The central bank’s latest cut of its key interest rates by 12.5 basis points for a second consecutive quarter was a surprise to markets, especially when the move came just hours after the US Federal Reserve announced a rate hike of 25 basis points. While the move affirms Taiwan’s departure from the US in terms of monetary policy at a time when there is growing policy divergence among central banks worldwide, it delivers one important message to the general public: Challenges abound on the road ahead.
For the first time in nearly a decade, the Fed last week finally raised its policy rate, saying that future rate hikes would be “gradual,” which means a tilt toward rising capital outflows in Asia. Consequently, the outflows could trigger higher financing costs and downward pressure on Asian currencies across the board.
The Fed move indicates a long-promised step toward the normalization of US monetary policy. In theory, the action should have taken potential rate cuts off the table for Asian central banks in a bid to slow the pace of potential capital outflows. However, that the central bank cut rates within hours of the Fed’s decision underscores not just Taiwanese monetary policymakers’ grave concerns over the economy, but also an implication that the New Taiwan dollar is likely to face more depreciation pressure than its regional peers amid rising exchange rate volatility.
Taiwan’s strong current-account surplus and ample foreign exchange reserves can shield the nation from the risk of a potential outflow contagion in Asia. However, the central bank wanted so badly to emphasize that the economy has yet to fully bottom out, it said a moderate global recovery next year would not be able to drive significant improvement in external demand and consequently slow private investment, as well as consumer spending in Taiwan, according to a statement issued after the bank’s quarterly board meeting on Thursday last week.
Central bank Governor Perng Fai-nan (彭淮南) said at a news conference on Thursday that other concerns monetary policymakers hold regarding the nation’s economy include the recent underperformance of export growth; the ongoing regional currency devaluation race; and the economic threats of not participating in bilateral and multilateral trade pacts in Asia.
Nonetheless, managing currency competitiveness seems to be an issue the central bank did not clearly address, but is a crucial tool to beef up the nation’s export growth. Further weakness in the yuan going forward and its spillover impact on other Asian currencies, including the NT dollar, are other unaddressed questions.
Perng suggested that the impact of the rate cuts would take some time to feed through the real economy and interest rate policy should not be too aggressive. However, the bank’s latest move suggests that monetary authorities might have discovered something suspicious on the economic front that the Directorate-General of Budget, Accounting and Statistics has not yet factored into last month’s GDP growth forecasts, which predicted the economy could grow 1.06 percent this year and 2.32 percent next year: Things could get worse if other Asian nations, particularly China, get into trouble and drag Taiwan into a further slowdown.
Moreover, there exists a greater uncertainty about next year’s political repercussions in regards to the presidential and legislative elections next month and cross-strait relations afterward.
Any delayed or inappropriate policy response, or even any political development that would negatively surprise investors, could have a bigger impact than an economic slowdown in Asia. With this in mind, the uncertainty is far from over. Instead, more bold actions might be in the central bank’s policy pipeline if things go really wrong.
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