Challenges Faced By Central Banks In Policy Normalization In 2018 (essay).

Critically analyze the challenges posed to Central Banks as they move towards policy normalization in 2018 and tighten monetary policy and impact of the US-China trade war and volatility of cryptocurrencies on their policy towards normalization.

Normalization of Asian Central Bank

The normalization policy of central banks refers to the attempt of the banks to reduce size of the balance sheet. To accomplish the objective, the central bank’s target to increase the interest rate from the benchmark level to return the environment of monetary policy before the event of global financial crisis (Reid 2018). Like several other advanced economies, Asian Central Banks are adapting normalization policy with believe that their economy will account a strong growth in coming years. The normalization policy of Asian central banks further followed from the normalization attempt of United State. The higher interest rate of Fed makes domestic currencies of Asia less attractive lading to outflow of capital. The monetary Authority of Singapore decided to tighten its monetary policy for the first time in last six years. The tight monetary policy in Singapore was followed by the other Asian countries such as Korea, Malaysia, Hong Kong, Philippines and others. The move towards normalization has been backed by strong growth of Asian economies in last years (Masciandaro and Volpicella 2016). Asian Development Bank predicts that the economy will experience a real economic growth of 6.0 percent and 5.9 percent in 2018 and 2019 respectively. The continuous easing of monetary policy has the possibility of over-heating the economy.

The normalization of central banks of several economies possesses tough challenges compounded by a loose financial condition. Normalization at a much slower rate could lead to overheating of the economy and associated financial risk. Moving too fast towards normalization is also harmful for an economy. Faster pace of normalization is associated with disruptive reactions of the market hampering economic recovery (bis.org 2018). The pace of normalization varies across different Asian nations leading to the possibility of differing outcomes from the same type of policy.

The normalization policy involves normalization of both policy rate and balance sheet. The Bank of Japan has continued purchase of large-scale assets along with a negative interest rate. This has been taken place against the background of a relatively low interest rate. This posing serious challenge for central banks ahead.

The attempts of Asian central banks to normalize banking activities will lower the gap between Asian and US interest rate. The smaller gap between the two interest rates can cause domestic economies to bleed foreign capital and cause domestic currencies to decline. This will make stocks and bonds of Asia less attractive blocking investment potential of Asian countries. The central bankers have found the possibility of another financial crunch in Asia like that during 1997 (Filardo, Genberg and Hofmann 2016). The hike in interest rate by Fed might add to volatility in Asia.

Challenges to normalization of Asian central banks 

In medium term, higher interest rate by Fed along with tight liquidity condition in global market affected the normalization process of Asia. Normalization of Fed and European Central Bank further tightened global liquidity market.

From the normalization process, Asia thus expects higher cost in the financial market in medium and long term. Since the third quarter of 2014, the US dollar recorded strong gains. Any further reduction in the interest rate differential between US and emerging economies of Asia would reduce attractiveness of assets of emerging market (Zhang and Zoli 2014). This poses a pressure in terms of valuation assets in the emerging markets of Asia.

An increase in interest rate to squeeze the balance sheet indicates adaption of tight monetary policy. In an emerging economy like that of Asia, a tight monetary policy bears deep implication for the economy. The growth of Asian economies is linked with global market integration and openness to flow of foreign capital. The sudden tightening of condition of liquidity in domestic and global market inject volatility in the currency in financial and foreign exchange market (Japantimes.co.jp 2018). Following this some economists suggest that central banks of Asian countries should pursue the policy of low interest rate thus hampering the normalization process. The sudden increase in interest rate could left the household with huge debt which in turn undermine consumption and investment in the economy. The ultimate effect is impediment to economic growth.  The attempts of normalization is thus threatened by the potential risk in terms of slower economic growth.

The normalization attempts of Fed at this moment thus impose the greatest challenge on normalization in Asia. If interest rate in US rises at a faster than expected rate, then foreign exchange market in Asia will come under severe pressure. Another challenge for the central bank to implement tight monetary policy is to trace the movement of international trade. The growing trade tension between US and some countries causes net economic loss to export dependent emerging nations (Schnab 2017). Under this circumstances central banks can possibly lose their determination towards a tight monetary policy. This makes the normalization process vulnerable to outside events.

