TOKYO: Asian central banks that have spent 2022 battling inflation by jacking up interest rates are expected to shift their focus next year, changing the picture for investors as price increases slow and economies feel the impact of a global downturn.
Most central banks in the region have been less aggressive than the US Federal Reserve – which on Wednesday raised rates for the seventh time this year – because inflation has not been as severe.
While the rising dollar has given investors more incentives to shift money to the US and has put pressure on Asia’s currencies, monetary policymakers have responded with a mix of rate hikes, currency depreciation and market intervention.
Improved current-account balances, reduced reliance on foreign debt and larger foreign exchange reserves have also helped them ride out the pressure.
Inflation has started to ease in most economies in the region, from South Korea and China to Thailand and India. But there are now signs of weaker growth, as seen in a sharp drop in exports for China and South Korea in November.
One silver lining for the region is an economic reopening of China after nearly three years during which Beijing stuck to a zero-Covid strategy. This could also put pressure on commodity prices. However, a recession in the US and Europe, as some forecast, would mean weaker demand for commodities and help to keep inflation at bay.
“Yes, a China recovery will be on the cards, but we think it will be bumpy at first. At the same time, we have other major economies, including the US and the eurozone, going into recession, so balancing all out, we think it will be a very soft environment for commodity prices, at least in the first half of next year,” says Rob Subbaraman, Nomura’s head of global macro research.
The US dollar is seen to have hit a peak after rising to the highest level since 1985 in terms of the real effective exchange rate, as calculated by the Bank for International Settlements.
“We think the US dollar has peaked, to be followed by a decline through 2023,” predicted economists at Morgan Stanley.
That would mean that Asian central banks would not have to raise rates so aggressively just to shore up their currencies next year.
“The interest rate story is mostly absorbed in the market. For the FX market, it has to shift to recession concerns,” said Charu Chanana, a Singapore-based market strategist for Saxo Markets.
The Fed reduced the pace of monetary policy tightening on Wednesday. It is now expected to pause once it raises the short-term rate to around 5.00% to 5.25% by early next year, which would amount to a cumulative increase of 500 basis points (5.0%) in just one year.
But investors are still worried that inflation will persist. Markets dropped on Friday after central banks, including the European Central Bank and the Bank of England, raised rates and struck a hawkish tone.
The full impact of the US rate increases will only be felt next year because of a lag of six to eight months in policy transmission, say economists at Moody’s Investors Service. If inflation is tamed, some economists predict the Fed will again shift into rate-cutting mode by the end of the year, with a first rate cut between September and December. Moody’s expects a rate cut of 25 to 50 basis points as early as November.
In Asia, investors will be scrutinising how closely national central banks mirror the Fed – with policymakers moving at different speeds.
South Korea could be among the first to shift gears. It is among the Asian countries most exposed to exports and most affected by any slowdown in the US. It also started tightening monetary policy before other countries, with a rate hike in August 2021 aimed at arresting the fall of the South Korean won against the dollar and cooling an overheating property market.
But the rate increase of 275 basis points since August 2021 – the second-largest in Asia, after the Philippines – has been a shock to the country’s highly leveraged private sector.
South Korea’s household sector is the world’s most indebted, with debt at 102% of GDP, according to the Institute of International Finance (IIF). Over 80% of mortgages carry variable interest rates. There has also been a liquidity crunch in the South Korean corporate bond market.
Analysts think the Bank of Korea has become wary of raising rates too aggressively. “We believe that the ongoing squeeze in the credit market and a weakening economy will give the central bank reason to proceed cautiously,” said analysts at Fitch Solutions. The country’s policy cycle is “close to peaking”, they said.
Thailand is another example of a central bank close to the end of the rate-tightening cycle. Nomura economists say consumer inflation peaked in August, at 7.9%, and is expected to return to the Bank of Thailand’s target of 1% to 3% by May. They predict the BOT will implement a final hike of 25 basis points to 1.5% by January.
Like South Korea, Thailand has a highly leveraged household sector, with household debt at 87% of GDP as of the end of September, according to the IIF, and is exposed to global exports, especially those of automobiles.
Nomura economists add that Thai household debt is highly concentrated in credit cards and personal loans, which are subject to high interest rate payments. Inbound tourism is rebounding rapidly but won’t be enough to reverse the expected growth slowdown.
Even India won’t be immune from the global slowdown, despite it being billed as a domestic-driven economy and a major beneficiary of supply chain relocation from China.
Inflation will likely remain sticky until the first quarter of 2023, but slowing growth and lower commodity prices should bring inflation down, Nomura economists predicted: “We believe the monetary policy hiking cycle is on its last legs.”
The central banks in Indonesia and the Philippines are likely to remain on watch for inflation through 2023, as prices are not expected to fall back within the two central bank’s 2-4% targets till 2024. The central bank in the Philippines (BSP) struck a dovish tone on Thursday, predicting that the country’s inflation, which hit a 14-year high of 8% in November, will peak in December. Analysts are carefully monitoring to see if that will indeed be the case.
Meanwhile, China is expected to remain in a league of its own. The People’s Bank of China lowered policy rates in January and August by 10 basis points each, and reduced the reserve requirement ratio twice, in April and December, to 7.8% from 8.4%.
The PBOC “will maintain a broadly easing stance next year, in contrast to what the global central banks are doing, because they focus so much on reviving growth”, said Saxo Markets’ Chanana. “They can’t do broad-based easing because that will cause a massive depreciation of the yuan. They are going to look at more targeted measures.”