With the global economy on an uncertain trajectory, China and the U.S. on the cusp of a trade war and commodity prices recovering, Asian central banks are reassessing their monetary policies. After significant rate cuts in the last year, central banks are now adopting a "wait-and-see" attitude.
Last July, Bank Negara Malaysia surprised financial markets by cutting its benchmark interest rate for the first time in seven years in response to subdued inflationary pressures, a slowdown in growth and, crucially, improving sentiment toward emerging markets.
Fast forward six months and that rate cut seems a distant memory.
On Jan. 19, Malaysia's central bank kept its main rate on hold for a third consecutive time, stressing that "uncertainties in the global economy, the policy environment and geopolitical developments may result in bouts of volatility in the regional financial and foreign exchange markets."
Malaysia has already experienced a sharp sell-off. The ringgit has plunged 12.5% against the dollar since last July, with nearly half the decline occurring since the unexpected victory of Donald Trump in the U.S. presidential election on Nov. 8. Malaysia's local currency government debt market, moreover, suffered outflows of nearly $6 billion in November and December, according to JPMorgan Chase, amid fears that Trump's reflationary economic policies would force the U.S. Federal Reserve to tighten monetary policy more aggressively.
It is not just Malaysia's central bank that has been forced to reassess its policy stance.
Its Indonesian counterpart, which was still cutting rates as recently as October, left its benchmark rate unchanged in December for the second month in a row, warning of the need to "remain vigilant of several risks, especially relating to U.S. and China policies." The rupiah has fallen nearly 3% against the dollar since the end of October, after having strengthened for most of last year.
Meanwhile, the Reserve Bank of India's new monetary policy committee, which cut rates in October for the first time in six months, unexpectedly kept its main rate on hold last month in the face of a severe cash crunch stemming from Prime Minister Narendra Modi's controversial "demonetization" initiative which took a heavy toll on domestic demand. India took 500-rupee and 1,000-rupee banknotes out of circulation in November. The RBI cited the possibility of a faster pace of rate hikes in the U.S. as a reason for it to act cautiously.
Other emerging Asian central banks which stood pat in the last two months of 2016 include those of South Korea and Taiwan, both of which were trimming rates as recently as June.
While JPMorgan expects India's central bank to lower its main rate next month, it does not anticipate any further cuts in benchmark rates in the region in the first quarter of this year and expects monetary policy to remain firmly on hold in Malaysia, Thailand, Taiwan and the Philippines for the whole of 2017.
Make no mistake, emerging Asian central banks' conspicuously dovish stance over the past two years or so has run its course.
It is not just the tightening in global financial conditions -- the yield on benchmark U.S. 10-year Treasury bonds has shot up nearly 65 basis points since Trump's victory, to its highest level since September 2014 -- that has reduced the scope for further monetary easing across the region. It is also the recovery in commodity prices. Since hitting a record low in January last year, the widely followed Bloomberg Commodity Index has risen 20%.
The rebound in commodity prices -- which stems partly from a stimulus-driven improvement in China's economy -- is contributing to stronger economic data in several economies. Indonesia's exports rose 9% on a monthly basis in November, buoyed by sharp increases in the prices of coal and crude palm oil, while those of Malaysia -- emerging Asia's sole net oil exporter -- increased nearly 12%. Inflation rates across the region are picking up and are expected to rise further this year as the recovery in commodity prices takes hold.
JPMorgan noted that the scope for easier monetary policy across emerging Asia has narrowed further due to rising commodity prices and higher core bond yields.
Not surprisingly, the more cautious stance on the part of emerging Asia's central banks is weighing on the region's local currency bond markets, already under strain because of a significant reduction in foreign purchases. According to JPMorgan, foreigners only bought $12 billion of emerging Asian local bonds last year, compared with $86 billion in 2014 and $23 billion in 2015.
Another reason for prudence, thrown into sharp relief by Trump's decision on Jan. 23 (three days after he assumed the presidency) to pull the U.S. out of the 12-nation Trans-Pacific Partnership agreement, is the threat of a destructive trade war between America and China. Emerging Asia is acutely vulnerable to an escalation in trade tensions because of the openness of the region's economies and the importance of China's financial markets -- particularly the value of the yuan against the dollar -- in shaping sentiment toward the region.
Still, the greenback has weakened this year -- the dollar index, a gauge of its performance against a basket of its peers, has fallen 2.2% since Jan. 3 -- and emerging market bond and equity mutual funds are once again enjoying inflows after several weeks of outflows following the U.S. election.
The region's rate-cutting cycle may have just about run its course, but there is no pressure to tighten monetary policy just yet.
Nicholas Spiro is a partner at Lauressa Advisory, a specialist macroeconomic and property consultancy in London.