Frederic Neumann is Co-head of Asian Economics Research at HSBC.
Give Asia’s central bankers their credit. By taking swift and determined action, they have kept financial systems on an even keel during the pandemic, and their policies have cushioned the economic blow.
As the emergency begins to pass, however, there is a risk that overly loose monetary policy will breed distortions. If left unheeded, these could eventually trigger another crisis: a bursting asset bubble.
Central bankers will need to reach deeper into their tool kit to maintain the right balance between supporting the recovery and avoiding calamity later on. Asset bubbles are stealthy affairs. Easy to identify once they have collapsed — often with devastating consequences for growth — they are much harder to pinpoint while they are underway.
Not every rally in financial or property markets, after all, ends in a tumble. Still, history provides clues to when they might occur: extremely loose monetary policy for a stretch of time certainly raises the risk that leverage rises unsustainably and asset values become detached from fundamentals.
For over a year now, central bankers have had their feet firmly on the gas. And for good reason: economies have stumbled hard, and even with growth gradually returning, severe hardships remain. At the same time, as optimism returns and interest rates are still close to their historical lows, financial markets across much of the region are climbing to ever loftier levels, while house prices in many economies scale new highs.
Even the latest jitters around U.S. inflation have done little to undermine confidence. True, portfolios are being reshuffled, pushing up the dollar and inducing volatility, but money and confidence remain seemingly abundant. In part that is because central bankers are providing no hint that tightening will occur any time soon. In both East and West, many monetary officials deem the tightening that occurred after the 2008 global financial crisis to have been premature. Better to wait this time around to ensure that economies are fully healed before policy normalization occurs.
The parallels between then and now, however, apply only partially. In both cases, activity plunged and unemployment soared. However, in the West, financial systems were severely impaired by the global financial crisis, something that is not the case today. In the East, where banks never took as big a hit, leverage is far higher today. And it is leverage that poses an especially big risk for sustained growth if monetary policy remains excessively loose for too long.
Take households. On average in emerging Asia, household debt rose as a share of gross domestic product from around 45% in 2008 to over 60% last year. To be sure, that’s still well below the 100% level that the U.S. reached on the eve of the global financial crisis. However, per capita income in Asia is also lower, which reduces the level of debt consumers can sustainably carry. Research by the IMF shows that when household debt approaches 70% of GDP, there is a tipping point where further increases are associated with greater risk of financial instability and lower growth.
These numbers mask considerable variations across Asia. In South Korea, Malaysia, Thailand, Hong Kong and Taiwan, household debt is close to 90% of GDP or higher. In mainland China and Singapore, it is close to 70%. What is more, research shows that it is not simply the level of debt that matters, but the speed of increase. In the U.S., in the three years before the global financial crisis, household debt rose by about 11% of GDP, a speed now matched or exceeded by mainland China, Hong Kong, South Korea, Malaysia and Thailand since 2017.
Corporate debt has risen even faster over the past decade in many economies. Unlike the global financial crisis, in short, Asia entered the pandemic with far higher levels of leverage. This raises the risk of prolonged monetary accommodation: not only for financial markets, where valuations may become stretched, but for the economy more broadly, where excessive debt, especially if built on inflated asset values, could ultimately trigger a severe economic adjustment.
This puts central bankers in a tough spot. On the one hand, premature tightening would endanger the still fragile recovery. On the other hand, leaving monetary policy highly accommodative for too long risks stoking leverage further and creating asset bubbles.
The solution, for now, is to dig deeper into the policy tool kit. While leaving interest rates unchanged and providing liquidity as the situation warrants, regulatory officials may choose to tighten macro-prudential measures to curb an undue rise in debt and excessive risk-taking.
Household lending, for example, could be subject to even lower loan-to-value ratios, requiring bigger down-payments for any purchase of property. Officials might also lean against the wind in financial markets by tightening margin lending rules. Meanwhile, bank regulations that have been relaxed during the pandemic — a welcome step to guard financial systems at a time of acute crisis — can be swiftly restored once the main risks have passed.
And then there is another tool — one that has been used explicitly or implicitly with great effect over the past year, but that now needs to be reversed: forward guidance. By promising to keep policy loose for a long time, central banks supercharged their easing over the past year. But the usefulness of that pledge has run its course: as confidence rebounds, the belief in enduring monetary accommodation only encourages the buildup of excessive leverage. In short, a clear signal is needed that the punch bowl is not here to stay.
And yes, that may dent spirits in the near term, but it will go a long way toward preventing another calamity later as an asset bubble bursts.