The US Federal Reserve kept its benchmark interest rate unchanged at 0.25 to 0.5 percent on Wednesday last week, with a dovish statement from Fed Chair Janet Yellen, who said that the Fed has halved its planned rate hikes from four to two and lowered its forecasts on a number of economic indicators, such as GDP growth, unemployment and inflation.
The Fed’s vigilance in deciding interest rates shows US policymakers’ concerns over the nation’s economy and external uncertainties. A dovish Fed, along with continuing accommodative monetary policies in other developed economies, is good news for emerging-market currencies, due to the strong capital inflows. Since Wednesday, the New Taiwan dollar has appreciated by 1.32 percent against the US dollar, compared with the South Korean won’s 2.65 percent rise and more than 2 percent rise for the yen as well as the ringgit.
The strengthening NT dollar is likely to be a key discussion point in the central bank’s quarterly meeting on Thursday. The turn in market sentiment since the start of the year has bolstered the local currency, which has risen 1.68 percent against the US dollar, greater than the won’s 0.86 percent increase, to close at a five-month high on Friday at NT$32.520 per US dollar.
Major economic forecasters have lowered their expectations for Taiwan’s economic performance this year. The official estimate for this year’s GDP growth stands at 1.47 percent, but the risk of downward adjustment has picked up steadily, judging by recent macroeconomic data. Therefore, a fresh rate cut could weaken the NT dollar to increase the competitiveness of Taiwanese exporters and boost the nation’s GDP.
In addition, the overnight interbank rate — which was reportedly guided lower to less than 0.2 percent recently from a high of 0.39 percent in August last year — reflects the market’s anticipation of easier monetary conditions, as moves in the overnight rate are usually followed by policy rate adjustments.
With global economic recovery remaining slow and Taiwan’s negative output gap continuing to widen, coupled with a soft inflation outlook and a relatively high real interest rate, the central bank seems to have room to further ease its monetary policy. The question is: How big will the rate cuts be this time? Will they be big enough to keep hot money from destabilizing the local currency and affecting domestic asset prices? And when would the rate-cut cycle come to an end?
Some say that loose monetary policy alone might not spur economic growth and bring inflation back to normal levels, and that expansionary fiscal policy would be more effective in boosting aggregate demand. However, economists say the government’s efforts to keep its debt level under the ceiling of 40.6 percent of the past three years’ average GDP — which stood at 38.6 percent in 2014 — means the nation’s challenging fiscal situation and increasingly rigid budget allocation would restrict the scope of fiscal policy stimulus.
The central bank’s monetary policy would have to play a larger role in easing credit conditions and boosting aggregate demand. Furthermore, considering that Taiwan’s export figures have been shrinking for 13 consecutive months, coupled with slowing lending and a correction in the housing market in the past few months, the central bank’s rate-cut cycle is likely to continue for a while longer. It might not be good for the economy in the long run, but might be necessary for a period of time.
Even so, monetary authorities must be careful of potential volatility regarding the Fed’s rate hike trajectory and China’s “new normal” in economic growth. After all, local businesses want to see stability in the exchange rate rather than wild swings.
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