Regional safety net

Asian economies should adopt measures to address the risks of cross-border capital flows

The mounting inflation pressure, slowing economic recovery, and the accelerated quantitative tightening of the US Federal Reserve, which increased its benchmark interest rate by half a percentage point this month, pose challenges to the monetary policies of Asian economies. To ensure economic and financial stability Asian countries need to improve their monetary cooperation.

The International Monetary Fund projected in April that the global inflation rate would reach 7.4 percent this year, up 2.7 percentage points from 2021, reaching a record high since 1997. Most Asian economies face severe inflation pressure.

According to a report released at the Boao Forum for Asia Annual Conference 2022, the average inflation rate of 33 Asian economies reached 7.6 percent in December 2021, and inflation rates still remain high in some of the countries this year with the numbers in Central Asian countries such as Kazakhstan, Uzbekistan and Kyrgyzstan exceeding 10 percent.

There are also Asian economies with low inflation. China's inflation rate was 1.5 percent in March, and Japan's 1.2 percent, still below the 2-percent inflation target of its central bank. The number for Indonesia was 2.6 percent, within the inflation target range of its central bank. However, the inflation rates in these economies still see an upward trend.

Monetary policies in Asian countries hence have diverged. Amid rising inflation pressure and tightening monetary policy of the Fed, some Asian economies have started to tighten monetary policies. The Republic of Korea started raising interest rates in August 2021, increasing its benchmark interest rate to 1.5 percent in April this year. Pakistan and Sri Lanka began to raise interest rates in the second half of 2021. The latter enhanced the base interest rate by 700 basis points in April this year. Countries in Central Asia, such as Kazakhstan, Kyrgyzstan, Tajikistan and Uzbekistan, have raised benchmark interest rates to more than 10 percent. The policy rate of Uzbekistan has even reached 17 percent.

Some other Asian economies have maintained their monetary policies and even lowered interest rates. The central bank of India has maintained easing monetary policy since May 2020 to stimulate economic growth, although the interest rates have been above its inflation targets for several months. As inflation is below the expected level, the central bank of Japan continued to implement an ultra-easing monetary policy. Despite great inflation pressure, the central bank of Turkey lowered its benchmark interest rate by 500 basis points throughout 2021, and maintained its monetary policy in 2022. Indonesia has also kept monetary policies unchanged since February 2021. For the first time since April 2020, the People's Bank of China cut the one-year loan prime rate by 5 basis points to 3.8 percent in December 2021, and further cut to 3.7 percent in January.

Asian economies are at crossroads. The slowdown in economic recovery makes them more cautious about tightening monetary policies. Facing mounting downward pressure on the global economy, the prospects for economic recovery in Asia are gloomy. According to the IMF's projection, Asia's economic growth rate will be 4.9 percent in 2022, which is significantly lower than 6.5 percent in 2021. The World Bank also lowered its projections for economic growth in East Asia and the Pacific region to 5 percent in April, down 0.4 percentage points from its estimate in October 2021. Due to sluggish economic growth, some economies have maintained easing monetary policies despite inflation pressure. Some Asian economies still need to choose between ensuring economic growth and stabilizing commodity prices.

The tightening monetary policy of the Fed has put more pressure on Asian economies. In March, it raised the federal funds rate by 25 basis points to 0.25-0.5 percent. It is expected to accelerate its hiking of interest rates, and will start to shrink its balance sheet. The United Kingdom's central bank also started hiking interest rates at the end of 2021, and the European Central Bank is expected to turn to quantitative tightening. If the monetary policies of Asian economies are not adjusted accordingly, rising interest rate spreads between these economies and the United States will lead to capital outflows and currency depreciations in Asia, which may trigger turbulence in the financial market.

To ensure currency and financial stability, Asian economies need to improve their management of cross-border capital flows. As the Fed accelerates quantitative tightening, Asian countries will face more pressure from capital outflows. Besides boosting domestic economic fundamentals, Asian economies can adopt capital flow management measures to address the risks of cross-border capital flows. Since 2012, the IMF started to recognize the role of the CFMs in managing cross-border capital flows. In March, the IMF updated its view on capital flows, and said that the CFMs could help counties to mitigate risks to financial stability. The measures can help avoid the impacts of changes in the external environment and maintain the monetary policy independence of Asian economies.

Asian economies should improve cooperation to safeguard regional financial stability. More bilateral currency swap agreements should be created among Asian economies. China can further expand its bilateral currency swaps with other Asian economies and promote the renminbi to play a greater role in Asian financial stability. Efforts are needed to improve the Asian regional financial safety net, enhance the surveillance capabilities of the ASEAN+3 Macroeconomic Research Office, and bring the role of the Chiang Mai Initiative Multilateralization into full play to enhance the financial stability of Asian economies.

International monetary cooperation should be strengthened. Asian economies need to improve their coordination of international macroeconomic policies via multilateral mechanisms and platforms such as the G20, and urge developed economies to implement responsible monetary policies. Efforts are needed to improve communication and regulatory cooperation with other economies to reduce the negative impacts of policy spillovers. International organizations such as the IMF and the World Bank should also enhance support for ensuring economic and financial stability in developing Asian economies.

The author is an associate researcher with the Institute of World Economics and Politics at the Chinese Academy of Social Sciences. The author contributed this article to China Watch, a think tank powered by China Daily. The views do not necessarily reflect those of China Daily.

Contact the editor at editor@chinawatch.cn