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    Asia’s central banks: economic shock from the Russia-Ukraine crisis poses challenges to growth and green transition

    Published On: 3 March 2022


    Phyllis Papadavid
    Head of Research and Advisory
    Phyllis Papadavid is a leading international economist and financial strategist with extensive research experience across the private and public sectors. She leads Asia House’s Research and Advisory work, driving the organisation’s research agenda and directing projects.

    Key takeaways

    • Central banks now must contend with a broad-based oil price shock and increased downside risks to the global economy
    • Central bank reserve management in resource-rich and resource-dependent economies is key in order to diversify and increase resilience
    • Asia’s central banks have seen increases in their foreign exchange reserves and are well-positioned to contribute to a resilient green energy transition
    • Key to watch will be central banks’ expanded green initiatives, including subsidised lending rates and targeted financing schemes.

    Central banks are tackling multiple economic shocks, including economic scarring from the COVID-19 crisis and what is now a significant oil price shock and growing downside risks to the global economy.

    Central banks, particularly in emerging economies, will have to stabilise  a deteriorating growth-inflation mix and bolster financial resilience. Mitigating the impact of this latest shock on the wider economy is one objective. Doing so without threatening the green transition is another.

    Energy price volatility partly preceded the current Ukraine-Russia conflict. Energy companies have had to prioritise balance sheet repair and returning capital to investors, which has come at the expense of investment to meet higher energy demand. And yet, the current oil spike constitutes a new, additional shock.

    Economically, to the extent that current developments constitute an supply side oil shock, Asia’s energy dependent economies stand to see a negative impact on economic growth: the broad rule-of-thumb that a 10 per cent increase in oil prices is associated with a decline in real activity of 0.3-0.6 per cent is applicable to Asia.

    Global financial markets are reflecting widespread risk aversion. Russia’s rouble has collapsed and the administration has started to institute capital controls to prevent investment flight as well as having taken their main policy rate to 20 per cent. But the main downside risk to global GDP – and the economic recovery – is largely via the oil price.

    The typical configuration when the investment community becomes risk averse is higher gold prices, a higher US dollar and pervasive weakness in equity markets – all of which are materialising. The strength in some of these ‘safe-haven’ assets typically comes at the expense of countries that are seen to be riskier, including some in Asia.

    Asia’s central banks’ and the green financial ecosystem

    The economic impact of the COVID-19 crisis and concerns of increasing domestic borrowing rates ahead of, and amid, US rate rises might cause challenges. Of the nearly two dozen emerging and developing economy central banks that have announced or implemented asset purchase programmes in 2020, more than one-third have raised policy rates.

    Against this backdrop, Asia’s economies need to be further supported by central banks. Central banks need to engage in more proactive reserve management and financial deepening to facilitate a financial ecosystem that is conducive to green finance. Examples of this could include allocating larger shares of central banks’ investment portfolios to green investments or incorporating climate risks into monetary policy reaction functions more explicitly, given the role that it plays in expectations. This is key for Asia, given its higher exposure to climate change impacts.

    Economic diversification helps build resilience. Financial and monetary policies are also important, especially in the short term. They are means to protect an economy in times of uncertainty: countries that have built up their reserves fare better when capital inflows slow. They can also be used strategically to build a greener financial ecosystem.

    Indonesia’s multi-pronged policy as an oil exporting economy is illustrative of successfully having diverted resources to the non-oil sector and deepening central bank usage of money market instruments to stabilise the real economy.

    Many of Asia’s policymakers realise the resilience inherent in economic diversification and of employing reserves to support those  objectives. This strategy now needs to include mainstreaming green finance – for resource-dependent and resource-rich economies alike.

    Looking ahead

    The mainstreaming of green finance should take place at both economy-wide and institutional levels.  As highlighted in the Asia House Annual Outlook 2022, further transformation in Asia’s financial sector is necessary to facilitate greater green finance, given that its financial systems are largely bank-dominated. And green central bank initiatives are core to this.

    Maintaining a high level of reserves comes at a cost. There are multiple opportunity costs to holding foreign exchange reserves, including effective economic diversification. And yet, there is a need to build up precautionary buffers, the size of which will depend on a number of factors, including the economy’s vulnerability to shocks.

    Asia’s sustainable monetary policy tools are growing. Key to watch will be central banks’ expanded green initiatives including varying reserve requirements based on carbon footprint, subsidised lending rates and targeted financing schemes for green sectors and a greater dominance of ESG framing in central banks’ portfolio management.

    Asia House will be speaking with Indonesia’s central bank governor, Perry Warjiyo, during an exclusive briefing with Corporate Members on Monday 7 March. Find out more


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