Photographer: Prashanth Vishwanathan/Bloomberg

India's Surprise Tightening Offers Path for Peers to Follow

Updated on
  • Regional economies may opt to tighten through money markets
  • ‘It’s a reasonable middle path’ amid growth concern: economist

India’s central bank is using tools to keep a lid on prices that could provide a template for the rest of Asia.

Instead of the time-tested increase in the benchmark rate, the Reserve Bank of India on Thursday chose to tighten through the money markets, unexpectedly raising the reverse repo rate. The move is aimed at draining a flood of cash in the banking system and containing inflation without jeopardizing investment.

"It’s a reasonable middle path for Asian central banks to adopt while they are still cautious about growth against a backdrop of ‘de-globalization’ concerns," said Priyanka Kishore, lead Asia economist at Oxford Economics in Singapore.

Money market levers offer more flexibility than traditional tightening. That can be useful amid an economic shock -- such as India’s demonetization which triggered the cash surplus -- or an uncertain global environment as U.S. President Donald Trump meets China’s Xi Jinping. While India is still among the world’s fastest-growing economies, any trade war risks stalling the recovery. Underlying inflation pressures persist, the RBI said Thursday.

"While we are less convinced about the extent of potential improvement in economic activity, we share the bank’s concern about the likely upward pressure on inflation," Societe Generale SA economists wrote in a note.

Read: India Unexpectedly Tightens, Flags Cash Tools to Curb Prices

Others may follow the RBI’s path. On Monday, the Bank of Thailand said it may mull more steps to discourage short-term capital inflows that are putting upward pressure on the baht. Earlier this month, the central bank curbed the supply of short-term bills in its effort to reduce incentives for foreign investors to park money in Thailand.

Indonesia and the Philippines are also likely to opt for policy levers rather than lift benchmark rates, according to Singapore-based Sean Yokota, head of Asia strategy at Skandinaviska Enskilda Banken AB. 

"I think Indonesia is next, which makes me more optimistic on the Indonesian rupiah," Yokota said.

China is already driving money rates higher to cut excessive leverage in the financial system in a move it hopes won’t hurt the wider economy. The People’s Bank of China has raised the cost it charges on reverse-repurchase agreements twice this year, while benchmark interest rates have been on hold since 2015.

Cautious Approach

"Keeping stability is still key this year. The PBOC won’t tighten liquidity significantly," said Raymond Yeung, Hong Kong-based chief China economist at Australia & New Zealand Banking Group Ltd. "The strategy is to fine-tune the cost it charges on open-market operations and using that to influence money market rates and navigate market expectation." 

Still, central banks have to be cautious because money market rates immediately impact short-term or wholesale borrowers. While some analysts say Japan is tightening by stealth by slowing its massive bond purchase program, the Bank of Japan says it will keep buying government bonds at an annual pace of 80 trillion yen ($721 billion) “more or less." Other central banks, including Australia and South Korea, remain some distance from tightening.

In Southeast Asia, because deposits still make up the bulk of bank funding, monetary authorities are under less pressure to act, said Chua Hak Bin, a Singapore-based senior economist with Maybank.

Global Risks

"The Southeast Asian countries have not witnessed as strong a shift to short-maturity wholesale funding or surge in shadow banking activities," Chua said. "This is in part because loan growth has not been as strong as China in recent years, and domestic credit-to-GDP have not reached the kind of ratios seen in China."

India’s Deputy Governor Viral Acharya on Thursday said excess cash isn’t leaking into inflation. The rupee’s relative strength in Asia also makes it an outlier as other regional economies face the prospect of weakening currencies amid the probability of more U.S. tightening.

“Central banks in Asia and emerging nations have to mop up excessive liquidity to avoid their currency weakening too much and excessive inflation," said Hiromichi Shirakawa, a former BOJ official and chief Japan economist at Credit Suisse Group AG. "The risk is that I’m not so sure the global economy is fundamentally strong enough to withstand less accommodative policies."

— With assistance by Yinan Zhao, Toru Fujioka, and Malcolm Scott

(Updates with economist reaction in fifth paragraph.)
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