The global COVID-19 pandemic has led to another round of ultra-loose monetary policy from developed market central banks. While the global economy is still recovering from the pandemic, a prolonged period of low interest rates could lead to asset inflation or excessive credit growth. A number of Asian central banks, such as the Bank of Korea, People’s Bank of China and Reserve Bank of New Zealand (RBNZ), have voiced concerns about the rapid rise in asset prices. RBNZ tightened mortgage lending in its February meeting to cool the local property market. Beyond raising interest rates, what can Asian central banks do to handle the renewal of the zero rate policy environment? 

Since the Federal Reserve (Fed) is unlikely to raise policy rates in any material way in the coming years, Asian central banks’ ability to take the lead and raise interest rates is limited. While higher interest rates locally could prevent the domestic economy from overheating, this is complicated by the potential international capital inflow into these Asian markets by global investors looking to take advantage of the interest rate differentials. Therefore, Asian central banks and governments will need to look for a wider range of tools to prepare for this possible inflow of liquidity. 

Following a similar episode of ultra-loose monetary policy after the global financial crisis (GFC) in 2008/2009, Asian policymakers have focused more on macroprudential policies (MPPs). These include higher reserve and capital requirements for banks, loan-to-value ratios for mortgages and debt-to-income ratios for consumer loans. Some measures are also aimed at managing foreign capital inflow, although these are harder to implement for many Asian economies with relatively free cross-border flow of capital. Some governments, such as Hong Kong and Singapore, also introduced stamp duties to curb speculations in the residential property market. 

As Exhibit 1 shows, the number of MPPs implemented rose significantly after the GFC when the Fed and other developed market central banks adopted zero rate policies and asset purchases. These were kept throughout the 2010s.

These measures are not directly aimed at curbing asset price increases. Instead, they target credit growth and build buffers to protect the banking sector and borrowers. For example, a more stringent loan-to-value ratio would protect both banks and mortgage borrowers in case the real estate market corrects. A study by the International Monetary Fund shows that housing-related measures have the most significant impact on credit growth in Asia, while the effect from changes in reserve requirement and capital regulation was limited. MPPs and capital flow management measures do not discourage portfolio equity inflow and do not have any significant impact on debt inflows. Asian authorities are also more focused on curbing property prices since expensive housing could create social stress. MPPs tend not to apply to financial assets, such as equities and fixed income, in Asia. 

Asian central banks have taken a more active approach, using MPPs to build resilience in the banking sector and borrowers
Exhibit 1: Number of incidents of mpp tightening and loosening in asia pacific

Sources:  IMF integrated Macroprudential Policy (iMaPP) Database, originally constructed by Alam et al. (2019), J.P. Morgan Asset Management. The IMF iMaPP database provides dummy-type indicators of tightening and loosening actions of various macroprudential policy instruments. Data reflect most recently available as of 15/02/21.

Investment Implication

Loose monetary policy by global central banks is expected to support Asian equities and fixed income market performance, justified by improvement in cyclical economic performance and structural advantages. Room for Asian central banks to raise interest rates is limited, and they could turn to MPPs and capital flow management measures to manage credit growth and limit systemic risks in the banking sector. 

Empirical evidence suggests that these measures can help to cool property market momentum and real estate-related bank lending. Yet these policies did not seem to have an impact on capital flows into equities and fixed income. This implies that investors should focus on specific sectors, such as construction, real estate and banking, instead of the broader market. Bank lending growth could slow under these measures. While this could dampen earnings growth during the upcycle, it could also reduce the need for provisioning for bad loans during economic downturns. For construction and real estate, the authorities’ objectives are to maintain affordability for potential home owners. Hence, the volume of construction should be less affected, but developers’ profit margins could take a hit if property price momentum is dampened.