Asia's central bankers have yet another reason to hesitate now that the U.S. Federal Reserve looks likely to keep interest rates low for longer.
Indonesia, Thailand, Australia and the Philippines have all cut interest rates at least once in the past three months to try to shore up economic growth, and many economists predict more easing to come this year from India and South Korea.
But as the U.S. central bank extends the horizon for its first rate hike, it changes the Asian equation. Instead of lowering interest rates, which may have unintended consequences when the Fed is on hyper-extended hold, it may make more sense for some economies to tinker with currency exchange rates.
Forecasts released last week from Fed officials show that it will probably be late 2014 before rates rise from the current level near zero -- considerably longer than the mid-2013 low-rate pledge the central bank had made back in November.
That could provide a policy breather for emerging markets if it helps sustain U.S. growth, which is essential to export-sensitive Asia, Philippines central bank Governor Amando Tetangco said on Thursday.
However, the Fed's forecasts are conditional. If the U.S. economy strengthens more than expected or inflation threatens to build, the Fed is under no obligation to stick to a late 2014 timetable for tightening.
There is still much confusion over what the Fed did or didn't do, said Thomas Lam, chief economist at OSK-DMG in Singapore. That's going to add another layer of complexity for Asian policymakers.
Asia's central bankers typically set interest rates with an eye on currency values because so many of the region's economies are driven by exports. An ultra-easy Fed probably means a weaker dollar, which eats into Asia's export price advantage.
That is why Lam expects Asian officials to rely on currency market intervention more than interest rate cuts to try to bolster economic growth. In Singapore, where exports are larger than the city-state's entire annual output, the exchange rate is the primary policy tool.
There's never a disconnect between interest and exchange rates, particularly in Asia, he said. Most of the Asian economies are export-driven, so even though they have an interest rate policy, exchange rates always play a key role in their decision making.
OUT OF SYNC
When the Fed embarked on its aggressive easing campaign, which eventually took rates to near-zero in December 2008, the global financial crisis was raging and the rest of the world was cutting rates as well.
But the world is not really in sync now.
Economies such as Hong Kong, China and Singapore effectively cede some control over monetary policy to Washington because they tightly manage their currencies against the U.S. dollar, which can cause headaches when growth rates diverge.
The Fed's easy-money policy can weaken the dollar, putting a drag on Asia's dollar-linked currencies and driving up imported inflation. Hong Kong, Singapore and China are already grappling with inflation rates running above policymakers' comfort levels.
Even those countries that keep a looser grip on foreign exchange rates must be mindful of Fed policy when setting their own interest rates. Cut too far and the gap between the two rates narrows, making it less attractive for foreign investors; hike too much and it could draw an onslaught of speculative money that drives up inflation.
Rahul Bajoria, an economist with Barclays Capital in Singapore, said emerging Asia's rate-cutting cycle was pretty much done for now, with the exception of India where domestic growth and inflation are both slowing sharply.
FOLLOW THE MONEY
The Fed also said it was ready to provide more economic stimulus should growth falter, which economists took to mean it would probably buy more government bonds or mortgage-related securities. It has already more than tripled its balance sheet to $2.9 trillion through two sets of bond purchase programs.
The second round of bond purchases, launched in 2010, provoked howls of protest from Asian officials, who blamed it for stoking inflation and sending uncontrollable waves of speculative money into emerging markets. But talk of a third batch has so far elicited few, if any, complaints.
Part of the reason is that Asia's own growth is slowing, unlike in 2010 when it came charging back from the global slump. In addition, some Asian economies such as India and China have been more worried lately about capital flowing out rather than in, and would welcome a little more foreign capital.
In the first four months of 2011, emerging market foreign exchange reserves shot up at a nearly 30 percent annualized pace, according to data from J.P. Morgan. But the pace tapered off in the second half of the year as investors shied away from riskier markets. China's official reserves recorded a rare decline in the final quarter of 2011.
But if the Fed's easy-money stance helps boost U.S. growth and Europe's debt troubles simmer down, Asia could soon be back to worrying about inflation instead of growth, and a wave of foreign money might once again be unwelcome.
Given the point in the (economic) cycle we are at, I don't think they will be very concerned about capital flows, but six months down the line, the outlook could change once the worst is behind us, Barclays' Bajoria said.
Policymaking has to be pretty nimble on both sides.
(Reporting by Emily Kaiser; Editing by Vinu Pilakkott)