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monetary policy normalisation in advanced economies

The upward march of the US policy rate since December 2015 has had benign effects on financial markets in Emerging Asia thus far, thanks largely to the advanced transmission of monetary policy direction. The commitment to accommodative monetary policy made by the European Central Bank and the Bank of Japan, at least in the next few months, has also helped to keep speculation at bay. The concern is what may happen if major central banks proceed with monetary policy normalisation at a more rapid pace than expected. With the amount of liquidity involved, economic activity in Emerging Asia could be dampened through various channels. First, rapid monetary normalisation in advanced economies will potentially narrow interest rate differentials rather sharply and can instigate capital outflow from Emerging Asian economies. Capital flight can in turn intensify depreciation pressures, can be inflationary and can trigger central banks to raise their own policy rates. Second, it can expose some vulnerabilities in the corporate sector. Higher interest rates can lead to capital losses and can ultimately result in a downsizing of corporate balance sheets. Financial institutions, especially those already facing some asset quality OVERVIEW 1. Overview 1. Overview ECONOMIC OUTLOOK FOR SOUTHEAST ASIA, CHINA AND INDIA 2018: FOSTERING GROWTH THROUGH DIGITALISATION © OECD 2018 23 issues, might face difficulties as corporate solvency risks rise. And as firms’ spending capacity gets constrained, domestic demand will have to carry more slack. Third, liquidity reduction in advanced economies can dampen their own demand for imported goods. Imports coming from Emerging Asia can be affected directly and indirectly through global value chains. In summary, as it is, the monetary normalisation in advanced economies will affect Emerging Asia’s growth through various channels. It is arguable, however, that adjustments will not be disruptive should there be no significant deviation between the announced path of policy changes in the US, Europe or Japan and the actual policy changes. In addition, the scale of Emerging Asia’s international reserves provides a considerable buffer while the generally stable macro fundamentals give the region some room for manoeuvre to mitigate negative effects.