MASB2505 Financial Markets: Analyzing Central Banks Normalization

This essay critically analyzes the challenges faced by central banks in Asia as they move towards policy normalization in 2018 and tighten monetary policy. It examines the impact of the US-China trade war and the volatility of cryptocurrencies on their policy decisions. The essay discusses the complexities of balancing interest rates, managing capital outflow, and addressing currency devaluation. It also explores the potential risks of both fast and slow normalization paces, highlighting the need for careful consideration of internal and external economic environments. Furthermore, the essay delves into the influence of global liquidity conditions and the strengthening US dollar on Asian economies. Finally, the analysis incorporates the implications of the US-China trade war and cryptocurrency volatility, emphasizing the need for central banks to adapt their strategies in response to these external factors.

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Table of Contents
Central Banks’ normalization in Asia..............................................................................................2
Challenges faced by central banks in normalization...................................................................2
Impact of US - China trade war on central banks’ normalization...............................................4
Impact of crypto currency volatility on Asia’s normalization.....................................................5
References list..................................................................................................................................7

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Central Banks’ normalization in Asia
The term ‘normalization’ indicates policy initiatives of central bank with the aim of
contraction in balance sheet. This is done by raising the interest rate in the economy. During the
hit of global financial crisis, central banks’ of major economies set their interest rate to a
historically low level. After years of financial crisis, most countries are in path of economic
recovery and expansion (Gertler and Karadi 2015). Gaining support from a strong growth central
banks’ now focus of reducing their balance sheet through increase in interest rate. Like most of
the developed economies, Central Banks in Asia are also moving towards the policy of
normalization. The decision has been taken with the expectation that the economy will remain
strong in future years and will account a steady growth. The normalization policy of Federal
Reserve further accelerates the normalization initiatives in Asia. Fearing the outflow of capital
due to interest rate hike in US, Asia has attempted to raise domestic interest rate. After long
years of expansionary policy, several Asian economies have adapted the path of tight monetary
policy. The central banks in Singapore, Korea, Hong Kong, Malaysia and Philippines have
adapted the policy of normalization (Le Hong 2013). These economies have recorded a steady
economic growth in the past years. The expected real economic growth in Asia for 2018 and
2019 are 6.0 percent and 5.9 percent respectively.
Challenges faced by central banks in normalization
The attempt of normalization by the central banks encompasses to tough challenges. The
loose financial state imposes financial risk on the economy. The pace of normalization is an
important determinant of success of the policy undertaken. Neither too fast nor too slow pace of
normalization is beneficial for health of the economy. The normalization policy moving at a
faster rate results in disruptive reaction in the economy (Masciandaro and Volpicella 2016). This

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impedes the path of economic recovery. Conversely, slower pace of normalization is also
harmful in the sense that this overheats the economy bringing several financial risk. The pace of
normalization depends on internal and external economic environment. The potential of Asian
economy varies across countries resulting in differing policy outcome. Successful policy of
normalization requires normalization of balance sheet as well as policy rate. The normalization
policy in Asia has been undertaken with a background of expansionary monetary policy. For
example, the central bank of Japan has purchased different assets at large scale maintaining a
negative rate of interest (Filardo, Genberg and Hofmann 2016). This brings challenge to the
central banks in terms of balancing the interest rates.
In order to normalize the balance sheet, the central banks of Asia has raised the prevailing
interest rate. This reduces the differences in interest rates between US and Asia. This causes
many of the Asian economies to bleed capital of foreign investors. This in turn leads to a decline
in currency value. The weak currency of Asia makes bonds and stocks relatively less attractive
reducing potential for foreign investment. Many economists have suggested a potential financial
crisis in Asian economy same as the crisis during 1997. The lower interest rate differential and
increase in interest rate in United States contributes to volatility in the liquidity market. The
process of normalization in Asia has been impeded by Fed’s hike in interest rate in combination
with a tight liquidity condition globally. The global liquidity market is tightened by
normalization process of European Central Bank (Johnson, Arel‐Bundock and Portniaguine
2018). Asia thus expected to incur a higher cost of normalization in the medium and longer term
following global economic condition. US dollar has been strengthened against Asian dollar from
the second half of 2014. The already weak Asian currency faces further decline in currency value
following a reduction in the gap in interest rate between Asia and United State. The emerging

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markets of Asia suffers with a lower valuation of assets and an associated lower demand. The
valuation pressure on Asian assets pose a challenge to the central banks in successfully
accomplishing the normalization goal.
In times of global recession in 2008, the affected economies took an expansionary policy.
With the objective of contraction of balance sheet, central banks lowered the interest rate. This
indicates a tight monetary policy in the economy. In the developing economies like that of Asia,
a tight monetary policy has severe impact on the economy. The fast pace of growth in the Asian
economies are contributed from integration with the international market (Bayoumi and Gagnon
2018). The inflow of foreign capital plays an important role in growth of Asian economies. The
decision of a sudden tightening of monetary policy adds volatility in foreign exchange and
market of financial assets.
Taking the existing and upcoming challenges in the process of normalization some
economists argue that it is not the right time for Asia to go for normalization. Rather the
economy should continue the low interest rate for a while. The hike in the domestic interest rate
has a direct adverse effect on consumption and investment. Consumption and investment being
an integral part of economic growth, the ultimate result is slowing down the pace of economic
growth (Koepke 2018). In contrast to this argument, another group of policy makers suggests
that it is right for economic health of Asia to take normalization as a persistently low interest rate
might overheat the economy creating bubble in the property market with a potential crisis in
property market.
Impact of US - China trade war on central banks’ normalization

