EDITORIAL: Rate cut not enough to stop deflation

Sun, Feb 22, 2009 - Page 8

The central bank cut interest rates last week, this time to a record low, to help combat the nation’s first recession since 2001.

With the latest government figures showing that the economy shrank a record 8.36 percent year-on-year in the fourth quarter and will likely contract 2.97 percent this year, the central bank’s move was widely expected.

The rate cut was the central bank’s seventh consecutive reduction since September, and in theory, such monetary-easing measures could help reduce the costs of households and businesses while boosting private consumption and investment.

But will the rate cut be able to stimulate the economy this time?

The cut was necessary but will not be sufficient to boost the economy, because the key economic problems — falling exports, weakening domestic demand and rising unemployment — are largely the result of the global economic downturn.

The harsh reality is that exports are likely to continue falling in the coming months as the global downturn worsens, which will hurt household incomes and domestic consumption. On the corporate front, banks are reluctant to extend credit and companies are postponing expansion and investment plans because of the uncertainty.

As idle funds continue to pile up within the financial system, there is no liquidity problem at banks.

The central bank’s auction of treasury bills on Thursday demonstrated that the central bank’s rate cuts do not always work.

The auction of NT$20 billion (US$575 million) in 182-day treasury bills was the fifth auction of government debt this year, but still saw strong demand from banks, drawing NT$140.36 billion in bids, or 7.02 times the amount of debt on offer, the central bank said.

The strong demand pushed the yield on Thursday’s offer to a record low of 0.15 percent, falling from 0.22 percent at an auction of 168-day treasury bills on Feb. 12. The offer of 294-day treasury bills on Jan. 21 saw a yield of 0.399 percent, an offer of 273-day treasury bills on Jan. 14 saw 0.405 percent and an offer of 91-day treasury bills on Jan. 5 saw 0.66 percent.

The central bank’s effort to offer cheap funds is understandable, but it is telling that banks thought buying government debt — despite the declining yield — preferable to extending credit to companies for fear of incurring bad loans.

Assuming that depositors will be forced to withdraw their money from banks for spending or investment purposes under the central bank’s interest rate policy is also questionable. As the recession continues, what households lack is confidence in the domestic economy and orientation for their plans.

Perhaps more important than the central bank’s decision to slash interest rates was its recognition of the threat of deflation, which came after government figures showed consumer prices were expected to fall by a record 0.82 percent this year from last year.

In light of subdued wage growth and rising unemployment, households have already tightened their belts. If consumers refrain from spending even when companies lower their prices, it will create a vicious downward spiral, with domestic demand and business activity further weakening.

Sustained deflation could damage the central bank’s efforts to keep credit flowing to cash-strapped companies. Policymakers need to look at other options to prevent a deflationary spiral.