Policy makers in AXJ have signaled their readiness to act if needed. We think they will act first to stabilise financial conditions before responding with fiscal and monetary easing to mitigate downside risks to growth.
* Policy makers have signaled their readiness to act: Since the results of the UK
referendum were announced on 24th June, policy makers across the region
issued statements to reassure markets that they were closely monitoring
developments, while at the same time pledging to act to stabilise markets and
stand ready to provide liquidity as needed. In this report, we detail the possible
policy responses, by country. Specifically we address the questions of (1) What is
the current policy stance? (2) What are the tools available? and (3) What will be
the likely policy response?
* Increased external headwinds to region's growth outlook: Increased uncertainty
in the external environment due to UK's vote should add to downward pressures
on growth and inflation in the region. Principal channels of transmission should
be via trade and financial channels. Moreover, as we will likely enter a period of
profound and protracted uncertainty, we think the concern will be that
headwinds to the region's growth persist longer.
Within the region, we think Hong Kong, Singapore, and Malaysia will rank as
those which are most exposed, while the economies of Thailand, Indonesia,
Taiwan, Korea and China would be moderately exposed and India and Philippines
would be least exposed on a relative basis. Taking these channels into
consideration, we expect AXJ real GDP growth to be impacted by 20bps in 2016
and 30bps in 2017 in a medium stress scenario. In a high stress scenario, in which
higher uncertainty affects business confidence even more, we would expect an
impact of 30bps in 2016 and 50bs in 2017.
* How will policy makers respond?: As it is, policy makers are already on a path of
gradual easing. As the immediate impact should be felt mostly via the financial
channel, we think near-term focus of policy makers will be to mitigate adverse
impacts on financial conditions. Specifically, we expect policy makers to introduce
liquidity injections measures such as open market operations and reserve
requirement ratio cuts. If growth headwinds persist, we expect policy makers to
respond first with fiscal easing, particularly if the capital flows situation remains
volatile; central banks may be constrained in cutting interest rates immediately
as that could add to depreciation pressures. Once the constraint of volatile
capital flows and tighter liquidity conditions is lifted, central banks should move
to cut interest rates, although we do not expect an aggressive response.