Is the Asian Market Slump Due to China´s Monetary Policy?

The prospect of the ebbing of easy liquidity has exposed many emerging market economies’ vulnerabilities this summer, with India and Indonesia as epicenters of recent currency, stock and bond market losses in Asia. Despite ongoing sharp correction in the asset markets of those countries, the short-term pain may not be over yet: When it rains, it pours in emerging markets. With foreign flows becoming scarce, inevitable and painful current account adjustment is underway, with interest rates rising, consumption and imports falling, and GDP growth rate decelerating.

 

Usually, the current travails in emerging markets are blamed on expectations of slowing open market purchases by the US Federal Reserve System. Lars Christensen, head of emerging market research at Danske Bank, however, blames China´s monetary tightening as at least as important as the expected US Fed ´tapering´.  I have myself, with former colleagues, pointed to the growing impact that China´s growth has exerted since the last decade on GDP growth in middle- and low-income countries[1], pointing to the growing raw material, trade and production links of increasingly China centric emerging countries. So I shall have a lot of sympathy for Lars Christensen´s earlier proposition that China has also grown into a monetary superpower in a Sino monetary transmission mechanism with the rest of Asia. China´s monetary tightening, however, can hardly explain the current slump in Asian markets, on closer inspection.

Graph 1: US 10y Treasuries, Futures

Source: finanztreff.de, 20/08/2013

 

First, let us consider  the expected monetary stance in the US and in China. Graph 1 clearly shows that the market has formed expectations since May that the Fed would not continue open market purchases at the pace witnessed over the last years, partly fueled by Bernanke´s taper talk that month to US Congress. China´s monetary tightening, by contrast, occurred during late 2010 to early 2012 from when the Bank of China started to ease again[2]. Since then, minimum reserve requirements were repeatedly reduced. Further, the PBC reduced its benchmark deposit and loan rates in June 2012. In addition, the PBC has also used a mix of monetary policy instruments to appropriately increase market liquidity. Between Q1 2012 and Q2 2013, China´s M1 aggregates rose by more than 13%. Even considering huge time lags, the current turmoil of Asia stock and bond markets cannot be blamed on China´s monetary tightening prior to end 2011. Nor can the current drop in raw material prices, which is also related to rising bond yields in the US.

 

Second, both emerging bond markets (Graph 2) and equity outflows (Graph 3) from the emerging market space (to which China belongs) back to the safe heaven developed markets display a very close connection to the US 10y Treasuries futures prices displayed above in Graph 1. Virtually no time lag seems involved, confirming the validity of the 1990s literature on push (v pull) factors which had emphasized the importance of US interest rates for emerging-market flows[3].

 

 

Graph 2: SPDR Barclays Capital Emerging Market Local Bond ETF

Source: finanztreff.de, 20/08/2013

 

Graph 3: Net Flows EM Equity Funds, 2013

Source: ft.com, 20/08/2013

 

End of story. But let´s go on, for the sake of learning.

 

Third, monetary transmission from China to Asian markets would imply, as correctly emphasized by Christensen, some sort of renminbi peg by the affected countries. Indeed, the ever closer integration of global value chains in Asia, with China replacing Japan as the major hub,  arguably creates  (and partly justifies) “Fear of Floating” more than anywhere else in the world. But closer inspection of the recent literature on effective (as opposed to merely proclaimed) currency regimes in Asia reveals that the two countries most affected by the current slump – India and Indonesia – did mostly not show a strong weight of the renminbi in their effective (trade weighted) exchange rates. Randall Henning[4] finds that during 2010-11 the Indonesian rupiah was strongly pegged to the US dollar. As for India, Cavoli and Rajan[5] find evidence of moving from a quasi-peg to the US dollar to more flexibility over recent years.

 

Cheap advice to the Asian victims of US monetary policy comes easy – from abroad. Most observers today recommend that the countries float (rather than impose outflow controls). This advice ignores the growing production and trade integration within Asia. It also ignores that those who suffer most these days were found to run the most flexible currency regimes among Asian peers.

 

To link Asia´s current asset market slump to China´s monetary stance is a red herring, perhaps an attempt to deflect responsibility from the US Fed for cyclical in- and outflows into emerging markets and return the blame to China. (In a way, a variation ofthe disapproved Bernanke hypothesis that the Asian saving glut caused globalimbalances in the past.)

 

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[1] “The Renminbi and Poor-Country Growth”, The World Economy, Vol. 35, 2012.

[2] Wang Yu, The adjustment of China´s monetary stance in the face of global liquidity, BIS Papers No. 70.

[3] See, e.g., Eduardo Fernandez-Arias, „The new wave of private capital inflows: Push or pull?”, Journal of Development Economics, Volume 48, 1996.

[4] C. Randall Henning (2012), „Choice and Coercion in East Asian Exchange Rate Regimes”, Peterson International Institute Working Paper 12-15.

[5] T. Cavoli and R.S. Rajan (2013), „South Asian Exchange Rate Regimes: Fixed, Flexible or Something In-between?”, South Asia Economic Journal, Vol. 14, 2013.

Germany´s Next Aid Model

No, this is not about Heidi Klum. God forbid! Neither it is about the German deputy development minister Gudrun Kopp (see picture for blond hair).

