Impacts Of Us Quantitative Easing Policy On Cambodia’s Economy

The2008global financial crisis was caused by the subprime mortgage market crisis in the United States. The mortgage price went up to its peak then declined dramatically in2007leading the mortgage market itself and entire economy to fall into depression. By that time, the Federal Reserve had been cutting the policy rates too close to zero. Yet, the crisis could not be solved, leaving the conventional monetary policy ineffective. In order to stimulate the whole economy as well as the mortgage market, the Federal Reserve System of the United States decided to implement an unconventional monetary policy which is known as Quantitative Easing (QE). Quantitative easing is a monetary policy used by central banks to stimulate the economy when conventional monetary policy has become ineffective. Central banks implement QE by buying specified amounts of financial assets from commercial banks and other private institutions, so that the central bank can inject money into the economy.After the collapse of Lehman Brothers in September2008, the Fed decided to adopt the QE which aimed to stimulate financial market and the whole economy. The Fed introduced QE1, QE2in2010and "Operation Twist" in2011, and more recently the third round of QE (QE3). US QE is carried out through purchases of mortgage backed securities, agency debt and long-term treasuries. Through this money injection, the Fed makes more money available for banks to borrow, thereby expanding the amount of money circulating in the economy, which in turn reduces long-term interest rates. It also reduces the cost and increases the availability of credit for the purchase of houses, which support housing markets and improve financial markets more generally.The US QE policy implementation has aroused concern all over the world. All emerging countries were afraid that the US QE would bring inflationary pressure to their countries through the capital outflow from the US; especially that it would appreciate their local currency against US dollar. Then, it would put their export competitiveness at risk. At the same time, the international spillovers of QE over dollarized economies are critical since those countries directly absorb the US monetary shocks through the use of US dollar in their economic circulations. So far, many studies on the effects of QE have mainly focused on dollarized countries in Latin America and ignore most dollarized economies in Asia like Cambodia. Cambodia is a highly dollarized economy and nearly all transactions in either business or daily living are in US dollars and more than95%of money deposits in banks are foreign currencies and, the majority being the US dollar. It is one of the emerging economies with the fastest growth with huge inflow of capital. Given that, Cambodia is one of the vulnerable countries which is most likely to be affected by the US quantitative monetary policy.In response to the crisis as well as to protect Cambodia from liquidity risks from the world crisis and US QE policy, the NBC has taken a few initial steps to improve liquidity management over the past several years. A new liquidity-reporting requirement for banks was introduced to better monitor developments on a day-to-day basis. The NBC has also increased the volume of cash in vault available as a contingency. The reserve requirement on foreign currency deposits was lowered by4percentage points to12percent. The reserve requirement system has been improved. Commercial bank capital has been increased. The bank assets and loans by sectors have been reclassified. The stability of exchange rate has been maintained.This particular research aims to fill up the gap. It seeks to:firstly, study whether or not the US quantitative easing has had significant impacts on Cambodian’s economy; secondly, disclose how Cambodia monetary authorities deals with negative US quantitative easing spillovers; at last propose some recommendations to Cambodia government economic agents, particularly monetary authorities to mitigate the negative effects foreign monetary policy on domestic economy. This empirical research mainly focuses on impacts of US QE policy which means it is not concerned with influences of conventional monetary policy on the Cambodian economy. In addition, it does not aim to study the details of the quantitative easing, but rather it aims at capturing its effects on such dollarized economy.This research discloses the impacts of the US quantitative easing (QE) policy on Cambodia economy by using Ordinary Least Square (OLS) approach. It takes on static model of time series analysis. It mainly focuses on QE effects on Cambodia inflation, interest rate and exchange rate. This research captures the effects of US QE policy through the Federal Reserve’s asset holdings and QE announcement. All the data incorporated in empirical studies are monthly data from January2008to September2012consisting of57observations. The macroeconomic variables included in the study are inflation rate (INF), interest rate (INT), exchange rate (EXR), mortgage backed securities holdings (MBS), long term treasuries holdings with maturity date more than one year (LTH), and QE announcement (binary variable).The empirical evidence indicates that the Fed’s MBS holdings decrease inflation rate in Cambodia while long-term treasuries and QE announcement are statistically insignificant. The sign of the coefficient tells that the increase of US MBS purchases is likely to help lower inflation rate. In other words, the QE reduces Cambodia’s inflation pressure. If the Fed purchases MBS1billion USD, it would cut off inflation in Cambodia by0.01%. Hence, to decrease monthly inflation by1%it needs100billion USD of MBS holdings a month. Yet, its effect is relatively small. Many studies claim that inflation in Cambodia is mainly subject to the oil price and food price. Cambodia inflation rate declined even before the US QE was adopted. Therefore, its absolute effect on Cambodia economy is still questionable. The finding also shows that both MBS and treasury have negative sign on interest rate. Still, the QE announcement remains statistically insignificant on interest rate. MBS and treasuries holdings lessen interest rate in Cambodia. As such, it is possible that QE would bring more investment into the country which helps accelerate the economic growth. If the fed increases MBS holdings by1000billion USD a month, the monthly interest rate will decrease about0.65%and1000billion USD in treasury securities holdings will decrease interest rate only0.25%. It shows that US QE policy has little impacts on Cambodia interest rate.Furthermore, the regression result points out that MBS leads to Cambodia Riel depreciation while treasuries and announcement of QE lead Cambodia local currency to appreciation. That is, QE bring instability to Cambodia exchange rate market. It is good to see that QE makes KHR depreciate. However, QE makes KHR appreciate as well. Since Cambodia economy is garment-export driven, currency appreciation is a significant issue. It puts Cambodia’s export competitiveness at risk. More than that, in dollarized country, USD depreciation/local currency appreciation means lower purchasing power because they use USD for their daily expense. For high income groups, currency appreciation is not a big deal. In contrast, for vulnerable groups with low USD salary, especially garment sector workers are exposed to exchange rate risk, this is a depression. It could lead to extreme poverty.In order to mitigate the risks that US monetary policy will bring to Cambodia as well as to make domestic monetary more effective, Cambodian monetary authority, National Bank of Cambodia in particular, should consider the followings. NBC should encourage de-dollarization. The main reason that QE affects Cambodia is because Cambodia uses USD, so de-dollarization will help mitigate the risks that the US brings to Cambodia. If Cambodia does not encourage her citizens to use local currency more, it will always be under US influences. De-dollarization does not only prevent Cambodia from the US monetary policy, but it also makes Cambodia monetary policy more effective. Cambodia should be prepared for large spillover from US monetary policy. The QE had brought inflationary pressure to the world financial and equity markets. During the crisis, securities market in Cambodia was not born yet, so the spillovers were not that serious on the Cambodian economy. The absence of securities market might be one of the reasons that prevented Cambodia from harmful effects of QE. NBC need to develop monetary policy instruments and make sure it has all major conventional monetary tools. Thus it can help prevent monetary influences from the US and other countries. The NBC needs to be aware of all changes as well as updated information about US monetary policies very quickly in order to design policy to protect the national economy from monetary shock’s negative spillovers.