Wednesday, 21 August 2013

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:, 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:, 20/08/2013


Graph 3: Net Flows EM Equity Funds, 2013

Source:, 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.)


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

1 comment:

  1. Surely the Swiss are in for a shock then, if one follows your argument to its logical conclusion? The SNB has blown 100 billion francs on its peg on a mark to market basis, and I very much doubt they are as relaxed about it as Prof W-L suggests they should be.

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