Graduate School of Business

International Finance CFGB6305

Global Monetary Stimulus, the benefit and the risk to the emerging Asian companies.
Lecturer: Dr.Roselee Shah Shaharudin Group 4 Junaidi Bin Musa Kamal AbdelHamid Ahmad Tajuddin Mohammadmahdi Toobaee April 2013 CGA100041 CGA110063 CGA120091 CGA110057

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

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

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 shortterm 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.

Why does Global Monetary Stimulus affect emerging Asian economies? Emerging marketsespecially those in Asia with stronger fundamentals and lower debt-toGDP 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 onemonth 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.

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.

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 Nov2009Oct2010 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.

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

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.

Andrew Bergman, World Largest Economies, CNN Money. Access on 22 Apr 2013 from 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 U.S. Stimulus Program 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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