Region: South East Asia: Monetary Relief


Malcolm Cook

For the past two years at least, Southeast Asia’s recovering economies have been blessed by a very loose and benign global monetary situation featuring low inflation, low interest rates, and a weakening US dollar. This monetary ‘holy trinity’* has been a crucial underlying support minimizing the carrying costs of persistent budget deficits and government borrowings in Southeast Asia, and East Asia more generally. On the flipside, it has also been a key factor in keeping the Chinese economy from overheating despite ‘hothouse’ GDP growth approaching 10 per cent per annum. China has been able to grow this fast while suffering few inflationary pressures and boosting Southeast Asia’s exports (China has a trade deficit with the region). However, there are some emerging signs that the global tide may be turning, suggesting tougher fiscal and macro-economic times ahead, especially for the most vulnerable countries like the Philippines and Indonesia.

Short-term and long-term interest rates are at record lows across the major economies in the world and Southeast Asia. On 5 November, short-term interest rates in the United States were 1.03 per cent, while the EU chimed in at 2.16 per cent and Japan at 0.02 per cent. In Southeast Asia, the Thai rate averaged 1.35 per cent, Singapore’s 0.88 per cent, and Malaysia’s 3.05 per cent. Such low domestic and global interest rates have served local governments and recovering banks well by minimizing upward pressures on key non-performing loan ratios and on the costs of funding persistent budget deficits approaching 5 per cent of GDP in Malaysia and the Philippines. Moreover, the very low rates available on OECD government bonds has pushed investors back into emerging market bonds, lowering bond spreads at the same time that governments are borrowing overseas to deal with the budget deficits and major regional corporate groups like Petronas are seeking foreign funds for expansion.

The general weakness of the US dollar and strong pressures against raising interest rates in the US have also helped as Malaysia pegs its currency to the dollar, while the other major regional economies follow a dirty float exchange rate policy against the greenback. This regional ‘tie’ to the dollar has helped local exports remain competitive despite the fall in the dollar while the weakening dollar has lightened the high foreign debt levels of the Philippines and Indonesia. If the United States dollar had not declined and interest rates were not at all-time lows, the Philippines may very well have suffered a serious fiscal and financial crisis along with Brazil and Mexico.

However, Southeast Asia’s benign monetary environment faces two new threats. First, after sustained pressure from the US and the EU, the Japanese yen has recently surged against the US dollar with the Bank of Japan largely staying on the sidelines. A rising yen puts upward pressure on unpegged regional currencies and raises the debt-servicing costs of regional governments with exposure to Japanese aid and Samurai bonds. Second, the US government may be forced to raise interest rates in the future to service America’s ballooning fiscal, trade, and current account deficits. The recent sharp rise in the euro despite the EU’s own fiscal problems and lethargic growth suggest retail and institutional investors are moving out of the dollar. Any rise in the US interest rate would put pressure on interest rates around the world and cast doubt on global economic stability.

*This is a play on words contrasting with the ‘unholy trinity’ of an open capital account, exchange rate stability, and domestic policy autonomy blamed for the Asian financial crisis.

WATCHPOINT: If Southeast Asian governments live up to their fiscal consolidation pledges, their reliance on a benign monetary environment will reduce.


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