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The US – China trade war put the global trade policy into pressure. With the claim of
unfair trade practices with United States and large trade deficit in US, the President Donald
Trump announced huge tariff on imported items from China. The imposed trade barriers
triggered a trade war between two of world’s biggest economies – China and United State. Asian
currencies are largely vulnerable to the trade conflict between China and US (Ross 2016). The
trade war put Asian currencies into the pressure of depreciation. The impact however varies
across the higher, middle and lower income group. In high-income countries like Singapore,
Korea and Taiwan, currency has weakened to large extent. The same trend has been observed for
Yuan in China and Thai baht (Noland 2018). The relatively low-income countries such as
Indonesia, Philippines and India are the most vulnerable to depreciation risk. The existence of
twin deficit in these countries further aggravated the problem. Asian countries that exchanged a
larger volume of goods and services with China compared to United States were at a relatively
better position at the beginning of the trade war. These nations include Singapore, Malaysia,
Korea, Indonesia and Taiwan. The effect of trade war between US and China are more severe for
countries that has a relatively larger volume of trade with US (Hurley and Papanikolaou 2018).
The depreciation pressure from US- China trade war causes the central banks to slower the
normalization pace in Asia postponing the target of balance sheet normalization.
Impact of crypto currency volatility on Asia’s normalization
The volatile crypto currency market imposes great risk to the global financial market. The
price growth of these digital currencies follow an exponential path. Price of bitcoin in 2018 has
slide down by nearly 50 percent compared to its price in the last year. The rapid and sudden
decline in prices of Bitcoin impacted the crypto currency market as decline in market valuation
lowers the volume of Bitcoin trade decreasing the interest rate in the market of digital currency

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(Conrad, Custovic and Ghysels 2018). The regulators in the financial market of Asia has been
largely affected by volatility in crypto currency globally.
Asia is highly exposed to the risk of volatility in crypto currencies because of massive
involvement in trading of different types of crypto currencies. In the last year, Vietnam, Japan
and South Korea accounted for 80 percent of Bitcoin transaction in global market. Most of the
central banks have taken the growing volatility of digital currency as a serious threat to the
financial market. The central bank of Japan has declared the sudden upswing of Bitcoin prices
abnormal. The central bank of China has demanded complete authorization of digital currency
(Oh et al. 2017). The Bank announced that unregulated market like that of crypto currency
market would add high volatility to financial market. Implementing a tight monetary policy in a
volatile financial market thus become difficult for central banks. This ultimately results in
delaying of normalization objectives.

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References list
Bayoumi, T. and Gagnon, J., 2018. Unconventional monetary policy in the Asian financial
crisis. Pacific Economic Review, 23(1), pp.80-94.
Conrad, C., Custovic, A. and Ghysels, E., 2018. Long-and Short-Term Cryptocurrency Volatility
Components: A GARCH-MIDAS Analysis. Journal of Risk and Financial Management, 11(2),
p.23.
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.
Gertler, M. and Karadi, P., 2015. Monetary policy surprises, credit costs, and economic
activity. American Economic Journal: Macroeconomics, 7(1), pp.44-76.
Hurley, D.T. and Papanikolaou, N., 2018. An Investigation of China‐US Bilateral Trade and
Exchange Rate Changes Using the Autoregressive Distributed Lag Model. Economic Papers: A
journal of applied economics and policy.
Johnson, J., Arel‐Bundock, V. and Portniaguine, V., 2018. Adding Rooms onto a House We
Love: Central Banking after the Global Financial Crisis. Public Administration.
Koepke, R., 2018. Fed policy expectations and portfolio flows to emerging markets. Journal of
International Financial Markets, Institutions and Money.
Le Hong, H.I.E.P., 2013. Vietnam's hedging strategy against China since
normalization. Contemporary Southeast Asia, pp.333-368.
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.

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Noland, M., 2018. US trade policy in the Trump administration. Asian Economic Policy
Review, 13(2), pp.262-278.
Oh, S.C., Kim, M.S., Park, Y., Roh, G.T. and Lee, C.W., 2017. Implementation of blockchain-
based energy trading system. Asia Pacific Journal of Innovation and Entrepreneurship, 11(3),
pp.322-334.
Ross, R.J., 2016. After the Cold War: Domestic Factors and US-China Relations: Domestic
Factors and US-China Relations. Routledge.