(Bloomberg) – Central banks in emerging markets are facing a catch-22, where slumping economic growth means they can’t keep monetary conditions tight, but elevated inflation doesn’t allow them to halt interest rate hikes either.
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The result is a growing risk of monetary policy errors. Countries from Poland to Colombia, from India to South Korea are walking a tightrope trying to figure out the exact cost of borrowing that will not cripple their economies but keep consumer prices in check. The answer is not clear or simple. As long as the Federal Reserve keeps raising interest rates and China is hampered 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 raising interest rates at an unprecedented pace. Local government bonds have fallen the most since at least 2009 and currencies have suffered their worst annual losses since Russia’s 1998 default. While a recovery since October has mitigated that slump, smaller economies are one misstep away from a full-blown currency crisis. Any further sell-off could bar them from accessing capital markets and push them into a cost-of-living crisis or even an economic meltdown like Sri Lanka’s.
“Political mistakes are certainly something to worry about,” said Tilmann Kolb, emerging markets analyst at UBS Global Wealth Management in Zurich, of the dilemma he sees in Central and Eastern Europe. “If you raised interest rates by another 25 basis points, would that collapse your economy?”
Hungary was the first to learn this bitter lesson. After one of the world’s fastest tightening cycles, with interest rates doubling more than 21 times in 16 months, the eastern European country paused following a move in September. But within days it was forced to adopt a hawkish stance as inflation soared to its highest level since 1996 and its currency plummeted to record lows against the euro. Now pressure is building in the opposite direction as the economy shrinks for quarters in a row and economists polled by Bloomberg forecast a recession in the first half of 2023.
The story goes on
Hungary’s experience is an early warning for many other emerging markets. Within Eastern Europe, both the Czech Republic and Poland are halfway as forecasts show they face an 82.5% and 67.5% chance of recession, respectively, despite halting rate hikes months ago. With inflation hovering in the double digits in both countries, they may have little leeway to combat the slowdown.
“It is questionable whether Poles can stop migrating,” said Amer Bisat, global head of emerging markets fixed income at BlackRock Inc. in New York. “They would like to stop hiking because they are worried about the economy, but inflation is not under control.”
It’s not as if the temptation to pause tightening is entirely unwarranted. Indeed, inflation has shown signs of peaking in several emerging economies, particularly in early migrants like Brazil. Slowing consumer price growth in the US has encouraged policymakers and investors to turn their attention to growth concerns. But examples like Hungary have imposed a reality check; it might be too early to stop fighting the cost of living.
Exploding country risk
The dilemma echoes in distant Colombia. The nation famous for aromatic coffee, fine emeralds and exotic fruits has reported a sixth straight month of tougher consumer prices even as economic expansion falters. Forecasts for 2023 call for a dramatic decline in gross domestic product growth from 7.5% in 2022 to 1.8%. Political uncertainty surrounding the newly formed left-wing government worsens the outlook, according to Barclays Plc.
“The problem would be that the new administration will undertake more aggressive fiscal expansion or become too radical in terms of stymieing investment and hydrocarbon production,” said Erick Martinez, currency strategist at Barclays. “That would increase sovereign risk and justify higher interest rates for longer. It’s not our base case, but it’s a risk.”
The mystery is also spreading to Asia. Although the continent is blessed with strong domestic demand, interest rates lower than other emerging markets and weaker inflation, they remain vulnerable to capital outflows due to sharply negative real yields. Countries in China’s neighborhood are also sensitive to growth problems in the world’s second largest economy.
South Korea’s monetary policy board was at odds last month over when to stop the tightening cycle. Of the seven members, three wanted to exit after another 25 basis point rise, two wanted to continue beyond that level and one said enough had already been done. This dispersion of opinion underscores the difficulty of estimating a definitive rate for emerging markets when the Fed isn’t done picking a top. Meanwhile, officials dismissed forecasts by Citigroup Inc. and Nomura Holdings for rate cuts set to begin as early as mid-2023 as premature speculation.
In India, economic growth more than halved from a year earlier to 6.3% in the most recent quarter, although consumer price growth remained above the upper limit of policymakers’ tolerance. The nation has lagged behind in raising borrowing costs and has increased its repurchase rate by just 190 basis points overall. That leaves room for further tightening but could undermine its growth ambitions. The Reserve Bank of India’s policy path beyond a softer rate hike in December is a coin toss.
All in all, the clamor for a rate pause is only getting louder in EM, underscoring the fatigue from hiking cycles. In Poland, for example, the latest data showed weaker reading for the first time in eight months and the case for an end to tightening resurfaced immediately.
“The scope for further rate hikes is limited, but a strong commitment to leave rates unchanged in times of high inflationary pressures appears premature and inflexible,” wrote Dan Bucsa, UniCredit SpA’s chief economist for Central and Eastern Europe, in a statement. “Central banks commit too early to end rate hikes.”
What to watch this week:
Bloomberg TOPLive: EM Turbulence: What’s in Store for 2023 on 6 December at 2pm London time, where journalists will discuss all things Emerging Markets and answer questions. Send questions to [email protected] in advance
South Africa’s political drama could continue for days as President Cyril Ramaphosa defies calls to resign over possible constitutional violations over the theft of $580,000 hidden on a game farm he owns
Inflation data released: 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
Rate decision: India, Brazil, Peru, Chile
–Assisted by Selcuk Gokoluk and Maria Elena Vizcaino.
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