Inflation outpaces rate cuts in emerging market economies - Analysis

Inflation outpaces rate cuts in emerging market economies - Analysis

28 April 2015, 13:15

According to the data compiled by Bloomberg, real rates (benchmarks minus inflation) in South Korea, Poland and Israel are now higher than they were at the start of the year.

China’s is just half a percentage point lower, while India's has hardly changed. South Africa’s real rate is also higher having resisted easing and Mexico and Russia potentially loosen again this week.

Central banks in developing nations currently face the risk that so long as real rates keep rising, the inflation and expansion they want to encourage will be capped.

“Emerging-market monetary conditions have actually become tighter over the last six months and there has been little support for growth,” Morgan Stanley economists Manoj Pradhan and Patryk Drozdzik told clients in a report last week.

Analysts write that such central banks may seek to provide some support for their economies without kick-starting a surge in credit growth that could ultimately do more damage than a dose of weak inflation.

Three reasons for such an approach were given:

1) Credit ballooned in emerging markets following the global financial crisis of 2008, raising concerns of a misallocation of capital that undermines their economies today.

2) Policy makers may only want to do enough to offset the disinflation from abroad in the form of lower oil prices and weak demand rather than spur domestic inflation.

3) The US central bank’s pending interest-rate increases may mean they are forced to raise borrowing costs too so as to prevent steep drops in their currencies again. Better not to cut rates now only to reverse in a few months.

Those economies, suffering from weak inflation, will face even harsher disinflationary forces, making debts harder to manage, if they are not more aggressive. Those at risk include China, South Korea, Israel and central and eastern European nations, according to Morgan Stanley.

India may suffer weaker growth than desirable.

“Far from generating enough monetary accommodation to promise high future inflation to bring real interest rates down today, central banks are allowing falling inflation to tighten the monetary stance by raising real rates,” said Pradhan and Drozdzik.

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