EDITORIAL: Central bank walking tightrope

Taiwan’s financial market has undergone a significant liquidity squeeze, with many banks raising loan rates to new highs, and local media reporting that several banks were extending approval periods, reducing loan amounts or rejecting loan applications. Where did the money go? Are monetary authorities ensuring that banks maintain adequate liquidity? Some experts attributed the changes to large-scale foreign fund outflows as overseas investors repatriated stock gains and dividends, while others cited the widening interest rate differential between the US and Taiwan, making some exporters more willing to hold US dollars than convert to New Taiwan dollars.

However, some analysts pointed to the artificial intelligence (AI)-driven economic boom as the reason it has become more difficult for individuals and businesses to apply for mortgages, loans and corporate financing. As large technology companies have an urgent need for capital expenditures and financing for AI projects, they are borrowing from banks or raising funds in the open market, leading to tighter liquidity and higher funding costs in the financial system, which has in turn caused banks to prioritize funding for tech firms over traditional industries and small and medium-sized enterprises (SMEs).

Of course, booming stock market investment also absorbed market liquidity to a certain degree, as official data showed margin financing and securities account balances continued to hit new highs in the past few months. That explained why a key consideration in the central bank’s decision to keep policy interest rates unchanged at its quarterly board meeting on Sept. 17 was signs of tighter liquidity in the financial system; it would not want to make the situation worse by raising rates. While policymakers say market liquidity remains sufficient, analysts see the liquidity issue as an ongoing trend following a “death cross” between two major money supply gauges for two consecutive months.

In July, the M1B, a narrow measure of money in circulation, including cash and savings deposits, rose 7.34 percent from the previous year, while the broader M2 measure, which includes M1B, time deposits, foreign currency deposits and mutual funds, increased 7.42 percent year-on-year, resulting in the first “death cross” in four years, central bank data showed. M1B last month rose 6.65 percent from a year earlier, which was again smaller than M2’s 6.79 percent annual increase, the central bank reported on Wednesday last week. The death cross between the two money supply gauges occurs when people put cash away and choose the safety of time deposits, which signaled tighter liquidity in the market, experts said.

Loan rates have climbed steadily as deposit growth at banks fails to keep up with the pace of lending demand, and banks have become more stringent in extending credit as they prioritize larger or high-asset clients. For businesses, cash flow is key to building factories, purchasing equipment and raw materials, and paying their employees. Once banks raise rates and reduce credit lines amid a shrinking liquidity pool, it would affect firms’ product prices and profits. If businesses postpone factory expansion, reduce investment, slow recruitment or even re-evaluate bonuses and workforce allocation, what initially appears to be a funding issue between banks and businesses would trickle down to employees and customers.

Given uneven economic development and uneven capital allocation among local industries, the central bank has continued to use quantitative tools and monetary operations rather than interest rates to manage money supply conditions and contain liquidity expansion, while avoiding greater harm to interest-sensitive industries and vulnerable mortgage borrowers. If the central bank keeps rates unchanged longer than expected, it could create market expectations that it is in no hurry to raise rates.

However, if such expectations take hold and inflation rises again, the cost for the central bank to unwind the situation could be much greater. That puts the central bank in an awkward position.

As businesses and individuals face higher funding costs and tighter credit standards, the central bank must exercise monetary policy to control inflation while addressing the liquidity issue.

In the short term, foreign fund flows and local exporters’ US dollar holdings are the two main factors in determining whether market liquidity would become more ample. In the long term, it requires interagency coordination within the government to facilitate funding access for companies in need, especially traditional industries and SMEs.