Easier Monetary Policies Amid Covid-19: Maintain, Not Roll Back

More than 18 months into the Covid-19 pandemic, Southeast Asian economies have sought to dampen the contractionary effects of the coronavirus by adopting easy monetary policies. This, however, has led to the rearing of inflation’s ugly head. Instead of tightening monetary policies, it might be better for countries to utilise cash transfers and other in-kind transfers to mitigate the effects of inflation.

ASEAN governments have mitigated the negative impacts of Covid-19 on households and firms through economic stimulus packages and easy monetary policies. An analysis of economic stimulus packages in ASEAN using data from the Asian Development Bank’s COVID-19 Policy Database reveals that the stimulus packages are mostly in the form of income support to smooth consumption of households as well as direct long-term lending to businesses to avoid bankruptcies. Central banks have also eased monetary policy by reducing the reserve requirement ratio and policy interest rate. For example, the reserve requirement ratio and policy rate have been cut by one percentage point each in Malaysia, whereas in the Philippines, the same rates have been cut by 1.8 and 2 percentage points, respectively. The introduction of easy monetary policy has also been observed in Indonesia, Laos, Myanmar, Thailand, and Vietnam. 

However, the resulting upward trend of inflation may put pressure on ASEAN central banks to tighten their monetary policies. The International Monetary Fund predicted in its World Economic Outlook in April 2021 that four ASEAN countries — Indonesia, Singapore, Myanmar and Vietnam — will face higher inflation in 2022. The inflation rate based on the consumer price index in Indonesia is projected to increase from 2.0 per cent in 2021 to 3.1 per cent in 2022. In the same period, Singapore’s inflation will rise from 0.2 to 0.8 per cent; Myanmar’s from 5.0 to 5.6 per cent; and Vietnam’s from 3.88 to 3.94 per cent. Inflation in other ASEAN countries are projected to remain the same or decline slightly from 2021 to 2022. 

If ASEAN central banks were to tighten their monetary policy to reduce inflation for the rest of 2021, we could expect a weaker economic recovery in the region.

An increase in food prices is one of the key drivers of inflation in the region. An analysis of the World Bank’s commodity prices reveals that the global agricultural commodity price index in June 2021 was 29 per cent higher than its pre-pandemic level in June 2019. Among three components of agricultural commodity prices, namely beverages, food, and raw materials (e.g. timber), food prices increased the fastest. The food price index rose by 39 per cent from June 2019 to June 2021, while beverages and raw materials rose by 17 per cent and 7 per cent, respectively. Maise, wheat and rice prices in June 2021 were about 50 per cent, 24 per cent and 11 per cent higher than June 2019 levels. Southeast Asia had also seen a spike in food price inflation from 2.1 per cent in 2019 to 3.3 per cent in 2020. The surge in food prices reflects strong demand and disruptions in supply chains due to Covid-19 related restrictions.  

While rising food prices can increase real incomes for households that are net sellers of food products, they can also reduce investor confidence and undercut incentives to save. The burden of high food prices can also fall disproportionately on the poor. Poorer households spend a larger proportion of their income on food, are more reliant on wage income, have less access to interest-bearing accounts, and are unlikely to have significant holdings of financial or real assets apart from cash. Moreover, in net food-importing countries, higher food prices may result in exchange rate depreciation, which can then compel central banks to tighten monetary policy. For example, during the 2007-2008 food price spike, about half of emerging and developing economies’ central banks responded to the surge in inflation and currency depreciation by tightening monetary policy.

If ASEAN central banks were to tighten their monetary policy to reduce inflation for the rest of 2021, we could expect a weaker economic recovery in the region. Reserve requirement ratios and policy interest rates will be increased, and central banks’ financial asset purchases and direct lending to firms will decrease. Higher reserve requirement ratio and higher policy interest rates will increase the costs of bank lending, which discourages firms from borrowing from commercial banks. The contraction of loans will directly reduce financial capital for firms to sustain or expand the production of goods and services. High costs of borrowing and reduction in financial capital will reduce private investments, which will lead to an increase in unemployment rates and reduce household wage incomes. 

Instead of tightening monetary policy, targeted safety net interventions such as cash transfers as well as food and in-kind transfers can be more effective in mitigating the negative effects of food price inflation on poorer households. This should further boost households’ consumption while maintaining low-interest rates to provide low costs of borrowing for supporting firms’ recovery from the Covid-19 pandemic.

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