Monetary policy normalization in the United States to affect Asia Pacific growth

The normalization monetary policy in the United States, which began with the tapering of quantitative easing by the Federal Reserve at the beginning of this year, may have a significant impact on economic growth in Asia Pacific developing countries.

Survey 2014 estimates that in a worst-case scenario, the effects of financial market turbulence due to the next stage of normalization, which is widely expected to be a hike interest rates by the Federal Reserve, could cut annual GDP growth by as much as 0.7 to 0.9% points in India, Malyasia, the  Russian Federation, Thailand and Turkey.

The growth reducing impact would be worse if the financial volatility needs to be addressed with monetary tightening in Asia Pacific economics. This could see annual output increase moderate by 0.8 to 1.3% points in the most affected countries, with the additional impact of the tightening being felt most by the  Russian Federation’s economy, followed by that of Indonesia.

Asia Pacific emerging economies witnessed a bout of capital outflows in January, 2014 as the Federal Reserve began reducing its 85 billion monthly monetary stimulus in slabs of 10 billion per month. This led to large falls in equity markets, particularly in Turkey and India.

The region’s markets had already seen an outward flow of capital in the second half of 2013, triggered by the anticipation that the lapering, announced by the Federal Reserve earlier in the year, would star in Sept, 2013. Stock market capitalization in seven Asia Pacific economics fell by 323 billion in August, 2013 from the preceding month.

Although there is uncertainty about the timing of the second stage in normalization that would see interest rates gradually being raised from zero, indications from the Federal Reserve shows that it as likely to begin in 2015. A mismatch between market expectations on the timing, pace and magnitude of the normalization and the actual policy announcement or even speculation about the timing of the announcement, could lead to financial market turbulence as happened in mid of 2013.

Financial volatility triggered by the normalization decision will affect growth in emerging Asia Pacific economies through atleast two channels : (1) A rise in corporate borrowing rates amid tighter financial liquidity and heightened

systematic risk premiums (ii) the effect of deteriorating market confidence and increased economic uncertainty on consumer spending and fixed investment.  

Survey 2014 uses a macroeconomic simulation exercise to analyze the impact of financial market turbulence on economic growth in selected Asia Pacific developing economies under a “High Case” and a “Low Case” scenario. The former assumes uncertainty about the timing of the start of the policy normalization leading to financial sector shocks similar to those observed from May to August, 2013. The scenario is also feasible when normalization is as expected but policy responses in affected economies are viewed as too slow or ineffective.

Fixed investment growth, under this scenario is expected to fall the most in Indonesia, Malyasia, the  Russian Federation & Thailand slowing industrial output and increasing job losses. Rising unemployment and borrowing costs, accompanied by the higher inflation linked to currency depreciation, would affect the household spending with annual private consumption growth estimated to be 0.7% points lower relative to the baseling. A “low case scenario” involves the market factoring in the normalization due to clarity in communication on the change.