Global Monetary Stimulus

7/22/2019 Global Monetary Stimulus

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Table of Contents

What is monetary policy?...........................................................................................................1

What is quantitative easing?.......................................................................................................2

Why does Global Monetary Stimulus affect emerging Asian economies?................................4

The Effects of Global Monetary Stimulus to Emerging Asian Companies...5

Conclusion....10

Appendix 1: Recent Global Monetary Policies....12

References....16


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What is monetary policy?

The actions of a central bank, currency board or other regulatory committee that determine

the size and rate of growth of the money supply, which in turn affects interest rates are

monetary policy. Monetary policy is maintained through actions such as increasing the

interest rate, or changing the amount of money banks need to keep in the vault (bank

reserves).

Central banks have three tools to manage money supply or conduct monetary policy:

- Changing the monetary base through open market operations

- Changing the monetary base through discount lending

- Changing the money multiplier by changing the required reserve ratio

Market operation could be divided into two main type i.e. open market purchase which means

the central bank buys the government securities to increase the monetary base, and open

market sales which means the central bank sells the government securities to decrease the

monetary base. Since the markets for the government securities especially treasury bills are

so active, central banks can make large purchases and sales quickly and easily, without

disrupting the market. Open market operations have number of advantages. For example,

they are under the direct and complete control of the central banks, they can be large or small,

they can be easily reversed and they can be implemented quickly.

When a bank receives a discount loan from the central bank, it is said to have received a loan

at the discount window. The central bank can affect the volume of discount loans by setting

the discount rate: A higher discount rate makes discount borrowing less attractive to banks

and will therefore reduce the volume of discount loans, but a lower discount rate makes

discount borrowing more attractive to banks and will therefore increase the volume of


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discount loans. The advantage of discount loans is that they allow the central bank to act as a

lender of last resort during a financial panic. But using discount loans as a tool for monetary

policy has its own disadvantages. For example, the volume of discount can be influenced by

the central banks, but not completely controlled (central banks cannot be sure how many

banks will request discount loans at any given interest rate). Besides, discount loans may not

be implemented as quickly as open market operation can be.

By affecting the money multiplier, changes in the required reserve ration can lead to change

into money supply. There are some disadvantages using change in reserve ratio as a monetary

policy. As an instance, it cannot be made quickly and easily. Moreover, if a bank holds only a

small amount of excess reserve and the required reserve ratio is increased, the bank will have

to quickly acquire reserve by borrowing, selling securities, or reducing its loans. Each of

these three options is costly and disruptive. Thus, changes in reserve requirements can cause

problems for banks by making liquidity management more difficult.

What is Quantitative Easing?

Usually, central banks try to raise the amount of lending and activity in the economy

indirectly, by cutting interest rates. Lower interest rates encourage people to spend, not save.

But when interest rates can go no lower, a central bank's only option is to pump money into

the economy directly. That is quantitative easing (QE). The way the central bank does this is

by buying assets - usually government bonds - using money it has simply created out of thin

air. The institutions selling those bonds (either commercial banks or other financial

businesses such as insurance companies) will then have "new" money in their accounts,

which then boosts the money supply. It was tried first by a central bank in Japan to get it out

of a period of deflation following its asset bubble collapse in the 1990s. In another words,

central banks first try to decrease the short-term rate of interest by buying back short-term


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government securities. When repurchasing short-term securities do not decrease the short-

term interest rate any more, central banks have to start repurchasing long-term government

securities to decrease the long-term interest rate. In this sense, quantitative easing could be

considered as last resort for governments to stimulate the economic growth.

The US started implementing QE in 1932 to combat the great depression (USD 1 billion).

However, this did not yield the desired effects. Japan is credited as the first country that

started implementing in 2001 the current version of the QE (Yen 50 trillion for 2001-2006).

