LOOKING AHEAD: POLICYMAKING IN THE POST-COVID WORLD
The normalization of unconventional policy has several long-lasting implications. Although the global real economic cycle will move even closer to Asia in the coming years, the Federal Reserve remains the driver of the global financial cycle. Importantly, however, the ‘quality’ gap between emerging markets (EM) and developed markets (DM) has narrowed.
Political risk is no longer just an issue for EM. It is very much an affliction in DM, including the US. Given the acute polarisation of the American electorate, US domestic politics have become more volatile than at any time in recent memory. Institutional risk is now prevalent in DM, as suggested by the uneven response of some advanced economies, including the US and UK, to the Covid-19 epidemic. This stands in contrast to the generally credible response across much of Asia. Finally, policy independence used to be a concern primarily in EM. But in DM it is where the lines between fiscal and monetary policy have become most blurred through the last two crises.
Importantly, the Chinese yuan has been broadly stable throughout the pandemic, alleviating concerns of a devaluation that could have tightened financial conditions throughout Asia-Pacific and led to a destabilizing series of currency depreciations and other responses across the region. This is the third crisis in succession where fears of large-scale CNY depreciation have proven to be unfounded. This is a notable trend. Moreover, it was only in the month of March 2020 that China saw foreign investors exit the bond market. Every other month this year has seen inflows, particularly May, which recorded the second largest month of inflows on record.
Importantly, Chinese authorities have eased less aggressively than their US and Asian counterparts, and the Chinese financial account remains quite carefully managed, reducing the global spillovers of Chinese monetary policy. Asia’s monetary policymakers will continue to take their cues from the Fed rather than the People’s Bank of China for the foreseeable future, but China’s economic and market stability has acted as a crucial stabiliser for the region.
Despite their apparent efficacy as a near-term stabilization tool, the widespread and rapid deployment of unconventional policies also present some risks once the Coronavirus crisis subsides. Given the relatively smaller size of those programs in Asia, however, and the narrowing risk profile between emerging Asia and DM, those risks shouldn’t be overplayed. Certainly central bank asset purchases might not be met with market approval in the context of larger interest rate differentials with the US or a more inflationary global environment. But if a somewhat more inflationary environment does materialize, many would probably welcome that.