The long and short of it for central banks

Originally from The Edge, Malaysia, 25 March.

Long term yields are rising. Optimism over growth prospects is fuelling this, but ironically the higher rates go, the greater the risk they pose to that very growth. Warning bells were sounded in South Korea and Thailand recently. South Korea's Budget Minister and ex-monetary board member Chang Seung-woo warned companies that borrowing costs are likely to rise ahead. Elsewhere, there were persistent rumours that the Bank of Thailand was supporting local bond prices.

Central banks seem almost helpless, as intervention budgets have limits too. Maya Sen, our bond analyst, writes: "It is interesting to note that yields on long UST (10 years out) are actually slightly higher today than they were when the Fed [US Federal Reserve] commenced its Blitzkrieg of 475bps in rate cuts on Jan 3, 2000. Consumer spending, which has been the sturdy support for the economy, has been driven in large part by cheap long-term mortgage rates and mortgage refinancing. But if long rates have not really budged, what is going to finance consumers in the future? Long rates remain high in spite of low inflation, a surplus which yes, has disappeared, but may reappear with economic recovery, and even the eradication of 30 year new bond supply. Even Mr Greenspan is stumped by this one."

Can central banks count on the equity market to relieve some of the borrowing burden? They can if price/earnings ratios (PER) are high, argues Lorraine Tan, our equity analyst: "The tendency is for companies to rely on share issuances when prices are high so that a lesser amount of shares needs to be issued to raise the same amount of cash and dilution is kept to a minimum for shareholders. China, for example, is seeing a number of new A-share issues relative to B-shares and H-shares since a company can price itself at 14 times PER on the former rather than the five to eight times PER on the latter two exchanges."

Based on this rule of thumb, the outlook is better for South Korea (trading at 29.3 times PER, highest since June 2000) and bleak for Thailand. Lorraine is more cautious about placing too much weight on Malaysia but adds the bonds will still enjoy more interest by default because "major shareholders don't have the liquidity to continue pumping in cash for rights issues".

At the short end, the problem is that though rates are down, most of the liquidity remains trapped in the pipeline.

Last week Bank Negara Malaysia noted that "...previous monetary easing [has] not been fully manifested". At the start of the month, Bank of Thailand governor Pridiyathorn said "finding measures to boost lending is our priority at this time, while interest rates will be a secondary concern". Similar overtones echoed in the Philippines as well.

Why? The case of the Philippines may be representative. On demand side, manufacturers see no need to borrow, after all capacity utilisation remains low.

The pickup is likely to lag rather than be simultaneous with rise in external demand. On the supply side, banks see little incentive to lend. Instead, the preference has been to invest excess cash in the liquid and lucrative Treasury bills.

What next? In diplomatic language, a possible shift to moral suasion as the preferred tool in monetary policy. In a nutshell, a few good strokes of the cane and arm twisting behind closed doors. Meryl Phang, our treasury analyst reminds us, "The only complaint from the central bank of Taiwan [CBC] is that banks are not lowering their mortgage loan rates although deposit rates have already fallen under 2.5 per cent. CBC aims to lower mortgage loan rates by meeting up with 38 banks on Wednesday, March 27, requesting banks to lower their mortgage rate to under 8.0 per cent for creditworthy customers who have made regular repayments and which would be reviewed after one year."