EM Monetary Policy Outlook – Asia

Mkts Blog_Monetary Policy-ASIA

The global liquidity backdrop has turned supportive for EM in recent weeks. However, we think that EM policymakers will continue to prepare for a less friendly global growth outlook in light of the Brexit vote as well as ongoing downside growth risks from China as well as resurgent Fed tightening concerns. As such, easy monetary policies are likely to prevail until the global outlook becomes clearer.

Over the next several days, we will be publishing our monetary policy outlooks for the three major EM regions. We are adding our outlooks on FX policy as well, as firmer EM currencies have a direct impact on domestic monetary conditions. We believe EM policymakers are starting to get more concerned about currency strength, with action already being taken by some countries.

Last week, we started with EMEA. This week, we continue with Asia. As in the case of EMEA, virtually all of the central banks in the Asian region are in dovish/neutral mode. This is due in large part to the slowdown in China and the lack of any persistent price pressures in most countries there.

1) China – The People’s Bank of China has been on hold since October 2015, when it cut its policy rates by 25 bp. CPI rose 1.8% y/y in July, the lowest since January and well below the targeted 3%. The economy continues to slow at a manageable pace, but the PBOC has signaled that it remains reluctant to cut rates further, preferring what it calls “prudent” monetary policy. Growth has slowed or stayed steady for six straight quarters and the 6.7% rate posted in both Q1 and Q2 is the lowest since Q1 2009. If the slowdown remains modest, we think PBOC will not ease further for fear of encouraging debt-fueled growth.

The PBOC has allowed a greater role for market forces in determining the exchange rate. Despite this, the yuan remains a heavily managed currency and FX policy remains a black box. Foreign reserves appear to have stabilized around $3.2 trln over the last few months, as capital outflows eased. For now, we think policymakers favor a broadly stable yuan and we see low risk of another devaluation.

2) India – The Reserve Bank of India restarted the easing cycle with a 25 bp cut in the repo rate back in April to 6.5%. Price pressures are rising again, with CPI rising 6.07% y/y in July. This is the highest rate since August 2014 and is now above the 2-6% target range. The RBI stood pat at the June and August meetings. Governor Rajan’s final meeting has been held, and his successor Urjit Patel will helm the next meeting on October 4. We suspect Modi would like him to cut rates quickly, but that won’t be so easy if inflation continues to rise. GDP rose 7.9% y/y in Q1, the strongest since Q3 2014, and so there really should be no urgency to cut rates.

The RBI maintains a generally hands-off approach to the exchange rate. However, it has used recent rupee strength to build up its foreign reserves. They stood at $365.5 bln in July, a record high.

3) Indonesia – Bank Indonesia surprised the markets with a 25 bp cut in the benchmark 12-month reference rate to 6.5% in June. It then stood pat in July. The central bank announced that it will use the 7-day reverse repo rate as its new benchmark policy rate, starting with last week’s meeting. This rate stands at 5.25%, and further cuts seem likely this year. CPI rose 3.2% y/y in July, the lowest since December 2009 and near the bottom of its 3-5% target range. On the other hand, GDP grew 5.2% y/y in Q2, the strongest since Q4 2013.

BI maintains a generally hands-off approach to the exchange rate. However, it has used recent rupiah strength to build up its foreign reserves that were depleted last year when the currency was under pressure. They stood at $111.4 bln in July, the highest since March 2015. Given the excessive rupiah weakness seen in 2015, we do not think officials are concerned about its recent gains.

4) Korea – Before its surprise 25 bp cut in June, the Bank of Korea had been on hold since its last 25 bp cut to 1.5% back in June 2015. There were four new members on the seven-member MPC at the June meeting, and they clearly leaned more dovish than their predecessors. The next policy meeting is September 9, and another 25 bp cut is possible to 1.0%. CPI rose 0.7% y/y in July, the lowest since September 2015 and well below the 2.5-3.5% target range. Meanwhile, GDP growth of 3.2% y/y in Q2 was the highest since Q3 2014 but remains weak by historical standards.

Despite US criticism of its FX policy (see footnote below), Korean officials have recently expressed concern about won strength. Last week, Vice Finance Minister said that a stronger won “impacts” exporters, and noted that his ministry will monitor flows and “take stabilization measures” if there are excessive moves. We would not be surprised to see periodic FX intervention. Foreign reserves stood at $371 bln in July, falling just short of the all-time high of $375 bln from June 2015.

