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Business News/ Opinion / Online-views/  Emerging market central banks get it mostly right

Emerging market central banks get it mostly right

Central banks in emerging markets have focused on stability while counting on reforms for growth

Photo: Reuters Premium
Photo: Reuters

Over dinner, during the Institute of International Finance’s (IIF’s) Spring Membership Meetings in Doha, commentator Martin Wolf spoke about mature economies being in a state of “managed depression", with central banks playing a key supporting role amidst policy divergences.

The Federal Reserve is poised to start raising interest rates from record lows later this year due to the improved economic performance, albeit at a measured pace reflecting labour market concerns, low inflation and the strong dollar.

In contrast, the European Central Bank (ECB) and the Bank of Japan (BoJ) are shifting to quantitative easing to combat deflationary pressures. Against this backdrop, emerging market central banks are juggling equally complex challenges and opportunities when making policy decisions.

A key consideration is recent depreciation pressure against the dollar in most emerging markets, which brought to the fore concerns about debt servicing for companies with dollar borrowing without sufficient hedges.

A second challenge is the potential for surprises in Fed tightening to spill over into a sudden reversal in capital flows, akin to the mid-2013 taper tantrum, which could exacerbate downward currency pressures. These could be acute for large current account deficit countries with domestic-demand driven growth and/or commodity and oil exporters such as Brazil, Indonesia, Russia, South Africa and Turkey. A third driver is the need to gradually exit accommodative monetary policies as in most of Southeast Asia and Korea.

Along with these challenges, the plunge in oil and commodity prices presents emerging markets with an opportunity. With sharply falling inflation or disinflation in some countries due to the positive supply shock, monetary authorities could ease, especially where the starting point is high rates and declining core inflation, to lend a hand to growth. While falling energy costs should eventually give a boost to domestic demand, households and firms have been slow to increase spending because they are unsure whether low prices are here to stay.

The emerging market response so far has been largely appropriate. Among emerging markets able to cut rates, India is the poster child of balancing challenges and opportunities to proceed with monetary easing and achieve stronger growth. Prime Minister Narendra Modi’s energized reform programme, fiscal consolidation and sharply lower inflation have allowed the Reserve Bank of India (RBI) to cut rates, with ample room for further reductions.

Meanwhile, the dramatic current account turnaround backed by large capital inflows and gradual reforms should allow the rupee to continue to outperform its peers besides allaying concerns of currency instability due to the Fed hike expressed by the International Monetary Fund (IMF) chief, Christine Lagarde, during her recent visit to Mumbai. Along with India, China has leant towards a prudent easing stance to manage the growth slowdown. Poland and Hungary have also cut rates due to negative output gaps.

At the other end of the spectrum, Brazil, hit hard by commodity weakness along with declining confidence and political headwinds, has rightly moved to hike interest rates accompanied by other adjustment measures. Faced with a perfect storm, the Russian central bank has also had to hike amidst a sharp weakening of the ruble due to capital outflows, before its stabilization recently allowed some unwinding of policy tightening.

In the middle are Korea and Southeast Asia. While Korea has made cuts, partly in response to the weak yen-related competitiveness issues, accompanied by Thailand and Indonesia, the room is constrained by concerns about risks from prolonged low interest rates along with a still large external financing requirement in Indonesia. Meanwhile, Malaysia and the Philippines have remained on hold as monetary policy is seen to be already quite accommodative with the authorities prepared to look through temporary disinflationary conditions.

In contrast, a large emerging market with concerns about the policy response is Turkey, where, although the positive impact of lower oil prices on the current account and inflation has prompted some pull back of last year’s monetary tightening, political pressures to ease are contributing to lira weakness. South Africa has also been hit by global headwinds and structural shortcomings, and interest rates may have to be raised after the Fed moves.

In sum, while vulnerabilities remain along with divergent outcomes ranging from recession in many commodity producers to relatively buoyant expansion in Asia, the emerging market central bank response has been alert to the need to focus on macro stability while counting on more productive spending and reforms for growth. Many also have latitude for greater reserve use in the event of intensified market turbulence. The leading Asian emerging markets in particular, with current account deficits relatively contained or in surplus, low inflation and positive pull factors, are well placed to weather the challenges.

Bejoy Das Gupta is chief economist for Asia/Pacific at the Institute of International Finance, Washington DC.

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Published: 22 Apr 2015, 04:11 PM IST
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