(Bloomberg) – Central banks in emerging markets face a catch-22 where falling economic growth means they can’t maintain tight monetary conditions, but high inflation doesn’t allow them to stop either. rate hikes.
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The result is a growing risk of monetary policy error. Countries from Poland to Colombia, India to South Korea are walking a tightrope trying to figure out the exact level of borrowing costs that won’t cripple their economies but keep prices capped. to consumption. The answer is neither clear nor easy. As long as the Federal Reserve continues to hike rates and China is hobbled by Covid, policymakers in poorer countries remain at the mercy of factors beyond their control.
Emerging markets have seen an exodus of investors this year despite rising interest rates at an unprecedented pace. Local sovereign bonds have plunged the most since at least 2009, and currencies have suffered the worst annual losses since Russia defaulted in 1998. While a rebound since October has mitigated that fall, smaller economies are not only one misstep from a real monetary crisis. . Any further selling could cut off their access to capital markets and plunge them into a cost of living crisis or even an economic collapse like Sri Lanka’s.
“Policy mistakes are definitely something we need to worry about,” said Tilmann Kolb, Zurich-based emerging markets analyst at UBS Global Wealth Management, of the dilemma he sees in Central and Eastern Europe. “If you hiked rates another 25 basis points, would that sink your economy?”
Hungary was the first to learn this bitter lesson. After one of the fastest tightening cycles in the world that saw the benchmark rate jump more than 21 times in 16 months, the eastern European country paused after a decision in September. But within days it was forced back into a hawkish stance as inflation soared to its highest level since 1996 and its currency plummeted to a record low against the euro. Now the pressure is building in the opposite direction, with the economy contracting on a quarterly sequential basis and economists polled by Bloomberg predicting a recession in the first half of 2023.
Hungary’s experience is an early warning for many other emerging markets. In Eastern Europe, the Czech Republic and Poland are halfway there, as forecasts show they face an 82.5% and 67.5% probability of recession, respectively, despite the shutdown rate hikes months ago. With double-digit inflation in both countries, they may have little room to fight the downturn.
“There is a question mark as to whether Poles can stop walking,” said Amer Bisat, global head of emerging markets fixed income at BlackRock Inc. in New York. “They would like to stop walking because they are worried about the economy, but inflation is out of control.”
It is not that the temptation to suspend the tightening is entirely unjustified. Inflation has indeed shown signs of peaking in several emerging markets, especially early markets like Brazil. Slowing consumer price growth in the United States has encouraged policymakers and investors to turn their attention to growth issues. But examples like Hungary imposed a reality check; it may be too early to stop the fight against the cost of living after all.
Explosion of country risk
The dilemma resonates in distant Colombia. The nation famous for aromatic coffee, beautiful emeralds and exotic fruits could report a sixth consecutive month of consumer price tightening even as economic expansion falters. Forecasts for 2023 call for a dramatic fall in gross domestic product growth, to 1.8% from 7.5% in 2022. Political uncertainty around the new leftist government is worsening the outlook, according to Barclays Plc.
“The problem would be if the new government implements a more aggressive fiscal expansion or becomes too radical in terms of hampering investment and hydrocarbon production,” said Erick Martinez, currency strategist at Barclays. “It would increase country risk and justify higher rates for longer. This is not our base case, but it is a risk.
The enigma also extends to Asia. While the continent benefits from strong domestic demand, lower benchmark rates than other emerging regions and lower inflation, it remains vulnerable to capital outflows due to deeply negative real yields. Countries neighboring China are also sensitive to slowdowns in growth in the world’s second largest economy.
South Korea’s monetary policy board was split last month on when to end the tightening cycle. Of its seven members, three wanted to quit after another 25 basis point raise, two wanted to continue beyond that level, and one said enough had already been done. This dispersion of views underlines how difficult it is to assess a terminal rate for emerging economies when the Fed has not finished determining a peak. Meanwhile, officials dismissed premature speculation forecasts by Citigroup Inc. and Nomura Holdings for rate cuts to begin as early as mid-2023.
In India, year-on-year economic growth more than halved to 6.3% last quarter, even as consumer price growth remained above policymakers’ upper tolerance threshold. The nation lagged in rising borrowing costs and added just 190 basis points to its repurchase rate. This leaves room for further tightening, but could undermine its growth ambitions. The Reserve Bank of India’s policy trajectory beyond a softer rise in December is a draw.
All in all, the clamor for a break in rates is only intensifying in emerging markets, underscoring a fatigue with up cycles. For example, in Poland, the latest data showed a weaker reading for the first time in eight months, and the case for ending the tightening immediately resurfaced.
“The scope for further rate hikes is narrow, but a firm commitment to leave rates unchanged at a time of high inflationary pressure seems premature and inflexible,” wrote Dan Bucsa, UniCredit SpA’s chief economist for Central Europe. and oriental, in a note. “Central banks are committing to ending rate hikes too soon.”
What to watch this week:
Bloomberg TOPLive: EM Turbulence: What’s in Store for 2023 on December 6 at 2:00 p.m. London time, where reporters discuss all things emerging markets and answer questions. Send your questions in advance to TOPLive@bloomberg.net
South Africa’s political drama could go on for days as President Cyril Ramaphosa resists calls to resign over potential constitutional violations linked to the theft of $580,000 stashed from a game farm that he owns
Inflation data releases: China, Taiwan, Thailand, Philippines, Turkey, Russia, Egypt, Colombia, Brazil, Mexico, Chile
Gross Domestic Product: South Africa
Purchasing managers index: China, India, Russia, South Africa, Egypt, Brazil
Interest rate decision: India, Brazil, Peru, Chile
–With help from Selcuk Gokoluk and Maria Elena Vizcaino.
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