5) Malaysia – Bank Negara surprised markets with a 25 bp cut to 3% in July. It had been on hold since its last 25 bp hike to 3.25% back in July 2014. CPI rose 1.6% y/y in June, the lowest since March 2015, and is expected to fall further to 1.1% in July. While the central bank does not have an explicit inflation target, low inflation will give it cover to ease further as the economic outlook weakens. The economy has slowed five straight quarters and the 4.0% growth rate posted in Q2 is the lowest since 2009. The next policy meeting is September 7, and no action is expected. However, we think a dovish surprise is possible. If not, further easing seems likely in Q4.

After depegging from the dollar back in 2005, the ringgit has been liberalized but remains a managed currency. Regulators recently introduced a new methodology based on market transactions to determine the daily USD/MYR fix, and also extended FX trading hours by an hour to 6 PM local time. Offshore trading of the ringgit is unlikely to be re-introduced anytime soon, however. Given the excessive MYR weakness seen in 2015, we do not think officials are concerned with its recent gains.

6) Philippines – The central bank has been on hold since it moved to an interest rate corridor and cut the main rate by one percentage point to 3.0% back in May. CPI rose 1.9% y/y in July, and has been below the 2-4% target range since May 2015. However, the economy has remained robust, with GDP growth accelerating five straight quarters. Indeed, the 7% y/y growth posted in Q2 was the strongest since Q2 2013. Given how low inflation is, the bank will have leeway to cut rates if the economy slows. Next policy meeting is September 22, no action is seen then. Officials said a cut in the reserve requirement has been discussed in recent meetings.

Policymakers continue to liberalize the FX market, but the peso is still a managed currency. This month, the central bank increased the daily limit for FX purchases requiring documentation from $120k to $500k for individuals and to $1 mln for companies. However, we do not think officials are too concerned about peso strength given how strong the economy is performing.

7) Singapore – The MAS eased policy in April by moving to a policy of no appreciation (zero slope for the S$NEER trading band). This policy setting was last put into place in 2008 during the financial crisis, so policymakers are clearly concerned about the growth outlook. GDP rose only 1.8% y/y in Q2, the lowest rate since Q3 2012. CPI came in at -0.8% y/y in June, and has been in negative territory since October 2014. Next policy meeting will be held mid-October, and another easing move seems likely.

The MAS runs monetary policy through the exchange rate, not interest rates. It adjusts the slope, width, and midpoint of its proprietary S$NEER trading band, a nominal trade-weighted measure of the exchange rate. The parameters of the band are not known outside of the MAS, but it is obligated to intervene in the FX market to stay within those parameters. The BIS measure of Singapore’s NEER is making new all-time highs, and we think the MAS will find recent currency strength undesirable.

8) Taiwan – The central bank has been cutting rates by 12.5 bp per quarter, with the last cut in June taking the policy rate down to 1.375%. We note that the rate troughed at 1.25% during the depths of the financial crisis in 2009. CPI rose 1.2% y/y in July, but we note that the central bank does not have an explicit inflation target. Even though the economy returned to growth in Q2 after three straight quarters of contraction, the 0.7% y/y rate is weak. Another 12.5 bp rate cut is expected to 1.25% at the next meeting in late September.

The Taiwan dollar is a heavily managed currency. FX intervention appears to have been scaled back a bit after the US Treasury report in April put a spotlight on Taiwan’s FX policy (see footnote below). Still, we would not be surprised to see FX intervention if USD/TWD moves back towards 31 (or below).

9) Thailand – Bank of Thailand has been on hold since its last 25 bp cut to 1.5% back in April 2015. CPI rose only 0.1% y/y in July, the lowest since April and threatening to move back into deflationary readings. This is also well below the 1-4% target range. However, growth remains quite robust, coming in at 3.5% y/y in Q2, the strongest since Q1 2013. For now, we think the BOT is on hold but if the economy slows in the coming months, it will have the ability to resume easing as needed. The next policy meeting is September 14, and no action is seen then.

The baht is a managed currency. Local press last week quotes a senior official as saying the BOT has been using its policy tools to curb the baht’s rise, including FX intervention. This week, another official noted that a stronger baht may hurt the economic recovery. Foreign reserves rose to $182.5 bln in early August, the highest since December 2012 but a bit short of the all-time high of $190 bln from April 2011.

===========

*Footnote:  A US Treasury report from April highlighted new measures to address unfair currency practices. From the press release: The Report also describes the factors Treasury used to assess, under the Act, whether a country that is a major trading partner of the United States has: (1) a significant bilateral trade surplus with the United States, (2) a material current account surplus, and (3) engaged in persistent one-sided intervention in the foreign exchange market.

