Interest Rate Cuts Are Dead. Long Live Rate Cuts

Interest rate cuts are becoming passe in important parts of Asia. The main game is now the expansion of monetary policy into arenas once considered off-limits for responsible central banks. While this new approach is quickly gaining adherents, officials would do well to tread carefully.

After waves of reductions in borrowing costs amid the pandemic, benchmark rates are unlikely to be lowered much further. It's important to grasp this isn't the end of easing. Rather, it marks a new chapter in juicing economies that suffered historic contractions last quarter. This next phase of central bank support is about bolstering government finances largely through hoovering up sovereign bonds, either overtly or indirectly. Strong signals from the Federal Reserve that U.S. rates will stay near zero for years, and Chair Jerome Powell’s advocacy of fiscal brawn, might only encourage more adventurism in Asia.

Indonesia was first to take action on the Fed’s hints earlier this year, unveiling debt monetization in July. This was a break with orthodoxy that would have been condemned in pre-pandemic times. Philippines President Rodrigo Duterte signed a bill Friday that provides for the central bank to finance more state spending. A few days earlier, the Bank of Korea said it will buy about $4.2 billion of government bonds through year-end. The Reserve Bank of Australia signaled Tuesday that further easing is in the cards, which observers say is likely to mean more debt buying.

Manila had long been eyed as a candidate to go down Indonesia's path. Gross domestic product fell by the most ever from April to June. Duterte’s fiscal response has been conservative relative to some neighbors: The central bank had been quietly offering what support it could, making discrete bond purchases here and there. Things are now more in the open. “This unprecedented, once-in-a-lifetime pandemic requires an all-of-government approach,” Governor Benjamin Diokno said in texted comments to Bloomberg News.

It’s not exactly what Jakarta officials call “burden sharing.” The Philippines does face constraints, says Justin Jimenez of Bloomberg Economics. Bangko Sentral ng Pilipinas may lend the administration 30% of average revenue in the past three years, compared with 20% previously. The money must be accessed within two years and paid back within one. Duterte and Diokno are also blessed with a favorable market backdrop: The peso is up 3% against the dollar this quarter.

That’s some comfort, but far from a get-out-of-jail card. Indonesia started off OK, too, as I wrote here and here. Monetization was framed as a one-off, and the rupiah had just ended a great second-quarter. Then things got squishy. President Joko Widodo said Bank Indonesia may need to support the economy for a few years, and legislation was presented in parliament that was perceived as eroding the central bank’s independence. The rupiah’s gains evaporated. It’s now Asia’s worst performer this quarter, down 4%. Not a bloodbath, but worrying.

That’s the danger for the Philippines. New laws can always be passed and loose lips can undo technocrats’ best efforts. Duterte has made no secret of his contempt for traditional protocol. Why would he give a basis point about central bank independence?

Towering in the background is a debt mountain as Asian leaders borrow to finance a revival of economic growth. If the pandemic rages on too long, nations may end up with more debt than they’ve ever seen and a weakened capacity to pay it back. And if they overdo it, inflation may spike.

In South Korea, the government has unveiled a fourth stimulus package that will see debt levels climb. Until last week, the BOK was reluctant to get into a lot of detail on bond purchases. Now, they will be conducted at the end of each month. The central bank has balked at the QE label and officials would be aghast if you mentioned something as heretical as monetization. But regular purchases will help smooth any jump in yields. In so doing, the BOK is making financing conditions more favorable for President Moon Jae-in.