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An accommodative stance in monetary policy, alongside increased fiscal outlays, has effectively engineered a sharp economic rebound in Asia in the year to date. For the region as a whole, gross domestic product (GDP) growth likely rebounded in the third quarter to an annualized seasonally adjusted rate of close to 10%, up from a post-Lehman low of −5.3% in the fourth quarter of 2008 (according to JPMorgan estimates). This is in marked contrast with the outputs in developed economies that had weaker initial conditions. GDP in the United Kingdom, for example, posted six consecutive quarters of contraction through the third quarter this year.

Yet, recent policy signals in Asia have generally eschewed a shift in the monetary policy course. An implicit assumption is that with a subdued inflation environment, easy monetary policy remains appropriate, given persistent economic sluggishness in industrial countries. Extending the argument further, some contend that Asia’s current policy stance is supported by the Federal Reserve’s decision to keep rates low for an extended period, implying tacit acquiescence to “importing” the Fed policy.

With the growing de-synchronization of the Asian economic cycle from the developed world, policymakers in Asia will need to address the issue of whether a loose monetary stance remains necessary and desirable. On both counts, central banks are likely to find that the case for maintaining low rates will continue to weaken.

Increasing Stability and Rising Assets Prompt Central Banks to Reassess Policy

True, given the scale of the global financial meltdown that started in September 2008, central banks around the world urgently needed to take drastic steps to avert systemic failures. Emerging Asia is no different. Its coordinated moves toward aggressive monetary easing represented a sharp reversal from its tightening bias in earlier years.

Arguably, renewed stability in financial markets since then has alleviated the necessity to maintain low rates. In fact, judging from recent history, the recent rapid pace of economic expansion is incongruent with the ongoing historically low level of policy rates (see Chart 1).

Critically, there are growing doubts over the desirability of easy money, given the emergence of bubble-like features in asset markets. Nowhere is this more apparent than in the residential property sector. The recent upturn in house prices has been pronounced in major cities in Emerging Asia. In Singapore, home prices rose 16% in the third quarter from the previous quarter, the first gain in over a year. In Hong Kong, high-end housing recently reached new highs, rising at least 30% from its low point of the first quarter of 2009¹. Anecdotal reports suggest similar trends in first- and second-tier cities in China, such as Beijing, Hangzhou, Shanghai and Shenzhen. The same can be said of home prices in Gangnam, a prime district in Korea’s capital city, Seoul.

The degree of froth in home prices, though, is debatable. In the Asian region, where household incomes are growing and urbanization remains in a nascent phase, rising house prices can be seen as consistent with underlying demand. Over 70% of housing loans in Singapore are for owner-occupied residential properties, for example².

More broadly, the lack of a wide range of investment alternatives tends to result in a barbell risk profile: In a typical investment portfolio, the exposure tends to be focused on cash deposits at one end, and equities and properties at the other, with little else available in the intermediate range of the asset spectrum. Conceivably, the current flush liquidity conditions have served to galvanize the appetite for risky assets, a case where too much money is chasing too few investment options.

Efforts Toward Managing the Risk of Another Asset Bubble

The trouble is that an asset bubble is seldom acknowledged until it bursts. From a macroeconomic perspective, the implications of a boom-bust cycle in asset markets are unambiguously damning. As a Chinese news editorial³ aptly cautioned, left unchecked, asset bubbles have the potential to distort resource allocation, undermining long-term growth prospects. In addition, an inordinate deterioration in housing affordability is prone to sow seeds of social discontent. This is true not only among the poor in the rural regions, but also with the so-called “sandwich” class that includes new job entrants and young families.

To be sure, policymakers in the Asian region have been quick to identify and control potential risks. They have already enacted various administrative controls to rein in the pace of gain in property prices. As early as July, curbs were placed on second-home mortgages in the Chinese city of Hangzhou, requiring a minimum down payment of 40% and an interest rate that is at least 110% of the benchmark lending rate⁴. I n September, the Singapore government banned housing loan schemes that allow buyers to defer mortgage payments for properties that are still under construction. Policymakers in Hong Kong recently raised the minimum down payment on homes with purchase values over HKD 20 million ($2.6 million) to 40% from 30%⁵.In both Hong Kong and Singapore, the government authorities have indicated the possibility of hastening the pace of release in new land for construction. This is one major supply-side measure used in Asia to regulate the housing market.

Responding to the Lure of Easy Money

The question remains whether sector-specific measures can sufficiently counter the lure of easy money. It is this unintended consequence on asset prices that the authorities must consider in assessing the desirability of keeping rates at the current extraordinarily low levels. As we head into 2010 with increased confidence that economic recovery is likely on a firm footing, the case for preemptive tightening in Asia should gain traction. It is entirely plausible that asset price inflation may help fuel inflation expectations. Tighter monetary conditions may come in the form of higher rates and currency appreciation.

Interestingly, for a region where GDP growth has outpaced most of the rest of the world, Asia’s nominal effective exchange rate (NEER), measured in aggregated terms, has paradoxically declined almost 4% over the past year (see Chart 2). Indeed, the current estimated level is close to the low end of the NEER range since the mid-1990s. All else equal, this would suggest room for greater flexibility and appreciation going forward.

Strategies for Emerging Asia

What are the investment implications? Emerging Asia’s strong economic performance relative to other regions of the world and prospects for monetary tightening point toward a defensive positioning in local interest rates. At the same time, both of these factors are positive for appreciation prospects for Asian currencies. We continue to view the Chinese yuan, the Korean won and the Singapore dollar as offering attractive value. In corporate credit space, the expectation of policy tightening recommends a focus on higher-quality credits in interest-rate–sensitive sectors, such as Hong Kong and Chinese real estate names.



¹ Source: Bloomberg
² Source: Monetary Authority of Singapore

³ The China Daily, November 5.

⁴ Source: Barclays

⁵ Source: Hong Kong Monetary Authority