The US at that time established a new “Monitoring List” that identified five major trading partners (China, Japan, Korea, Taiwan, and Germany) that met 2 of the 3 criteria that would trigger so-called enhanced analysis. From the report: “The Report calls on the authorities to limit foreign exchange interventions to the exceptional circumstances of disorderly market conditions, as well as increase the transparency of reserve holdings and foreign exchange market intervention.”

Over the next several days, we will be publishing our monetary policy outlooks for the three major EM regions. We are adding our outlooks on FX policy as well, as firmer EM currencies have a direct impact on domestic monetary conditions. We believe EM policymakers are starting to get more concerned about currency strength, with action already being taken by some countries.

Last week, we started with EMEA. This week, we continue with Asia. As in the case of EMEA, virtually all of the central banks in the Asian region are in dovish/neutral mode. This is due in large part to the slowdown in China and the lack of any persistent price pressures in most countries there.

1) China – The People’s Bank of China has been on hold since October 2015, when it cut its policy rates by 25 bp. CPI rose 1.8% y/y in July, the lowest since January and well below the targeted 3%. The economy continues to slow at a manageable pace, but the PBOC has signaled that it remains reluctant to cut rates further, preferring what it calls “prudent” monetary policy. Growth has slowed or stayed steady for six straight quarters and the 6.7% rate posted in both Q1 and Q2 is the lowest since Q1 2009. If the slowdown remains modest, we think PBOC will not ease further for fear of encouraging debt-fueled growth.

The PBOC has allowed a greater role for market forces in determining the exchange rate. Despite this, the yuan remains a heavily managed currency and FX policy remains a black box. Foreign reserves appear to have stabilized around $3.2 trln over the last few months, as capital outflows eased. For now, we think policymakers favor a broadly stable yuan and we see low risk of another devaluation.

2) India – The Reserve Bank of India restarted the easing cycle with a 25 bp cut in the repo rate back in April to 6.5%. Price pressures are rising again, with CPI rising 6.07% y/y in July. This is the highest rate since August 2014 and is now above the 2-6% target range. The RBI stood pat at the June and August meetings. Governor Rajan’s final meeting has been held, and his successor Urjit Patel will helm the next meeting on October 4. We suspect Modi would like him to cut rates quickly, but that won’t be so easy if inflation continues to rise. GDP rose 7.9% y/y in Q1, the strongest since Q3 2014, and so there really should be no urgency to cut rates.

The RBI maintains a generally hands-off approach to the exchange rate. However, it has used recent rupee strength to build up its foreign reserves. They stood at $365.5 bln in July, a record high.

3) Indonesia – Bank Indonesia surprised the markets with a 25 bp cut in the benchmark 12-month reference rate to 6.5% in June. It then stood pat in July. The central bank announced that it will use the 7-day reverse repo rate as its new benchmark policy rate, starting with last week’s meeting. This rate stands at 5.25%, and further cuts seem likely this year. CPI rose 3.2% y/y in July, the lowest since December 2009 and near the bottom of its 3-5% target range. On the other hand, GDP grew 5.2% y/y in Q2, the strongest since Q4 2013.

BI maintains a generally hands-off approach to the exchange rate. However, it has used recent rupiah strength to build up its foreign reserves that were depleted last year when the currency was under pressure. They stood at $111.4 bln in July, the highest since March 2015. Given the excessive rupiah weakness seen in 2015, we do not think officials are concerned about its recent gains.

4) Korea – Before its surprise 25 bp cut in June, the Bank of Korea had been on hold since its last 25 bp cut to 1.5% back in June 2015. There were four new members on the seven-member MPC at the June meeting, and they clearly leaned more dovish than their predecessors. The next policy meeting is September 9, and another 25 bp cut is possible to 1.0%. CPI rose 0.7% y/y in July, the lowest since September 2015 and well below the 2.5-3.5% target range. Meanwhile, GDP growth of 3.2% y/y in Q2 was the highest since Q3 2014 but remains weak by historical standards.

Despite US criticism of its FX policy (see footnote below), Korean officials have recently expressed concern about won strength. Last week, Vice Finance Minister said that a stronger won “impacts” exporters, and noted that his ministry will monitor flows and “take stabilization measures” if there are excessive moves. We would not be surprised to see periodic FX intervention. Foreign reserves stood at $371 bln in July, falling just short of the all-time high of $375 bln from June 2015.

5) Malaysia – Bank Negara surprised markets with a 25 bp cut to 3% in July. It had been on hold since its last 25 bp hike to 3.25% back in July 2014. CPI rose 1.6% y/y in June, the lowest since March 2015, and is expected to fall further to 1.1% in July. While the central bank does not have an explicit inflation target, low inflation will give it cover to ease further as the economic outlook weakens. The economy has slowed five straight quarters and the 4.0% growth rate posted in Q2 is the lowest since 2009. The next policy meeting is September 7, and no action is expected. However, we think a dovish surprise is possible. If not, further easing seems likely in Q4.

