Central banks are doing everything they can to revive growth. But blurring the line with fiscal spending comes with risks
From Seoul to Jakarta, central banks are breaking decades-old conventions to stabilize markets and put a floor under cratering economic activity. They're cutting interest rates to zero, buying bonds and financing budgets in all but name — each a step that would have been considered contentious six months ago.
These actions are justified in the wake of the coronavirus, and in some ways resemble the course charted in the developed world since the global financial crisis. But unlike in the US, Europe and Japan, there's a worrying air of improvisation about them. These measures risk blurring the line between governments and monetary authorities, and could undo the progress Asian economies have made in recent decades to earn the trust of foreign investors.
In little more than a week, South Korea's central bank declared a preparedness to buy government debt, consumer prices turned negative and President Moon Jae-in proposed a record supplementary budget. For now, investors aren't the least bit perturbed by the fiscal onslaught and the surge in borrowing entailed. Korean bonds rallied Thursday on bets the central bank will be a buyer.
BOK Governor Lee Ju-yeol said late last month he is considering using unconventional policy tools to support growth, but shied away from the specifics. While he is open to bond purchases, he appears loath to call it quantitative easing. This suggests ad hoc buying designed to absorb excess supply and iron out any market volatility.
The trouble is, big bond purchases — alongside such a robust budget — come perilously close to being deemed a monetization of state debt. That could embroil the central bank in the domestic political skirmishes bound to accompany the recovery.
The vaulting of policy boundaries is even more pronounced in developing markets. At least in Korea, the benchmark rate is almost zero, a natural jumping-off point for quantitative easing. In Indonesia and the Philippines, rates are well north of that, at 4.5% and 2.75%, respectively. That hasn't stopped overt support for government spending. Bank Indonesia has been given authority to buy bonds in the primary market — that is, directly from the state. In the Philippines, the purchases take place from investors. Either way, the practical effect is the same.
It's highly unusual for sovereign debt buying to take place without rates at zero. That's because, as we saw in the US, euro zone and Japan after the Great Recession, the idea was to boost low inflation and juice broad economic activity. Officials undertook QE only after traditional ammunition was depleted. It was introduced with a thoughtful policy framework that was clearly articulated. Inflation targets and forward guidance were baked into the package.
What we have with the Philippines and Indonesia is a hybrid, all the more stark because, in the past few decades, Asian economies adopted Western architecture to give them credibility with foreign investors: clear benchmark rates, numeric inflation targets, relatively independent central banks, scheduled meetings and efforts to distance themselves from politicians.
It's entirely appropriate that the virus disaster delivers a fresh monetary order and new role for the state. Investors have taken this in stride for the time being. But the longer we go without clarity, the higher the risk of eventual capital flight. Hemming and hawing from policy makers only adds to the murkiness about how to characterize what comes next. If it is QE, don't obfuscate. Develop a plan and clearly communicate goals. The sooner that's done, the sturdier this recovery will be.
Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement