MASB2505: Asian Central Banks and Policy Normalization Report

This report, prepared as an assignment for the MASB2505 Financial Markets & Institutions module at Bangor University and Management Development Institute of Singapore in Tashkent, analyzes the challenges Asian central banks face in moving towards policy normalization in 2018. The report critically examines the complexities arising from strong economic growth and Federal Reserve (Fed) interest rate hikes, while also considering the looming impact of the US-China trade war and the volatility of cryptocurrencies on these normalization efforts. It delves into the specific challenges of managing interest rates, balance sheet reduction, and capital flows, as well as the potential risks associated with slower or faster normalization. The report also explores how the US-China trade war exacerbates depreciation pressures on Asian currencies and how volatility in the cryptocurrency market, particularly Bitcoin, poses a significant threat to financial regulators and investors. The conclusion highlights the vulnerability of Asian economies and the need for central banks to adapt their monetary policies in the face of global economic uncertainties.

Running head: FINANCIAL INSTITUTES AND MARKETS
Financial Institutes and Markets
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Table of Contents
Normalization of Asian Central Bank........................................................................................2
Challenges to normalization of Asian central banks..............................................................2
US-China trade war and effect on normalization in Asia......................................................4
Effect on volatility in cryptocurrencies on normalization in Asia.........................................5
References..................................................................................................................................7

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Normalization of Asian Central Bank
The normalization policy of central banks refers to the attempt of the banks to reduce
size of the balance sheet. To accomplish the objective, the central bank’s target to increase
the interest rate from the benchmark level to return the environment of monetary policy
before the event of global financial crisis (Reid 2018). Like several other advanced
economies, Asian Central Banks are adapting normalization policy with believe that their
economy will account a strong growth in coming years. The normalization policy of Asian
central banks further followed from the normalization attempt of United State. The higher
interest rate of Fed makes domestic currencies of Asia less attractive lading to outflow of
capital. The monetary Authority of Singapore decided to tighten its monetary policy for the
first time in last six years. The tight monetary policy in Singapore was followed by the other
Asian countries such as Korea, Malaysia, Hong Kong, Philippines and others. The move
towards normalization has been backed by strong growth of Asian economies in last years
(Masciandaro and Volpicella 2016). Asian Development Bank predicts that the economy will
experience a real economic growth of 6.0 percent and 5.9 percent in 2018 and 2019
respectively. The continuous easing of monetary policy has the possibility of over-heating the
economy.
Challenges to normalization of Asian central banks
The normalization of central banks of several economies possesses tough challenges
compounded by a loose financial condition. Normalization at a much slower rate could lead
to overheating of the economy and associated financial risk. Moving too fast towards
normalization is also harmful for an economy. Faster pace of normalization is associated with
disruptive reactions of the market hampering economic recovery (bis.org 2018). The pace of

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normalization varies across different Asian nations leading to the possibility of differing
outcomes from the same type of policy.
The normalization policy involves normalization of both policy rate and balance
sheet. The Bank of Japan has continued purchase of large-scale assets along with a negative
interest rate. This has been taken place against the background of a relatively low interest
rate. This posing serious challenge for central banks ahead.
The attempts of Asian central banks to normalize banking activities will lower the gap
between Asian and US interest rate. The smaller gap between the two interest rates can cause
domestic economies to bleed foreign capital and cause domestic currencies to decline. This
will make stocks and bonds of Asia less attractive blocking investment potential of Asian
countries. The central bankers have found the possibility of another financial crunch in Asia
like that during 1997 (Filardo, Genberg and Hofmann 2016). The hike in interest rate by Fed
might add to volatility in Asia.
In medium term, higher interest rate by Fed along with tight liquidity condition in
global market affected the normalization process of Asia. Normalization of Fed and European
Central Bank further tightened global liquidity market.
From the normalization process, Asia thus expects higher cost in the financial market
in medium and long term. Since the third quarter of 2014, the US dollar recorded strong
gains. Any further reduction in the interest rate differential between US and emerging
economies of Asia would reduce attractiveness of assets of emerging market (Zhang and Zoli
2014). This poses a pressure in terms of valuation assets in the emerging markets of Asia.
An increase in interest rate to squeeze the balance sheet indicates adaption of tight
monetary policy. In an emerging economy like that of Asia, a tight monetary policy bears
deep implication for the economy. The growth of Asian economies is linked with global

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market integration and openness to flow of foreign capital. The sudden tightening of
condition of liquidity in domestic and global market inject volatility in the currency in
financial and foreign exchange market (Japantimes.co.jp 2018). Following this some
economists suggest that central banks of Asian countries should pursue the policy of low
interest rate thus hampering the normalization process. The sudden increase in interest rate
could left the household with huge debt which in turn undermine consumption and
investment in the economy. The ultimate effect is impediment to economic growth. The
attempts of normalization is thus threatened by the potential risk in terms of slower economic
growth.
The normalization attempts of Fed at this moment thus impose the greatest challenge
on normalization in Asia. If interest rate in US rises at a faster than expected rate, then
foreign exchange market in Asia will come under severe pressure. Another challenge for the
central bank to implement tight monetary policy is to trace the movement of international
trade. The growing trade tension between US and some countries causes net economic loss to
export dependent emerging nations (Schnab 2017). Under this circumstances central banks
can possibly lose their determination towards a tight monetary policy. This makes the
normalization process vulnerable to outside events.
US-China trade war and effect on normalization in Asia
Since the beginning of 2018, international trade policy has come under severe
pressure exposing the global growth towards high risk. The trade war between two of the
largest economies of world – China and US poses a great threat to global economic growth
(Li, He and Lin 2018). The origin of the trade war was imposition of huge tariff on China’s
import following the protectionist policy of Donald Trump. The US-China trade war increase
the depreciation pressure on Asian currencies. The depreciation pressure on many of Asian
economies is developing at a faster pace. The effect of US-China trade war varies across

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countries with different income group (Ross 2016). The currencies of high income economies
like Korean Won, Singapore dollar and Taiwanese dollar have weakened the most as against
US dollar. The same is true for currencies of upper middle income countries such as Thai
baht and China’s yuan. For lower middle income countries that represent the fastest growing
nations in Asia have weakened the most compared to US dollar. The vulnerable currencies
include Rupee in India, Peso of Philippines and rupiah on Indonesia. As these countries suffer
twin deficit, they are exposed to higher risk of currency depreciation. At the initial phase of
trade war countries like Taiwan, Indonesia, Korea, Singapore and Malaysia tend to be in a
better position as they export more to China than to United State. Countries engage in reverse
exchange on the other hand is vulnerable to high risk of depreciation (Guo et al. 2018). The
increase in international rise affects the pace of normalization. As the depreciation pressure
on Asian currencies increase, central banks might slow down the speed of normalization.
This might delay the attainment of normalization goals of central banks.
Effect on volatility in cryptocurrencies on normalization in Asia
One of the most contested aspect of cryptocurrencies is the volatility in the
cryptocurrency market. The values of cryptocurrencies have been recorded an exponential
increase in the past few years. The volatility in the cryptocurrencies market is considered as a
two edged sword. In 2018, price of Bitcoin declined by more than 50 percent from the year
end price of $13000. The volatility in Bitcoin prices has also affected the cryptocurrency
market as the decline in price of Bitcoin affected the volume of Bitcoin traded in the market
causing a decline in interest rate in realm of digital currency market. The growing volatility in
global cryptocurrency market has highly affected the financial regulators in the Asia Pacific
region. The government of ‘Bank of Japan’ declared the sudden upswing and downswing in
prices of Bitcoin is abnormal. Bitcoin is the highest valued cryptocurrency in Asia (Yi, Xu
and Wang 2018). Asia is thus highly threatened from the volatility in Bitcoin price that in

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turn affects the entire cryptocurrency market. Asia is involved in huge trading of Bitcoin.
Asian countries like Japan, South Korea and Vietnam together contribute more than 80
percent of bitcoin trading globally (Lee 2018). The volatility in cryptocurrency thus is a
matter of great concern for regulators. The volatility in cryptocurrency market also increases
financial risks to the mainstream society. The unforeseen fluctuations in prices hurts
confidence of investors. In this situation it become difficult for central banks to successfully
carry out tight monetary policy. This hampers the initiatives to normalization as taken by the
central banks. In connection to growing volatility in cryptocurrency market China claims full
control over the digital currency. The People’s Bank of China suggested that an unregulated
market would bring further risks to the financial market impeding the path of normalization.

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References
Bis.org., 2018. II. Monetary policy: a narrow normalisation path. [online] Bis.org. Available
at: https://www.bis.org/publ/arpdf/ar2018e2.htm [Accessed 15 Nov. 2018].
Filardo, A., Genberg, H. and Hofmann, B., 2016. Monetary analysis and the global financial
cycle: an Asian central bank perspective. Journal of Asian Economics, 46, pp.1-16.
Guo, M., Lu, L., Sheng, L. and Yu, M., 2018. The Day After Tomorrow: Evaluating the
Burden of Trump's Trade War. Asian Economic Papers, 17(1), pp.101-120.
Japantimes.co.jp,2018 The Japan Times Asia's central banks should prepare to raise interest
rates | The Japan Times. [online] Available at:
https://www.japantimes.co.jp/opinion/2018/01/31/commentary/world-commentary/asias-
central-banks-prepare-raise-interest-rates/#.W-0oFzgzbIU [Accessed 15 Nov. 2018].
Lee, Y., 2018. Asia's largest economies are increasingly uneasy with the rise of bitcoin.
[online] CNBC. Available at: https://www.cnbc.com/2017/12/22/bitcoin-china-singapore-
japan-issue-cryptocurrency-warnings.html [Accessed 15 Nov. 2018].
Li, C., He, C. and Lin, C., 2018. Economic Impacts of the Possible China–US Trade
War. Emerging Markets Finance and Trade, 54(7), pp.1557-1577.
Masciandaro, D. and Volpicella, A., 2016. Macro prudential governance and central banks:
Facts and drivers. Journal of International Money and Finance, 61, pp.101-119.
Reid, D., 2018. UBS Chairman Weber: Central banks are keeping cautious faith in policy
normalization. [online] CNBC. Available at: https://www.cnbc.com/2018/11/14/ubs-
chairman-weber-central-banks-want-policy-normalization.html [Accessed 15 Nov. 2018].
Ross, R.J., 2016. After the Cold War: Domestic Factors and US-China Relations: Domestic
Factors and US-China Relations. Routledge.

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Schnabl, G., 2017. Monetary policy and overinvestment in East Asia and Europe. Asia
Europe Journal, 15(4), pp.445-462.
Yi, S., Xu, Z. and Wang, G.J., 2018. Volatility connectedness in the cryptocurrency market:
Is Bitcoin a dominant cryptocurrency?. International Review of Financial Analysis, 60,
pp.98-114.
Zhang, M.L. and Zoli, M.E., 2014. Leaning against the wind: macroprudential policy in
Asia (No. 14-22). International Monetary Fund.