After depegging from the dollar back in 2005, the ringgit has been liberalized but remains a managed currency. Regulators recently introduced a new methodology based on market transactions to determine the daily USD/MYR fix, and also extended FX trading hours by an hour to 6 PM local time. Offshore trading of the ringgit is unlikely to be re-introduced anytime soon, however. Given the excessive MYR weakness seen in 2015, we do not think officials are concerned with its recent gains.

6) Philippines – The central bank has been on hold since it moved to an interest rate corridor and cut the main rate by one percentage point to 3.0% back in May. CPI rose 1.9% y/y in July, and has been below the 2-4% target range since May 2015. However, the economy has remained robust, with GDP growth accelerating five straight quarters. Indeed, the 7% y/y growth posted in Q2 was the strongest since Q2 2013. Given how low inflation is, the bank will have leeway to cut rates if the economy slows. Next policy meeting is September 22, no action is seen then. Officials said a cut in the reserve requirement has been discussed in recent meetings.

Policymakers continue to liberalize the FX market, but the peso is still a managed currency. This month, the central bank increased the daily limit for FX purchases requiring documentation from $120k to $500k for individuals and to $1 mln for companies. However, we do not think officials are too concerned about peso strength given how strong the economy is performing.

7) Singapore – The MAS eased policy in April by moving to a policy of no appreciation (zero slope for the S$NEER trading band). This policy setting was last put into place in 2008 during the financial crisis, so policymakers are clearly concerned about the growth outlook. GDP rose only 1.8% y/y in Q2, the lowest rate since Q3 2012. CPI came in at -0.8% y/y in June, and has been in negative territory since October 2014. Next policy meeting will be held mid-October, and another easing move seems likely.

The MAS runs monetary policy through the exchange rate, not interest rates. It adjusts the slope, width, and midpoint of its proprietary S$NEER trading band, a nominal trade-weighted measure of the exchange rate. The parameters of the band are not known outside of the MAS, but it is obligated to intervene in the FX market to stay within those parameters. The BIS measure of Singapore’s NEER is making new all-time highs, and we think the MAS will find recent currency strength undesirable.

8) Taiwan – The central bank has been cutting rates by 12.5 bp per quarter, with the last cut in June taking the policy rate down to 1.375%. We note that the rate troughed at 1.25% during the depths of the financial crisis in 2009. CPI rose 1.2% y/y in July, but we note that the central bank does not have an explicit inflation target. Even though the economy returned to growth in Q2 after three straight quarters of contraction, the 0.7% y/y rate is weak. Another 12.5 bp rate cut is expected to 1.25% at the next meeting in late September.

The Taiwan dollar is a heavily managed currency. FX intervention appears to have been scaled back a bit after the US Treasury report in April put a spotlight on Taiwan’s FX policy (see footnote below). Still, we would not be surprised to see FX intervention if USD/TWD moves back towards 31 (or below).

9) Thailand – Bank of Thailand has been on hold since its last 25 bp cut to 1.5% back in April 2015. CPI rose only 0.1% y/y in July, the lowest since April and threatening to move back into deflationary readings. This is also well below the 1-4% target range. However, growth remains quite robust, coming in at 3.5% y/y in Q2, the strongest since Q1 2013. For now, we think the BOT is on hold but if the economy slows in the coming months, it will have the ability to resume easing as needed. The next policy meeting is September 14, and no action is seen then.

The baht is a managed currency. Local press last week quotes a senior official as saying the BOT has been using its policy tools to curb the baht’s rise, including FX intervention. This week, another official noted that a stronger baht may hurt the economic recovery. Foreign reserves rose to $182.5 bln in early August, the highest since December 2012 but a bit short of the all-time high of $190 bln from April 2011.

========

*Footnote:  A US Treasury report from April highlighted new measures to address unfair currency practices. From the press release: The Report also describes the factors Treasury used to assess, under the Act, whether a country that is a major trading partner of the United States has: (1) a significant bilateral trade surplus with the United States, (2) a material current account surplus, and (3) engaged in persistent one-sided intervention in the foreign exchange market.

The US at that time established a new “Monitoring List” that identified five major trading partners (China, Japan, Korea, Taiwan, and Germany) that met 2 of the 3 criteria that would trigger so-called enhanced analysis. From the report: “The Report calls on the authorities to limit foreign exchange interventions to the exceptional circumstances of disorderly market conditions, as well as increase the transparency of reserve holdings and foreign exchange market intervention.”