Just seven weeks ahead of Germany´s national election, it is time to think about how German development cooperation should be conceptualised in the forthcoming government. Five years ago, William Easterly and Tobias Putze tried to get a handle at an ´ideal´ aid agency strictly based on empirically observable parameters[1] (rather than negotiated and vetted DAC peer reviews). Their study, covering 38 bilateral and several multilateral aid agencies, was based on criteria derived from the bulging development aid literature:

·         Transparency (a precondition necessary for any meaningful evaluation)

·         Specialisation (avoiding fragmentation of aid supplies costly to recipients)

·         Selectivity (focus on poor countries)

·         Efficient delivery (avoiding tied aid, food aid, and technical assistance)

·         Administrative loss (share of aid bureaucracy cost).

Among the bilateral aid agencies covered in the Easterly/Putze study, Germany´s BMZ occupied the second last rank! German cooperation was seen in particular as fragmented, bureaucratic and nontransparent compared to its DAC peers.

 

Meanwhile, the recalibration of the world economy toward China and the success of large emerging countries in helping lower global poverty (aka Shifting Wealth) have turned some of the cited criteria for evaluating aid agencies doubtful, even obsolete. Shifting Wealth, apart from allowing for a milder assessment of past and present BMZ performance than granted by the Easterly/Putze study, suggests some specific recommendations for Germany´s aid over the next legislation period (2013-17) that actually can be opposite to some of the traditional criteria:

·         The selective focus of aid needs to shift from poor countries to poor people. Only just two decades ago, 93 percent of the world´s poorest people lived indeed in the poorest (least developed) countries; today, three fourth of the world´s poorest people survive in countries now classified as middle-income countries (Ravi Kanbur und Andy Sumner, 2011)[2]. For humanitarian reasons, the aid focus needs to reflect the new geography of poverty, even against populist sentiment at home. In India, half a billion people remain in abject poverty, 200 million in China. Other countries that the BMZ should focus on, according to the selectivity criterion ´number of poor people´, are Nigeria, Bangladesh and Indonesia.

·         The implicit reorientation of development cooperation from Africa to Asia would also change the optimal mix of aid finance, from grants toward soft loans. Often cash rich, emerging countries´ poverty is their own prime responsibility. Western development loans, however, can lever political choices in those countries while they are less burdensome for fragile budgets in DAC countries, potentially more flexible and delivered more speedily (at least if they follow the innovative  Agence Franaise de Développement model) conceived by Cohen, Jacquet and Reisen (2006)[3].

·         China´s and other emerging countries´ proven contribution to global development and poverty reduction, notably in Africa (African Economic Outlook 2011), is forcing Western donors to reexamine their standards and to find ways to merge them with Eastern cooperation modes. The merger of Western standards, which is heavy on declamatory good-governance rhetoric, with project-oriented Eastern cooperation modes, often nontransparent as based on barter deals, is yet to be designed, it seems to me.

·         German bilateral cooperation excels on implementation – and should ´sell´ itself so. Unlike Britain (remember Tony Blair?) and France, Germany has relatively few spin doctors. But it has GIZ (the project implementation agency) and KfW (the development bank). These institutions grant Germany a comparative advantage in project delivery and completion. Germany´s bilateral cooperation is thus defined by close links with programmes and projects, creating high visibility for many German actors and facilitating their financial monitoring. These traits of German cooperation, largely undersold to DAC peers and multilaterals, make it a valuable partner for trilateral South-South-North cooperation, in particular joint with China.

·         Help restore core finance for multilateral development cooperation. Where -unlike in Germany - implementation agencies are lacking, there is a tendency to use multilaterals via earmarked funding. Germany has largely refrained from multilateral ´cherry-picking´ and should work hard on its peers to stop this trend, which has weakened the UN system ever since the US called to call the shots there, i.e. since the 1960s when many countries became sovereigns independent from colonial rule. A high share of earmarked finance in multilateral budgets causes permanent ´funds shopping´ by management, thus diverting its attention and time; it raises administrative overhead costs; and it intensifies the bureaucratic tendency for mission creep and fight for mandates. The unproductive struggle among multilaterals for G20 mandates provides a visible warning. Germany´s next government is called for to clean the multilateral donor chaos; due to tutelage problems, this task can´t be let to ministries – the Bundeskanzleramt will have to deal with the problem[4].

It is questionable whether the current BMZ ministry can confront these challenges in its current setup[5]. Where most of the extremely poor people reside today, namely in large emerging countries, development cooperation can only succeed by managing cross-cutting issues, integrating policy fields as diverse as food security, basic welfare systems and green urbanisation.

 

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[1] Easterly, W. und T. Putze (2008), “Where Does the Money Go? Best and Worse Practices in Foreign Aid”, Journal of Economic Perspectives, Vol.22.2, S. 29-52.

[2] Kanbur, R. und A. Sumner (2011), “Poor Countries or Poor People? Development Assistance and the New Geography of Global Poverty”, Cornell University, WP 2011-08.

[3] Cohen, D., P. Jacquet and H. Reisen (2006), “After Gleneagles: What Role for Loans in ODA?”, OECD Development Centre Policy Brief No.31.

[4] H. Reisen (2012), “Herausforderungen an die multilaterale Entwicklungszusammenarbeit“, KfW Meinungsforum Entwicklungspolitik, Nr.4, 4.April 2012.

[5] J. Faust und D. Messner (2012), “Probleme globaler Entwicklung und die ministerielle Organisation der Entwicklungspolitik“, Zeitschrift für Außen- und Sicherheitspolitik“, Vol. 5, S. 165-175.