But it wasnt until the 2008 financial crisis that central banks of developed countries have

used QE at such regular space to stimulate their economies, increase bank lending and

encourage spending. For instance, some of the post 2008 global financial crisis QE programs

for the U.S., Europe, U.K. and Japan amounted to USD 1.75 trillion (U.S. QE1 2008), EUR

489 billion (Europe Dec 2011), GBP 200 billion (UK 2009-2010), and YEN 65 trillion (Japan

Feb 2012) respectively.


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Why does Global Monetary Stimulus affect emerging Asian economies?

Emerging marketsespecially those in Asia with stronger fundamentals and lower debt-to-

GDP ratios than those of developed marketsare attracting those seeking a higher rate of

return on capital. Furthermore, emerging markets offer global investors the possibility of

portfolio diversification. Lower level of leverage and better ability to take on debts by

emerging countries compared with major economies indicate a strong capacity of the

developing economies to absorb greater foreign flows to feed their growth without

jeopardizing their financial viability.

However, this capital is coming at a time when most Asian countries are stepping on the

brakes to cool their economies. As such, Asia's central banks are looking to all monetary

policy tools at their disposal to achieve a more sustainable pace for economic growth. Raising

short-term interest rates is one way, but it has had the perverse effect of making the market

even more attractive to U.S. and European investors seeking higher yields. Another policy

tool is to increase bank reserve requirements, which is already being adopted as banks are

beefing up capital to meet so-called Basel III rulesthe third in a set of banking rules agreed

upon by central bankers and regulators from around the world at meetings in Basel,

Switzerland. In addition to the use of interest rates and reserve requirements, many central

banks are resorting to capital controls.

It could not mean that Asian governments are turning their backs on greater liberalization.

This time, however, even the International Monetary Fund is endorsing the use of capital

controls on a temporary basis under these exceptional circumstances. Indeed, the spirit of the

measures implemented so far appears to be short-term and tactical rather than long-term and

structural. Thailand removed a 15% tax exemption for foreigners on income from domestic

bonds. South Korea set a limit on the level of foreign exchange derivatives and a limit on the


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amount of foreign currency debt that local banks can borrow. Indonesia introduced a one-

month minimum holding period on their treasury bills. While the intention of the U.S. is to

step on the gas pedal to stimulate the domestic economy, the effect of its quantitative easing

has been to turbo-charge the emerging markets, especially the markets of Asia.

The Effects of Global Monetary Stimulus to Emerging Asian Companies

There are numerous effects of global monetary stimulus (GMS) to Emerging Asian countries

(EM). The theoretical impact would be the increase in liquidity of financial system which

boost the business confidence and increase in money inflow to EM which in turn

strengthening the local currency of EM. On the other hand, central banks in Asia are

concerned about adverse effects of inflow to their counties like inflationary effects and

currency war. Followings are the case studies of GMS across the world.

United States (US) - Quantitative Easing (QE)

As mentioned above, there are multiple rounds of interest rate cuts and money printing,

known as QE which has been embarked by Fed Chairman, Ben Bernanke in order to price-fix

the cost of money lower. The USA introduced QE1 in 2008, QE2 in 2010 and Operation

Twist in 2011, and more recently the third round of QE (QE3) which consisted of a monthly

USD40 billion injection through purchase of mortgage-backed securities. The Fed buys

government or other bonds and then makes this money available for banks to borrow, thereby

expanding the amount of money circulating in the economy, which in turn reduces long-term

interest rates. Indeed, the Fed is creating money out of thin air in order to achieve its

monetary goals. As a result, the great supply of currency relative to demand reduces value of

the currency.


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The positive impact to EM especially China would be the stability of the US to import the

excess goods and services from these countries. Thus, the EM companies revenue and

profitability are expected to maintain or grow in the near term to reflect the continuous

income from export market to US.

The negative impact to EM would be the depreciation of US dollar compared to EM

currencies. The falling US dollar is supposed to boost US exports and economic activity

while weakening imports and therefore economic activity of EM countries. However, EM

countries particularly China, have reacted by artificially devalued the yuan (by pegging to US

currency) to maintain its competitiveness in international trade. Hence, the EM companies are

expected to sustain the growth of their export market to US.

