Panel Discussion

Michael Hutchison
UC Santa Cruz
ADBI Annual Conference December 1-2, 2016

The views expressed in this presentation are the views of the author and do not necessarily reflect the views or policies of the Asian
Development Bank Institute (ADBI), the Asian Development Bank (ADB), its Board of Directors, or the governments they represent. ADBI
does not guarantee the accuracy of the data included in this paper and accepts no responsibility for any consequences of their use.
Terminology used may not necessarily be consistent with ADB official terms.
 Portfolio Rebalancing
Risk Structure and Term Structure

Bank Lending and Risk Taking

Exchange Rates and Capital Flows

 Wholesale interest rates fall with central bank deposit
rates
Investors switch from low yield government securities
to riskier assets such as equities and corporate bonds
Cost of funds fall for borrowers (e.g. large corporates)
who can directly finance in commercial paper and
corporate bond markets

Result: spur aggregate demand

 Fall in lending rates
limited by retail deposit rates remaining anchored at zero
or above

Spur aggregate demand (fall in lending rates)

 Exchange rates should depreciate in home country
(negative interest rate country, e.g. Japan)
Capital outflows from home country

Capital inflows to target countries

Exchange Rate appreciation in target

Spur aggregate demand (in home country)

 Relax financial conditions lower interest
rates, spur aggregate demand growth
Complement to / Extension of QE

Depreciate currencies, spur growth

Lower burden of debt

 Banks net interest margins squeezed, lower
profitability of the banking sector and others

Possible excessive risk-taking

Squeeze on bank margins may lead to
lending to riskier borrowers

Capital flows, increased search for yields;

capital flow volatility

Beggar thy neighbor currency depreciation;

exchange rate volatility
 The experience to date suggests that modestly negative policy rates have been
transmitted to money markets in much the same way as positive rates. The pass-
through to short-term money market rates has been persistent and the impact on
trading volumes already depressed by central banks abundant and cheap supply of
reserves appears to have been small, in general.

The introduction of negative policy rates also coincided with a decrease in longer-
maturity and higher-risk yields. Isolating their impact precisely is not easy, though,
owing to the simultaneous introduction or expansion of central bank asset purchase
programmes.

banks, motivated by deposit withdrawal concerns, have been reluctant to pass

negative rates through to retail depositors. Partly to limit the resulting impact on
their net interest margins, some central banks introduced exemption thresholds
for negative remuneration, thereby limiting banks average cost of holding central
bank liabilities.

The effect of negative policy rates on exchange rates was not uniform and in
some cases coincided with bouts of volatility. In Japan, the 2.8% depreciation of
the yen vis--vis the US dollar upon announcement of negative policy rates proved
transitory and was reversed in the following days.

BIS Annual Report 2016

 The Basic Discount Rate and Basic Loan Rate

Call Rates, Uncollateralized

Overnight/Average
Falling interest rates and Yen depreciation (2.8%) on announcement of
negative interest rate policy, but followed by sharp appreciation.

Announcement of
Negative IR Policy
 Interest rates

Exchange rates

Capital flows
Continuing declines in government
bond rates

Rate for Indonesia is lending rate.

Large declines in corporate bond yields in Asian EMs

Japan leading decline in

Asian EM interest
ratesrecent reversals
Dec
31
4.20
%

Nov 18 3.52%

Sept 28 2.96%

This data represents the effective yield of the BofA Merrill Lynch Asia Emerging Markets Corporate Plus Index is the
subset of the BofA Merrill Lynch Emerging Markets Corporate Plus Index, which includes only securities issued by countries associated with
the region of Asia, excluding Kazakhstan, Kyrgyzstan, Tajikistan, Turkmenistan, and Uzbekistan.
Mixed Developments in Exchange Rates.

India

Korea

Japan

Thailand

China
 No obvious change in capital flow volatility

Around March aggregate capital flows to EMs

increasing

Especially in EM Asia
 Weekly Net Non-Resident Purchases of EM Stocks
and Bonds ($ billion) (Excludes Turkey and Mexico)
Debt and Equity (combined), weekly data
Total Weekly Portfolio Flows (Debt and Equity)
$ billion

-2

-4

-6
Jan 15 Apr 15 Jul 15 Oct 15 Jan 16 Apr 16 Jul 16 Oct 16

Source: National Sources, IIF.

 Weekly Net Non-Resident Purchases of EM Stocks
and Bonds ($ billion) (Excludes Turkey and Mexico)
Debt and Equity (separately)
Weekly Debt and Equity Portfolio Flows
$ billion

6
Debt Flows

-2
Equity Flows

-4

-6
Jan 15 Apr 15 Jul 15 Oct 15 Jan 16 Apr 16 Jul 16 Oct 16

Source: National Sources, IIF.

 IIF Tracker: Total Portfolio Flows into Emerging Markets
$ billion, Monthly Data

IIF Tracker: Total Portfolio Flows into Emerging Markets

$ billion

Total Flows
45

Sept. and Aug. Estimates

35

25

15

-5

-15

-25
IIF Portfolio Debt Flows Tracker IIF Portfolio Equity Flows Tracker

-35
Jan 14 Jul 14 Jan 15 Jul 15 Jan 16 Jul 16

Source: National Sources, Bloomberg, IIF.

S
 Total Portfolio Investment Inflows to Emerging Economies
$ billion, IIF group of 25 emerging economies, quarterly data

Total Portfolio Investment Inflows to Emerging Economies

$ billion, IIF group of 25 emerging economies, quarterly data

200

Actual (BoP)

150

100

50

0
I

IIF Portfolio Flows Tracker

-50
2010 2011 2012 2013 2014 2015 2016

Source: National Sources, IIF.

S
both for debt andequity
 Rise in U.S. rates

Strong transmission to EMs in Asia and

elsewhere

Taper = Trump tantrums?

Overshadowing negative interest rate effects

Low inflation, negative rates old news?

What up for Japan?
Japan again
 Brave new world

Rise in uncertainty

Unclear on Trade/Financial Linkages and

globalization trends

Dominate effects of negative interest rates on

Asian financial markets
Net Non-Resident Purchases of EM Stocks and Bonds in $
Billion; MA = Moving Average (MA) Debt and Equity
Total EM Portfolio Flows (Debt and Equity)
$ billion

7-Day Moving Average

1.0

0.8

0.6

0.4

0.2

0.0

-0.2

-0.4

-0.6

-0.8 28-Day Moving Average

-1.0
Jul 15 Oct 15 Jan 16 Apr 16 Jul 16 Oct 16

Source: National Sources, IIF.

S
 Net Non-Resident Purchases of EM Stocks and Bonds in $
Billion; MA = Moving Average (MA) Equity
EM Portfolio Equity Flows
$ billion, all available countries (6 total)

1.0
7-Day Moving Average

0.8

0.6

0.4

0.2

0.0

-0.2

-0.4

-0.6 28-Day Moving Average

-0.8

-1.0
Jul 15 Oct 15 Jan 16 Apr 16 Jul 16 Oct 16

Source: National Sources, IIF.