While Asia Central Bankers Need to Go Easy on Rate Cuts, They will Cut Rates Anyway

Frederic Neumann co-head of HSBC’s Asian economic research counsels Asian monetary authorities to go slow with interest rate cuts. Writing at the Nikkei Asia “Asia needs to go easy on rate cuts”, he provides three reasons: (bold mine)

The trouble is, it will prove only mildly effective and, in some cases, possibly counterproductive. That interest rate cuts help to ease the debt servicing burden of indebted consumers and companies is not in doubt. But, in most economies, it seems unlikely they will exert a lift through their second, more potent channel: faster credit growth. Take India. State banks, which dominate the financial system, are saddled with non-performing loans. Many large companies, too, are stuck with too much debt. Rate cuts alone, therefore, may not boost spending. Thailand, Malaysia and South Korea face similar challenges.

Translation: When company balance sheets have been hocked to the eyeballs with debt, borrowing will about debt rollovers rather than capex. And that's if there will be borrowings at all. You can lead the horse to the water, but you cannot make it drink.

The second point is that rate cuts, to the extent that they spur lending, may fuel growing imbalances that could ultimately push economies deeper into a disinflationary, if not deflationary, trap. Leverage in Thailand, for example, is already high, especially among consumers. Cutting interest rates could provide a temporary boost to spending, but at the cost of driving debt ratios even higher. In Australia, too, further easing will add fuel to the booming housing market without curing the underlying problem: a deflating mining investment boom. China also comes to mind, with blanket easing doing little to correct imbalances.

Translation: When company balance sheets have been hocked to the eyeballs with debt, borrowing will about debt rollovers rather than capex. More companies will resort to Hyman Minsky’s Ponzi financing. With insufficient cash flows for debt servicing, companies become heavily reliant on using debt to service existing debt. Asset sales function as a compliment. In short, Ponzi finance=Debt IN debt OUT + asset sales. And this is why the need to spike asset values as they provide bridge financing for debt.

Unfortunately as Mr. Neumann rightly points out, increasing use of Ponzi finance signifies heightens the risk of ‘debt’ deflationary trap.

Third: Easing monetary policy exposes countries to greater financial volatility down the road. The Fed, of course, may raise rates only gradually in the coming years. But the dollar looks set to strengthen further. In itself, this may not be enough to drive capital out of the region. Still, if local central banks overplay their hand and ease too aggressively, especially with no improved growth prospects to show for it, investor jitters might return. The "taper tantrum" of 2013, when investors dumped risky assets, was a painful reminder of the vulnerability of emerging markets when the Fed starts to move. Indonesia, especially, looks exposed.

Translation: In a financial and economic landscape where asset sales become complimentary to debt IN debt OUT, today’s asset market pump have likely been about the use of inflation in asset markets to generate cash flows to service debt.

And because asset market inflation are unsustainable this leads to “greater financial volatility”. 

In addition, a general use of Ponzi financing can become a systemic issue. 

From Wikipedia (bold mine): If the use of Ponzi finance is general enough in the financial system, then the inevitable disillusionment of the Ponzi borrower can cause the system to seize up: when the bubble pops, i.e., when the asset prices stop increasing, the speculative borrower can no longer refinance (roll over) the principal even if able to cover interest payments. As with a line of dominoes, collapse of the speculative borrowers can then bring down even hedge borrowers, who are unable to find loans despite the apparent soundness of the underlying investments.

So even mainstream can see what I am seeing.

While the advise to monetary authorities of the diminished use of zero bound rates has been commendable, I doubt if such will be heeded.

Reasons?

Political agenda will dictate on monetary policies. Incumbent political leaders would not want to see volatilities happen during their tenure, so they are likely to pressure monetary authorities to resort to actions that will kick the can down the road. Here is an example, Turkish central bank yielded to the Prime Minister’s repeated demand for interest rate cuts. The Turkish  central bank trimmed 25 basis points for both overnight lending and borrowing rates yesterday

In short, authorities are likely to be concerned with short term developments. And political agenda will most likely revolve around popularity ratings and or the next election—or simply preserving or expanding political power.

Next, there is the social desirability bias factor. Monetary authorities won’t also want to be seen as “responsible” for a volatile environment. They don’t like to be subject to public lynching from market volatilities.

Third, there is the appeal to majority and path dependency. Since every central banker has been doing it and have long been doing it, they think that they might as well do it and blame external factors for any untoward outcomes. Again the cuts of central banks of Turkey and the record low rates by Israel two days back brings a tally of 21 nations on an easing path in 2015. 25 actions if we consider the multiple actions by some countries (Romania and Denmark) as I noted last weekend.

Asian central bankers are likely to embrace the “sound banker” escape hatchet as propagated by their political economic icon—JM Keynes: 

A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way along with his fellows, so that no one can really blame him.

So expect more rate cuts ahead.

As a side note: Indonesia "vulnerable"? Hasn't Indonesian stocks been at record upon record highs? Has record highs not been about a risk free environment? Of course, opposite record high stocks have been a milestone high USD-Indonesian rupiah.