The US financial institution may shift its focus on the excess cash supply from central bank

(QE) to EM market assets. Further, the risk adverse investor may also shift their investment

focus to commodities which are traditionally regarded as safe heaven investment against

economic uncertainty. This will cause distortion in a way of inflation to the EM market. The

vice minister of finance of the Peoples Republic of China, Zhu Guangyao, said on 18

November 2010 that As a major reserve currency issuer, for the US to launch a second

round of quantitative easing at this time, we feel that it did not recognize its responsibility to

stabilize global markets and did not think about of excessive liquidity on emerging markets.

(Reuters 2010).

As a result, the export growth is moderated by the measures taken by governments and

central banks of EM (such as curtailing the credit growth) in order to fight the inflation.

Hence, the companies in EM countries will have difficulty to expand their business as the

cost of production is expected to go up coupled with the credit constraint.


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P.J. Morgan (2011) investigated the impact of US quantitative easing policy on emerging

Asia. In his article he mentioned that US quantitative easing might lead to some effects on

emerging Asian economies. Weakening of the US dollar and stimulating capital outflows to

emerging economies which might increase inflationary pressure in Asians are among those

impacts. Morgan compared monetary flows during the QE1 and QE2 against Nov2009-

Oct2010 when no QE took place, and found that 40% of the increase in the US monetary base

in QE1 period leaked out in the form of gross private capital outflows. Besides, one-third

leaked out during the first two quarter of QE2. He argued that those amounts are small and

unlikely to have a significant impact on financial markets, economic activity or inflation. On

the whole, the direct impact of the QE policies on domestic liquidity in emerging Asia

appears to have been modest. He also investigated the impact of QE policy on regional bond

yield and exchange rate and found the greater impacts were on Korean Won and lower bond

yield in Indonesia. On the whole, Morgan found that likely excess Asian capital inflows

attributable to the QE policy were not large and only few economies experienced significant

impacts on exchange rates or bond yields.

Euro zone (EU) Long Term Refinancing Operation (LTRO) & United Kingdom (UK)

Quantitative Easing (QE)

In March 2009, the Monetary Policy Committee (MPC) announced that it would reduce Bank

Rate to 0.5%. The Committee also judged that Bank Rate could not practically be reduced

below that level, and in order to give a further monetary stimulus to the economy, it decided

to undertake a series of asset purchases. Between March and November 2009, the MPC

authorized the purchase of 200 billion worth of assets, mostly UK Government debt or

gilts. The MPC voted to begin further purchases of 75 billion in October 2011 and,

subsequently, at its meeting in February 2012 the Committee decided to buy an additional

50 bn. In July the MPC announced the purchase of a further 50bn to bring total assets


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purchases to 375 bn. The purpose of the purchases was and is to inject money directly into

the economy in order to boost nominal demand. Despite this different means of implementing

monetary policy, the objective remained unchanged - to meet the inflation target of 2 per cent

on the CPI measure of consumer prices. Without that extra spending in the economy, the

MPC thought that inflation would be more likely in the medium term to undershoot the

target.

Meanwhile, the European Commission, European Central Bank and International Monetary

Fund (troika) has response to save two countries, namely Italy and Spain which are the

biggest threat to transmit the crisis to the currencys core countries in Eurozone. The troika

has relied on LTRO (Long Term Refinancing Operation) to refinance the domestic sovereign

debt. The LTRO is similar to QE except that the liquidity is limited to the capacity of ECB to

provide the funding. LTROs provide an injection of low interest rate funding to euro zone

banks with sovereign debt as collateral on the loans. The loans are offered monthly and are

typically repaid in three months, six months or one year. But the ECB also announced a

three-year LTRO in December of 2011, which led to significantly higher demand than past

operations. The supply of money from LTRO by using ECBs cheap funding will lower the

sovereign bond yield for Italy and Spain in the immediate term in hoping to support the

growth of these countries. If the LTRO prove to be effective, then the EM companies will

benefit by the business confidence and strong demand from EU countries.