Since the beginning of 2018, international trade policy has come under severe pressure exposing the global growth towards high risk. The trade war between two of the largest economies of world – China and US poses a great threat to global economic growth (Li, He and Lin 2018). The origin of the trade war was imposition of huge tariff on China’s import following the protectionist policy of Donald Trump. The US-China trade war increase the depreciation pressure on Asian currencies. The depreciation pressure on many of Asian economies is developing at a faster pace. The effect of US-China trade war varies across countries with different income group (Ross 2016). The currencies of high income economies like Korean Won, Singapore dollar and Taiwanese dollar have weakened the most as against US dollar. The same is true for currencies of upper middle income countries such as Thai baht and China’s yuan. For lower middle income countries that represent the fastest growing nations in Asia have weakened the most compared to US dollar. The vulnerable currencies include Rupee in India, Peso of Philippines and rupiah on Indonesia. As these countries suffer twin deficit, they are exposed to higher risk of currency depreciation. At the initial phase of trade war countries like Taiwan, Indonesia, Korea, Singapore and Malaysia tend to be in a better position as they export more to China than to United State. Countries engage in reverse exchange on the other hand is vulnerable to high risk of depreciation (Guo et al. 2018). The increase in international rise affects the pace of normalization. As the depreciation pressure on Asian currencies increase, central banks might slow down the speed of normalization. This might delay the attainment of normalization goals of central banks.

US-China trade war and effect on normalization in Asia 

One of the most contested aspect of cryptocurrencies is the volatility in the cryptocurrency market. The values of cryptocurrencies have been recorded an exponential increase in the past few years. The volatility in the cryptocurrencies market is considered as a two edged sword. In 2018, price of Bitcoin declined by more than 50 percent from the year end price of $13000. The volatility in Bitcoin prices has also affected the cryptocurrency market as the decline in price of Bitcoin affected the volume of Bitcoin traded in the market causing a decline in interest rate in realm of digital currency market. The growing volatility in global cryptocurrency market has highly affected the financial regulators in the Asia Pacific region. The government of ‘Bank of Japan’ declared the sudden upswing and downswing in prices of Bitcoin is abnormal. Bitcoin is the highest valued cryptocurrency in Asia (Yi, Xu and Wang 2018). Asia is thus highly threatened from the volatility in Bitcoin price that in turn affects the entire cryptocurrency market. Asia is involved in huge trading of Bitcoin. Asian countries like Japan, South Korea and Vietnam together contribute more than 80 percent of bitcoin trading globally (Lee 2018). The volatility in cryptocurrency thus is a matter of great concern for regulators. The volatility in cryptocurrency market also increases financial risks to the mainstream society. The unforeseen fluctuations in prices hurts confidence of investors. In this situation it become difficult for central banks to successfully carry out tight monetary policy. This hampers the initiatives to normalization as taken by the central banks. In connection to growing volatility in cryptocurrency market China claims full control over the digital currency. The People’s Bank of China suggested that an unregulated market would bring further risks to the financial market impeding the path of normalization. 

References 

Bis.org., 2018. II. Monetary policy: a narrow normalisation path. [online] Bis.org. Available at: https://www.bis.org/publ/arpdf/ar2018e2.htm [Accessed 15 Nov. 2018].

Filardo, A., Genberg, H. and Hofmann, B., 2016. Monetary analysis and the global financial cycle: an Asian central bank perspective. Journal of Asian Economics, 46, pp.1-16.

Guo, M., Lu, L., Sheng, L. and Yu, M., 2018. The Day After Tomorrow: Evaluating the Burden of Trump's Trade War. Asian Economic Papers, 17(1), pp.101-120.

Japantimes.co.jp,2018 The Japan Times Asia's central banks should prepare to raise interest rates | The Japan Times. [online] Available at: https://www.japantimes.co.jp/opinion/2018/01/31/commentary/world-commentary/asias-central-banks-prepare-raise-interest-rates/#.W-0oFzgzbIU [Accessed 15 Nov. 2018].

Lee, Y., 2018. Asia's largest economies are increasingly uneasy with the rise of bitcoin. [online] CNBC. Available at: https://www.cnbc.com/2017/12/22/bitcoin-china-singapore-japan-issue-cryptocurrency-warnings.html [Accessed 15 Nov. 2018].

Li, C., He, C. and Lin, C., 2018. Economic Impacts of the Possible China–US Trade War. Emerging Markets Finance and Trade, 54(7), pp.1557-1577.

Masciandaro, D. and Volpicella, A., 2016. Macro prudential governance and central banks: Facts and drivers. Journal of International Money and Finance, 61, pp.101-119.

Reid, D., 2018. UBS Chairman Weber: Central banks are keeping cautious faith in policy normalization. [online] CNBC. Available at: https://www.cnbc.com/2018/11/14/ubs-chairman-weber-central-banks-want-policy-normalization.html [Accessed 15 Nov. 2018].

Ross, R.J., 2016. After the Cold War: Domestic Factors and US-China Relations: Domestic Factors and US-China Relations. Routledge.

Schnabl, G., 2017. Monetary policy and overinvestment in East Asia and Europe. Asia Europe Journal, 15(4), pp.445-462.

Yi, S., Xu, Z. and Wang, G.J., 2018. Volatility connectedness in the cryptocurrency market: Is Bitcoin a dominant cryptocurrency?. International Review of Financial Analysis, 60, pp.98-114.

Zhang, M.L. and Zoli, M.E., 2014. Leaning against the wind: macroprudential policy in Asia (No. 14-22). International Monetary Fund.