Monetary Tightening In Asia Continues With PBOC Move

By Win Thin

It’s all about monetary tightening in EM today. PBOC hiked reserve requirements another 50 bp today, effective January 20, and has hiked a total here of 350 bp since starting in January 2010. This comes after the Christmas hike in policy rates that took the 1-year lending rate to 5.81% for a total of 50 bp tightening since starting in October 2010. It appears that the PBOC may be front-loading its tightening measures, but markets should not think that such an aggressive tightening path will be seen all year. We downplay risks of a China hard landing, but acknowledge that markets will remain nervous until data confirms that this negative outcome has been avoided. As we noted before, last PBOC tightening cycle in 2006-2007 saw a combination of reserve requirement hikes, policy rate hikes, and CNY strength, and that’s what we are likely to see in 2011 as well.

Why are we so confident that China can manage its economy to avoid a hard landing? In 2008, the Chinese economy was already slowing when the financial crisis hit Asia, and so PBOC quickly reversed course and cut the 1-year lending rate by 216 bp from September to December 2008. The reserve requirement was also cut 200 bp, and CNY appreciation was shelved from mid-2008 to mid-2010. Fiscal stimulus was also seen, and as a result, China GDP growth never slowed below 7.5% y/y. We look for 8% growth in 2011, which should be enough to allay fears that China is slamming on the brakes. In terms of CNY strength, we think 12-month NDFs pricing in 2.4% gains are understating the likely appreciation, and we look for something closer to 5%. We also see another 75 bp of policy hikes in 2011 along with perhaps another 100-150 bp of reserve requirement hikes.

Looking ahead to the rest of Asia, India WPI jumped to 8.4% y/y in December from 7.5% y/y in November, and points to another likely hike by the RBI when it meets January 25 as price pressures remain an ongoing issue. Indonesia central bank Governor Nasution also made hawkish comments and appears to be preparing the markets for a rate hike. However, he warned that the bank will take measures to limit capital inflows if the rupiah were to gain too much. We think the odds are rising for the first hike at the February 4 meeting. Coming after BOK and BOT hikes earlier this week, all these developments in EM underscore that wider interest rate differentials will continue to encourage inflows into EM and that policy-makers will continue to try to manage the resulting currency gains.