Emerging Policy: Rate cuts proliferate

October 11, 2012

Emerging market central banks have clearly taken to heart the recent IMF warning that there is “an alarmingly high risk”  of a deeper global growth slump.

Two central banks have cut interest rates in the past 24 hours: Brazil  extended its year-long policy easing campaign with a quarter point cut to bring interest rates to a record low 7.25 percent and the Bank of Korea (BoK) also delivered a 25 basis point cut to 2.75 percent.  All eyes now are on Singapore which is expected to ease monetary policy on Friday while Turkey could do so next week and a Polish rate cut is looking a foregone conclusion for November.

South Africa, Hungary, Colombia, China and Turkey have eased policy in recent months while India has cut bank reserve ratios to spur lending.

The BoK’s explanation for its move shows how alarmed policymakers are becoming by the gloom  all around them. Its decision did not surprise markets but its (extremely dovish) post-meeting rhetoric did.  The bank said both exports and domestic demand were “lacklustre”.  (A change from July when it admitted exports were flagging but said domestic demand was resilient) But consumption has clearly failed to pick up after July’s surprise rate cut — retail sales disappointed even during September’s festival season.  BoK clearly expects things to get worse: it noted that ” a cut now is better than later to help the economy”.

Analysts argue that more EM central banks could and should cut interest rates.  After all, developed rates are rock bottom and falling (Australia cut rates last week and Japan is expected to ease policy again at the end of October). ING’s chief EEMEA economist Simon Quijano-Evans urges central banks in emerging Europe, especially Poland, to follow the example of Brazil and Korea. He notes:

The old argument of having high real interest rates as a risk premium simply doesn’t hold under current global conditions.

But how effective are these rate cuts? In Brazil’s case, not very so far. Despite 525 bps of rate cuts since July last year, growth this year will be 1.6 percent according to the central bank (versus the previous forecast of 2.5 percent) — that’s less that G7 nations such as the United States, Japan and Canada. In Korea, the hope is that lower rates will stimulate domestic spending and help the debt-burdened household sector. But the country’s high reliance on exports (53 percent of the economy, according the World Bank)  makes it unlikely that growth can be significantly lifted. The BoK  in fact acknowledged a worsening growth picture, cutting 2012 and 2013 GDP forecasts even more aggressively than the IMF did.

Still, forward rate (FRA)  markets are predicting more easing almost everywhere. South Korea, Turkey and South Africa are priced for 25 bps rate cuts in the next 3-6 months while a half point easing is expected in Poland and Hungary, analysts at Society Generale point out.

Not everyone is in rate-cutting mode, however, which goes to show what a differentiated asset class emerging markets have become.

Indonesia held interest rates steady on Thursday. With the economy expected to expand by up to 6.5 percent this year and loan growth running at over 20 percent, it could actually raise rates in coming months. Serbia’s surging inflation forced the central bank to raise rates this week while Russia stunned with a rise last month, also citing  inflation. FRAs are pricing one more quarter point rate rise in Russia.






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