We see evidence of precautionary demand for money
Growth in M1 (demand deposits and currency in circulation), %YoY
Liquidity has been a key part of the COVID-19 policy response
Some investors are worried that debt monetisation in EM will lead to weaker currencies and higher inflation. Asian central banks have made providing ample liquidity a key policy goal in recent months to cushion the impact of COVID-19 and related mobility restrictions. Our colleagues have published on the liquidity situation in China here. In this note we ask if other Asian central banks are providing too much or too little liquidity? We don't dismiss the risks, but think concerns of inflation and currency weakness from Asian central bank support for government deficit financing are overdone for now.
Demand for liquid assets has risen
Long experience tells us that the demand for liquid assets rises with economic uncertainty. Evidence that the demand for liquid assets has jumped as COVID-19 spread includes the relatively rapid growth in M1 money (currency in circulation and demand deposits). 7 out of 10 Asian economies recorded M1 money supply growth above decade averages in late Q2.
Central bank supported credit to governments is helping meet liquidity demand
A rise in the supply of liquid assets (broad money deposits) to meet demand requires an accommodating change in the banking system's balance sheet. In South Asia we think asset quality risks are limiting the expansion of deposits via credit to the private sector. Compensating, central bank inspired bank credit to governments potentially accounts for over 2ppts of the acceleration in domestic credit growth in Malaysia and Thailand. The contribution may be over 4ppts still in Philippines, Indonesia and India.
Should we worry about weaker currencies and inflation?
We believe it is too early to worry about an overly rapid expansion in credit leading to inflation or a weaker currency. 1) The expansion in overall domestic credit is not yet unusually quick across the region (Korea is a possible exception here); 2) Excess capacity may slow the translation of quick credit growth, should it occur, into inflation or trade deficits; 3) US banks' (including the Fed's) credit expansion may offset the impact of Asian credit expansions on exchange rates; 4) Depressed private credit growth and rising FX reserves suggest bank purchases of government debt are helping meet local liquidity demand rather than facilitating capital outflows.
What if the virus lingers?
Concerns over rising COVID-19 cases have already led HK, and to a lesser extent Vietnam, Philippines and Indonesia, to re-impose mobility restrictions in recent days. That could also point to wider fiscal deficits (or delayed consolidation) and more pressure for central banks to provide liquidity support. However, past experience also suggests mobility restrictions mean weaker domestic demand and greater trade surpluses. That lowers the inflation and currency risks associated with central bank credit expansion and increases the risks of not keeping monetary policy loose.
Case for lower (IndoGB) yields supported
Without significant newsflow on additional fiscal stimulus and hence issuance, we expect Thai and Malaysian 10-year government bond yields to fall with Bank of Thailand (BoT) and Central Bank of Malaysia (BNM) policy rates before rising in 2021 – assuming global growth prospects improve. In Indonesia, with private credit growth unusually low at 2.5% YoY in May, market concerns should be about spare capacity in the economy and not about monetary excesses from 4-4.5% of GDP worth of Bank of Indonesia's (BI) bond purchases. We expect lower risk premia to allow a decline in 10-year IndoGB yields.