Capital Markets report: Covid-19 pathway towards unconventional policies

New Zealand and Australia unveiled significant fiscal packages, with an emphasis on wage subsidies to support employees forced out of work by Covid-19.

COMMENT:

Weaning economies off their extraordinary monetary and fiscal accommodation will be the next big challenge, going by the experience of advanced economies in the aftermath of the GFC.

It is in developed markets where the lines between fiscal and monetary policy have become most blurred New Zealand and Australia unveiled significant fiscal packages, with an emphasis on wage subsidies to support employees forced out of work by Covid.

The pandemic is shaping up as a pivotal period for macroeconomic policy-making in the Asia-Pacific region. Amid an unprecedented economic shock — and in the wake of decisive action from policymakers in the US — authorities across the Asia-Pacific region have effectively combined the fiscal and monetary tools at their disposal to protect incomes and livelihoods.

They have combined increased transfers and healthcare spending with monetary expansion, and importantly, without provoking financial instability. As their economies went into lockdown, New Zealand and Australia unveiled significant fiscal packages, with an emphasis on wage subsidies to support employees forced out of work during lockdowns.

Monetary policy has also played a significant role across the region to support both market functioning and to reduce term interest rates via asset purchase programmes.

In New Zealand, the Reserve Bank cut the OCR by 75 basis points to 0.25 per cent in mid-March, and a week later embarked on its Large-Scale Asset Purchase quantitative easing (QE) programme.

Jennifer Kusuma.

Other regional central banks took similar steps — easing policy initially, then embarking on QE later. For many of the smaller Asian emerging economies, it was their first leap into QE, as they joined co-coordinated efforts across the region.

Historically, most emerging markets have faced market financing constraints that prevented recourse to such quantitative tools and, in some cases, counter-cyclical policy responses altogether. But the provision of ample liquidity by developed market central banks, as well as subdued inflationary pressures and heightened policy credibility, have allowed regional policymakers to go beyond rate cuts.

The main monetary support provided by the Reserve Bank of India, Bank Indonesia, and the Bangko Sentral ng Pilipinas came in the form of government bond purchases. In contrast, the Bank of Thailand, the Bank of Korea, and the People's Bank of China have purchased assets directly from distressed private sectors, including corporate bonds.

Most programmes were delivered to improve market functioning, rather than to ease financial conditions materially. The fact that most Asian economies implemented their programmes while policy rates were still positive is evidence of this.

However, the size of the asset purchases in some Asian emerging economies has been on a much smaller scale than in many advanced economies, including New Zealand, Australia, and Japan. It remains unclear to what extent the former can continue to do so without shaking market confidence and ultimately discovering the limits of debt accumulation.

The more prolonged the pandemic is, the more strain these measures will put on public balance sheets.

Bank Indonesia has significantly stepped up its fiscal support over the past few months — from purchasing government bonds in the secondary market to direct debt monetisation, and most recently to sharing the interest rate burden of the Covid-19 stimulus package.

A narrowing 'quality' gapImportantly, the Chinese yuan has been broadly stable throughout the pandemic. China's policymakers have eased less aggressively than their US and Asian counterparts, and the former's financial account remains quite carefully managed, reducing the global spillover effects of Chinese monetary policy.

The region's monetary policymakers will continue to take their cues from the Federal Reserve rather than the People's Bank of China in the foreseeable future, but China's economic and market stability has acted as a crucial stabiliser for the region.

On some levels, the risk profile between emerging Asia and advanced markets is also narrowing.

Political risk is very much an affliction of emerging markets as well as developed markets.

Richard Yetsenga.

Given the acute polarisation of the American electorate, US domestic politics have become more volatile than at any one time in recent memory.

Institutional risk is now prevalent in developed markets, as suggested by the deficient response of some advanced economies, including the US and UK, to the pandemic. This is in contrast to the generally credible response across much of Asia.

Finally, policy independence used to be a concern primarily in emerging markets. But it is in developed markets where the lines between fiscal and monetary policy have become most blurred in the last two crises.

Policy making in the post-Covid worldAs more economies emerge from their lockdowns, there is an active debate over the shape and size of future spending. Despite their apparent efficacy as a near-term stabilisation tool, the widespread and rapid deployment of unconventional policies presents some risks once the Covid-19 crisis subsides.

Weaning economies off their extraordinary monetary and fiscal accommodation will be the next big challenge, going by the experience of advanced economies in the aftermath of the Global Financial Crisis.

Productivity and economic growth will still be the surest way out of the crisis, The debt build-up will otherwise be unsustainable for emerging economies, and could lead to stagflation in advanced economies.

The combination of large-scale fiscal and monetary easing in response to Covid-19 could also presage further forays into unconventional policy in response to future economic shocks, potentially including applications of Modern Monetary Theory (MMT).

MMT holds that countries issuing debt in their own currencies cannot default on their (local currency) sovereign debt because central banks can always backstop their governments, if necessary. MMT supporters claim fiscal policy should be the primary cyclical stabiliser of the economy because it has a more direct impact on economic activity with fewer negative side-effects than monetary policy.

Some aspects of MMT remain quite controversial, and hence the probability of its pure application is low, but it is likely to be discussed with increasing frequency.

- Richard Yetsenga is Chief Economist/Head of Research of ANZ Banking Group; Jennifer Kusuma is Senior Asia Rates Strategist ANZ Institutional.