 2013 By Andy Mukherjee

Inflation in the Philippines reached a five-month high in February; prices rose the most in 20 months in Indonesia. Yet, there is no word from the central banks of Southeast Asia’s fast-growing nations on when they are likely to raise interest rates. While their coyness to signal policy tightening is understandable, it is nevertheless a mistake.

Southeast Asia’s central banks do not want to hint at rate increases because they fear being swamped by foreign capital. With interest rates in most developed nations stuck close to zero, hot money can destabilize financial systems that are generating credit at a very rapid clip.

Yet, not preparing the market for higher rates is risky. Strong wage growth could feed into inflation expectations and make them harder to reverse. When rates are eventually raised, they will either stifle economic activity, causing bank loans to sour, or, if growth momentum remains intact, attract more foreign capital, stoking asset bubbles.

The case for signalling higher interest rates is the strongest in Indonesia, where the government will probably wait until after the 2014 presidential elections before cutting fuel subsidies and tightening its fiscal belt.

In Thailand, where core inflation of 1.57 percent in February was well within the central bank’s target range of 0.5-3 percent, the government would prefer the monetary authority to lower rates further rather than hint at an increase. But the Thai economy grew 19 percent from a year earlier in the fourth quarter of 2012, and in the central bank’s own assessment, inflationary pressures have risen slightly. A record trade deficit in January, driven by a 41 percent jump in imports, suggests there may soon be a need to cool domestic demand.

A safer strategy for the region’s authorities will be to mop up hot money regardless of the fiscal cost. For instance, the Philippines monetary authority pays banks 3 percent interest to borrow their surplus funds. Strong inflows can also be repelled, where possible, by strengthening existing capital controls. Meanwhile, higher reserve and capital requirements for banks could help slow down domestic credit growth. Trying to maintain a narrow gap interest rate gap over advanced nations, when the latter are unlikely to stop printing money any time soon, will come back to haunt Southeast Asia.


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