Fed Reprieve Widens Asia’s Window for Reform as Growth Slows

The Federal Reserve’s decision to postpone its rollback of U.S. stimulus offered Asian policy makers extra time to address domestic economic fragilities as the region copes with diminished capital inflows.

“The policy adjustment at the Fed is going to happen” at some point, World Bank Managing Director Sri Mulyani Indrawati said in an interview today in Bali, where finance ministers from the Asia-Pacific Economic Cooperation are meeting. Knowing how markets will react when that occurs, many emerging markets need to persist with structural reforms, she said.

The Fed’s move spurred a rally in stocks and currencies from India to Indonesia, where officials in recent months have had to take steps including raising some interest rates to stem an outflow of capital. The reprieve still leaves India with the challenge of opening more industries to foreign investment, Indonesia with domestic infrastructure weaknesses, Malaysia with a persistent budget deficit and the Philippines with its anti-corruption campaign unfinished.

“The fact that the money train will continue for a while means the risk of a hard-landing or a balance of payments crisis has been greatly reduced, if not averted,” Frederic Neumann, co-head of Asian economic research at HSBC Holdings Plc in Hong Kong, wrote in a note today. “Policy makers in Asia will need to use this brief window to implement structural reforms to put Asian growth on a more sustainable path.”

Stocks Rally

Rising shares across the region sent the MSCI Asia Pacific Index up 2.2 percent as of 4:53 p.m. in Tokyo. Indonesia’s rupiah rose 1.7 percent against the dollar and the Indian rupee was up more than 2 percent. The Fed yesterday said it wants more evidence of an economic recovery before paring its $85 billion-a-month bond buying program, surprising analysts who predicted a $5 billion cut to purchases of Treasuries.

Emerging markets must continue reforms while waiting for the Fed’s policy shift, Indonesian Finance Minister Chatib Basri said in a separate interview today.

“We cannot prevent the Fed from doing the scale back,” he said in Bali, Indonesia. “It is absolutely their policy decision, but if they can communicate in a better way with emerging markets, with Europe, we would end up with a much better situation” of less turmoil for developing nations, while a clear road map or timetable for easing would allow policy makers to anticipate, the minister said.

Rate Increase

Indonesian growth won’t be less than 5 percent in the next one to two years, even as Southeast Asia’s biggest economy must accept slower expansion to narrow the current-account deficit, Basri said. Smaller growth may come from higher central bank interest rates, he said.

Bank Indonesia last week unexpectedly raised its benchmark rate for the fourth time since early June to support a weakening exchange rate. India will decide on its benchmark interest rates tomorrow, with all economists surveyed by Bloomberg News predicting the central bank will keep borrowing costs unchanged.

“It is business as usual for us,” Arvind Mayaram, economic affairs secretary in India’s finance ministry, told reporters in New Delhi today when asked about the Fed’s decision. “We will have to continue with structural reforms and not overly depend on the Fed. We have to continue deepening our reforms.”

India’s Response

The rupee sank to an all-time low 68.845 per dollar on Aug. 28, hurt by the possibility of reduced U.S. monetary stimulus and a current-account deficit that reached a record during the last fiscal year. The Reserve Bank of India raised two interest rates in July to curb short-term money flows, and Governor Raghuram Rajan announced concessional swaps for banks’ foreign-currency deposits after taking office earlier this month.

Infrastructure bottlenecks, electricity shortages, unclear rules for acquiring land and excessive bureaucracy are among structural issues holding back companies from investing in India. While the government has moved to allow more overseas investment in pension funds, it has struggled to introduce a goods and services tax that would broaden the revenue base.

“The Fed’s dovish tone does provide some breathing space, but that’s all it really is,” JPMorgan Chase & Co. said in a research note. “Recent history suggests that global risk can turn on a dime. We therefore expect the RBI to begin easing policy incrementally tomorrow but not be lured into a knee-jerk overreaction that could cause some nervousness in the foreign-exchange market.”

Unconventional Policy

The Fed’s decision shows how hard it is for a central bank to unwind an unconventional monetary policy, Bank of Japan policy board member Takahide Kiuchi said today in Hokkaido, northern Japan.

The BOJ in April embarked on unprecedented easing, ramping up purchases of Japanese government bonds and risk assets in a bid to end 15 years of deflation in the world’s third-biggest economy. By roughly doubling Japan’s monetary base over two years to the end of 2014, the central bank aims to achieve a 2 percent inflation target.

Some emerging markets might have preferred earlier Fed tapering. Luciano Coutinho, Brazil’s state development bank president, said yesterday he expects currency volatility to increase.

“For us, the sooner it starts and ends, the better,” Coutinho said in an interview at the Bloomberg headquarters in New York. “I would rather see it start today and have some date to finish because then we will feel the whole impact. The worst thing is the uncertainty.”

BRIC Collaboration

Brazil and Indonesia have embarked on a series of rate increases to buoy the real and rupiah. The so-called BRIC countries, which also include China and Russia, along with South Africa pledged this month in St. Petersburg to create a $100 billion pool of currency reserves to guard against shocks from the withdrawal of stimulus.

“Countries will do what they feel they need to do,” Philippine central bank Governor Amando Tetangco said in an e-mail today. “Unfortunately, some economies are large enough that their policies to address internal concerns invariably affect others and have spillovers. This is why there has been a general move towards greater communication among policy makers.”

Smaller economies can prepare for the impact of decisions by larger countries, and Asian emerging nations have seen reserves build-up, structural reforms to improve capital markets, increased intra-Asian trade, and a move toward strengthening regional consultation, he said.

“We can’t be complacent because the Fed’s priority is their economy,” even as the U.S. authority has paid more attention to its impact on emerging markets in the last three years, Bank of Thailand Governor Prasarn Trairatvorakul said. “We need to take care of ourselves and try to strengthen our economy in case the Fed’s action has a strong impact on either inflows or outflows.”

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