Global Investing

Interest rates in emerging markets – - harder to cut

February 9, 2012

Emerging market central banks and economic data are sending a message — interest rates will stay on hold for now.  There are exceptions of course.

Indonesia cut rates on Thursday but the move was unexpected and possibly the last for some time. Brazil has also signalled that rate cuts will continue.  But South Korea and Poland held rates steady this week and made hawkish noises. Peru and Chile will probably do the same.

The culprit that’s spoiling the party is of course inflation. Expectations that slowing growth will wipe out remaining price pressures have largely failed to materialise, leaving policymakers in a bind. Tensions over Iran could drive oil prices higher. Growth seems to be looking up in the United States.

On top of that, all the major central banks in the developed world are intent on flooding the world economy with cash and some of it will inevitably make its way to emerging nations. So while economies could do with a good dose of policy easing, most central banks cannot afford to let their guard down on inflation.

Take China where January inflation came in well above expectations on Thurday, with food prices up 10.5 percent on the year. Expect no cuts to the policy rate this year, warn analysts at RBC. Over in Seoul, Bank of Korea governor Kim Choong-soo said policymakers needed to be “on alert” for inflation risks and described inflation expectations as “considerably  high.” The verdict from Barclays:

Taken together these comments reflect a tilt in concern towards inflation.

Most central banks in emerging Europe never had much room to cut rates anyway, exposed as they are to the euro zone malaise. But as my colleague Emily Kaiser wrote a week back, policy easing bets in Asia are also being trimmed.

Data from Latin America indicates central banks there may pause their rate cut cycle as well.  In Brazil, which has led the emerging policy easing camp in this cycle, inflation has fallen for the fourth month in a row but ended 2011 at a seven-year high and is expected around 5.3 percent this year, well above the mid-point of the central bank’s target band. Still, it probably has more room to ease than Mexico where growth is sluggish but inflation is still on the rise. Latest data in Chile also showed price growth above the central bank’s tolerance level.

What might central banks do then? A year ago, they resorted to some unconventional tools, including raising banks reserve ratio requirements (RRR) to stem money and loan growth. Back then, they were battling inflation yet were reluctant to raise interest rates that would drive up currencies.

This time, they may cut reserve ratios – India and China have already done so and some analysts are predicting up to 100 basis points in Chinese RRR cuts by mid-year. Those countries that are in a position to loosen the purse strings will do so. Brazil has already embarked on higher spending to meet a rather ambitious 4 percent growth target for 2012. And Korea has approved a 5 percent spending boost for 2012, front-loaded to the first half of the year.

Finally, central banks may also look more kindly on currency appreciation. Most emerging currencies are up 7-10 percent this year against the dollar and stronger currencies will limit the pass-through from any oil price spike.

Post Your Comment

We welcome comments that advance the story through relevant opinion, anecdotes, links and data. If you see a comment that you believe is irrelevant or inappropriate, you can flag it to our editors by using the report abuse links. Views expressed in the comments do not represent those of Reuters. For more information on our comment policy, see http://blogs.reuters.com/fulldisclosure/2010/09/27/toward-a-more-thoughtful-conversation-on-stories/