The drawback is that the limited funding wouldnt solve the solvency issue (unlike USs QE

program). In addition, the austerity measures (such as budgetary discipline) set by troika

would undermine the potential growth. If this scenario happens, then the EM companies

would experience a slow down in its export market to EU countries.


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Japan Quantitative Easing (QE)

Japan had undertaken similar steps as US whereby numerous rounds of monetary injections

into the economy have been made and the central bank added 10 trillion yen to its already

existing asset purchasing program, thus raising the ceiling of the program to as much as 80

trillion yen. The main objective is to support the government borrowing, to drive competitive

depreciation of its currency and increase the inflation. The current Prime Minister, Shinzo

Abe has determined to depreciate the yen to strengthen the export sector of Japan in order to

reach the target inflation rate of 2.0%.

However, the easing from the major central banks in EU and US as well as the capital control

from EM has undermined the Japanese initiative. Countries like China, Korea and Taiwan

has responded to the competitive depreciation of yen currency through the foreign currency

intervention, capital control and policy rate cuts. The large swing in the yen/won exchange

rates between 2007 and 2009 reflected some of these trades. Unlike US, Japan has suffered

from deflation or liquidity trap which the target inflation is difficult to achieve, albeit with

QE program. The main reason is due to the high residents savings rate of 9.6%, invested in

government bond which makes them relatively safe heaven for foreign investors. Hence, it

has strengthened the yen.

If the inflation target is achieved and the currency has depreciated, the EM companies will

suffers as the export competition will be intense. However, if the policy does not go very

well, then the EM companies will continue to benefit with their advantage on export market.

China Monetary Stimulus

In reaction to the global recession in 2008, China has embarked on a massive stimulus largely

through the bank lending, which surged to $1.4 trillion. Then, in response to the inflation and


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real estate booms that accompanied rapid economic revival, China central bank has undertake

measures such as adjusting reserve requirements and placing limits on banks balance sheet

under its monetary policy. The results will be either hard landing (enter recession) or soft

landing (remains at moderate GDP growth).

If the situation is hard landing, then there will be another global crisis whereby EM

companies will definitely suffer due recession or enter into solvency. If the soft landing is

achieved, then the EA companies will maintain its growth at the moderate level.

Conclusion

Implementing monetary stimulus by developed economies, which usually lead to flow in a

huge amount of liquidity to emerging Asian economies, could have variety of positive and

negative impacts on emerging Asian companies. The benefits of those monetary measures by

developed economies on emerging Asian Companies can be listed as below:

1- Source of financing: Investors in developed economies who are seeking for greater

rate of interest move their liquidity from developed economies to emerging Asian

countries for set of reasons which discussed earlier in this report. This could be a good

opportunity for companies in Asian emerging economies to raise funds via debt

issuance to those investors. It also may spark gains in equity market.

2- By boosting aggregate demand, monetary easing could spur growth in countries

that implement this monetary policy. Therefore, it could help maintain the economic

stability in these countries which in turn maintain the stability in international trade

for Asian emerging companies.


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Flow of liquidity, also, may cause some risks for Asian emerging companies such as:

1- Inflation: The excess money flow from developed countries as a result of their

monetary policy will create growth for emerging Asian companies which

eventually increase the assets price and inflation to these countries.

2- As a result of inflation, the government and central banks in emerging Asian

countries will take several measures such as increasing the reserve requirements

for the banks and imposed some limits for the banks in order to curtail loan

growth. This will reduce the lending by financial institution for the emerging

Asian companies to expand its business.

3- In addition, the money flow out from developed countries will strengthen the

emerging Asian currencies which in turn increasing the price of goods in these

countries. This will dampen the export market and reduce the growth of emerging

Asian companies.

4- Commodities which are regarded as safe heaven investment against the economic

uncertainty (which partly caused by monetary stimulus from developed countries)

will become attractive for global investor. This will boost commodities demand

and its price will go up. The high commodities price will make emerging Asian

companies suffer as the cost of production increasing and therefore will distort the

market and curtail the growth rate of these countries.


