Fed’s shift is temporary boon for emerging market central banks - Hindustan Times
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Fed’s shift is temporary boon for emerging market central banks

ByBloomberg | Posted by Kanishka Sarkar
Aug 31, 2020 07:18 AM IST

Unlike the Fed, central banks in developing markets can’t allow inflation to run hot without triggering capital flight and currency turmoil. Food-price spikes are already a problem in countries like India and Turkey.

The Federal Reserve’s move to an extended era of low interest rates offers an opportunity for emerging economy central banks to do the same.

Investors are looking for more than dovish comments from Fed chairman Jerome Powell to keep the rally going.(AP File Photo)
Investors are looking for more than dovish comments from Fed chairman Jerome Powell to keep the rally going.(AP File Photo)

While the impact will vary by country, lower for longer US interest rates and a weaker dollar will boost emerging market assets and take pressure off monetary authorities to raise interest rates in order to protect their currencies or to attract foreign capital.

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Yet with several economies still saddled with high inflation and volatile currencies, there’s limited scope for developing markets to be as accommodative as the Fed.

“The Fed has bought some room for the emerging markets,” former Indian central banker Raghuram Rajan told Bloomberg Television’s Kathleen Hays. “But that doesn’t mean they have a license to do exactly what the Fed did, they don’t have that much room.”

The Fed’s shift to a new monetary policy approach -- implying interest rates could remain low for years to come -- allows central bankers in the developing world to keep borrowing costs low as they try to nurse a fragile economic recovery amid the coronavirus pandemic.

Low US rates and a weaker dollar have already stemmed a tide of capital outflows and drawn foreign investors back into emerging markets. The Bloomberg dollar index is down almost 10% since its March high, while the MSCI Emerging Markets Index of equities reclaimed its Dec. 31, 2019 level on Aug. 25, aided by a more than 40% rebound since the March rout. ​

But investors are looking for more than dovish comments from Fed chairman Jerome Powell to keep the rally going.

Unlike the Fed, central banks in developing markets can’t allow inflation to run hot without triggering capital flight and currency turmoil. Food-price spikes are already a problem in countries like India and Turkey.

Another reason for caution is that the global economic recovery will still require fiscal support and a medical solution to the virus, not just monetary stimulus, said Benjamin Diokno, governor of the Philippine central bank.

“It is in the interest of every jurisdiction that there is a coordinated solution to this unprecedented crisis,” he said.

Tai Hui, chief Asia market strategist at JPMorgan Asset Management, said a weaker dollar hasn’t proven to be a tonic for economies including India, Turkey and Argentina, and only those countries with strong fundamentals will benefit.

“It might not be a panacea for domestic structural weaknesses,” he said.

Weaker Dollar

Still, emerging markets are in a more comfortable position if interest rates in developed markets remain low.

Pacific Investment Management Co. says the dollar’s decline has only just started. While the greenback has dropped against major peers, it’s still up about 2% on a trade-weighted basis and stronger than its average in 2019, suggesting further scope to weaken against emerging economy peers.

Economists argue that a backdrop of a weaker dollar and firmer local currencies should mean inflation remains relatively subdued, allowing emerging economy central banks to stick with low rates.

“The Fed’s shift will give EM central banks some breathing room as typically interest rate differentials and their currency implications play a key role in monetary policy decisions,” said Tuuli McCully, the Singapore-based head of Asia Pacific economics at Scotiabank.

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