(Bloomberg) — Emerging market central banks face a Catch-22, where falling economic growth means they can’t keep monetary conditions tight, but high inflation keeps them from holding back interest rate hikes.
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The result is an increased risk of a monetary policy error. Countries from Poland to Colombia, India to South Korea are trying to figure out the exact level of borrowing costs that won’t cripple their economies but keep consumer prices under wraps. The answer is not clear or easy. As long as the Federal Reserve continues to raise rates and China is rattled by Covid, policymakers in poor 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. Domestic sovereign bonds fell the most since at least 2009, and currencies suffered their worst annual losses since Russia’s default in 1998. While the upturn since October has softened this downturn, smaller economies are only one step away from a full-blown currency crisis. . Any subsequent sell-off could cut off their access to capital markets and push them into a cost-of-living crisis or even an economic collapse like Sri Lanka.
Tilmann Kolb, Zurich-based emerging markets analyst at UBS Global Wealth Management, said of the dilemma he sees in central and eastern Europe: “Policy error is definitely something we have to worry about. “If you raise interest rates another 25 basis points, will that sink your economy?”
Hungary was the first to learn this bitter lesson. After one of the world’s fastest tightening cycles, which saw the benchmark rate rise more than 21 times in 16 months, the Eastern European country paused after a move in September. But within days, it was forced to regain its hawkish stance, with inflation hitting its highest level since 1996 and its currency falling to a record low against the euro. Now, the economy has been contracting consistently every quarter, and the pressure is building in the opposite direction, with 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. Within Eastern Europe, both the Czech Republic and Poland are halfway there, as forecasts show they face an 82.5% and 67.5% probability of recession, respectively, despite having stopped raising interest rates months ago. With inflation hovering in the double digits in both countries, they may have little room to fight the slowdown.
“There is a question mark over whether the Poles can stop the hike,” said Amer Bisat, global head of emerging markets fixed income at BlackRock Inc. in New York. “They want to stop the hikes because they are worried about the economy, but inflation is not under control.”
This is not to say that the desire to stop tightening is completely unfounded. Inflation has indeed shown signs of peaking in a number of emerging markets, particularly early adopters such as Brazil. Easing consumer price inflation in the US has emboldened policymakers and investors to focus on growth concerns. But examples like Hungary applied a reality check; it may be too early to stop fighting the cost of living.
Exploding Country Risk
The dilemma is echoed in distant Colombia. The country known for aromatic coffee, delicate emeralds and exotic fruits may report a sixth straight month of firming in consumer prices, even as the economic expansion eases. Projections for 2023 call for gross domestic product growth to drop dramatically to 1.8% from 7.5% in 2022. According to Barclays Plc, policy uncertainty surrounding the newly formed Left government is weighing on the outlook.
“The challenge will be whether the new government implements more aggressive fiscal expansion or is too radical in terms of curbing investment and hydrocarbon production,” said Eric Martinez, currency strategist at Barclays. “This will increase country risk and guarantee higher rates for longer. This is not our main business, but it is a risk.”
The madness is spreading to Asia. While the continent is blessed with strong domestic demand, lower benchmark rates and softer inflation than other emerging market regions, they remain vulnerable to capital outflows due to deeply negative real incomes. China’s neighbors are also vulnerable to growth hiccups in the world’s second-largest economy.
South Korea’s monetary policy council last month disagreed on when to end the tightening cycle. Three of its seven members wanted to stop after another 25 basis point increase, two wanted to continue beyond that level and one said enough had been done. This scattering of views underscores how difficult it is to gauge the ultimate rate for emerging economies when the Fed has yet to set a peak. Meanwhile, officials at Citigroup Inc. and rejected Nomura Holdings’ premature speculation that interest rate cuts would begin in mid-2023.
India’s annual economic growth more than halved to 6.3% in the last quarter, even as consumer price inflation remained above policymakers’ upper tolerance level. The country lagged behind in raising borrowing costs, adding just 190 basis points to its repo rate. That leaves room for further tightening, but could undermine its growth ambitions. The Reserve Bank of India’s policy path away from a softer hike in December is a coin toss.
All told, the noise of a rate cut is getting louder in emerging markets, highlighting fatigue with hiking cycles. In Poland, for example, the latest data showed a softer reading for the first time in eight months, and arguments for an end to tightening suddenly resurfaced.
Dan Bucsa, chief economist for central and eastern Europe at UniCredit SpA, wrote in a note: “The scope for further rate hikes is narrow, but a strong commitment to keep rates unchanged at a time of high inflationary pressure appears premature and inflexible.” “Central banks commit too quickly to stop interest rate increases.”
What to watch this week:
Bloomberg TOPLive: EM Turbulence: What’s in Store for 2023 on December 6 at 2pm London time, where journalists discuss all things emerging markets and answer questions. Send your questions in advance to TOPLive@bloomberg.net
South Africa’s political drama could drag on for days as President Cyril Ramaphosa resists calls to resign over potential constitutional violations over the theft of $580,000 hidden on a game farm he owns.
Inflation data: 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 decision: India, Brazil, Peru, Chile
–With assistance from Selcuk Gokoluk and Maria Elena Vizcaino.
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