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References

- P. J. Morgan, 2011, Impact of US quantitative easing Policy on Emerging Asia, Asian

Development Bank Institute

- Bank of Japan (BOJ), April 2013 Monetary Policy Report

- Morgan Stanley

- Euro monitor

- Roubini Global Economics

- Merril Lynch

- Bank of England (BOE), Website

- Bloomberg

- Reuters

- BBC

- African Development Bank

- Forbes

- Pacific Economic Cooperation Council


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Appendix 1: Recent Global Monetary Policies

Group of Eight (G8) consist of countries like France, Germany, Italy, Japan, United

Kingdom, United States, Canada and Russia are among the wealthiest countries around the

world. In 1999, another group called Group of Twenty (G20) which consists of twenty of

Finance Minister and Central Bank governors are formed, which also includes countries in

G8. These G20 represent 80% world trade including EU intra-trade.

According to IMF, as of 2011, top 10 world largest economic by GDP is United States,

China, Japan, Germany, France, Brazil, United Kingdom, Italy, Russia and India as depict in

below illustration.

Figure 1: World largest economies 1

With those major economic powerhouses, changes in monetary stimulus in the particular

countries will affect emerging Asian countries. However, since Germany, France, United

Kingdom and Italy are under Euro Zone, therefore Euro Central Bank controls the monetary

stimulus under it.

1Andrew Bergman, World Largest Economies, CNN Money. Access on 22 Apr 2013 from

http://money.cnn.com/news/economy/world_economies_gdp/
http://money.cnn.com/news/economy/world_economies_gdp/http://money.cnn.com/news/economy/world_economies_gdp/http://money.cnn.com/news/economy/world_economies_gdp/


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Globalization has major impact on how business would react on stimulus packages approved

by major economic countries to stimulate their economies activities.

Table 1: Global stimulus program

Countries Stimulus Program

U.S. March 2008 - $29 Billion Wall Street Bailout

May 2008 - $178 Billion Average American Bailout

July 2008 - $300 Billion Homeowners Bailout

September 2008 - $200 Billion Fannie Mae and Freddie Mac

Bailout

September 2008 - $50 Billion - To Guarantee Money Market Funds

September 2008 - $25 Billion Automakers Bailout

November 2008 - $150 Billion AIG Bailout

October 2008 - $700 Billion Banks Bailout

February 2009 - $787 Billion Average Americans Bailout

February 2009 - $275 Billion Homeowners Bailout

March 2009 - $30 Billion AIG Bailout

March 2009 - $15 Billion Small Business Loans

March 2009 - $1 Trillion "Toxic Asset" Program Banks Bailout

March 2009 - $22 Billion Automakers Bailout

April 2009 - $1 Trillion G-20 World Leaders Stimulus

China Nov 2008 - establishing a fund worth between 600 billion and 800

billion Yuan to purchase domestic shares


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Mar 2009 - announced a revision of the stimulus

a) infrastructure: 1.5-trillion yuan

b) reconstruction: 1trillion

c) rural & technology: 640 billion yuan

d) environmental projects: 210 billion yuan

e) education: 150 billion yuan

2010 - tightened regulation in the financial system on banks to curb

lending

2011 - 20% of the loans under the program may be written off

2012 - gave approval for 60 infrastructure projects totaling more

than 1 trillion Yuan

Europe Passed a 200 billion euro plan with member countries developing

their own national plans.

Germany

November 2008 32B - Investments in infrastructures

January 2009 50B - Public investments

France

December 2008 26B Auto, public works, housing, liquidity

Spain


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August 2008 20B aid SME, housing

November 2008 - 10.9B incentive hire unemployed, R&D, auto

Italy

November 2008 - 9B aid low income household, tax rebate

Netherlands

November 2008 - 8.5B tax rebate, social benefits, liquidity,

public works

United Kingdom

September 2008 - 1B real estate

November 2008 - 20B tax rebate

January 2009 - 10B schools, hospitals, green energy, create 10K

jobs

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Global Monetary Stimulus