London: Pressure is building for interest-rate cuts that could push emerging economies into a quagmire of runaway inflation and currency weakness.
That’s because average real yields in emerging markets may have already turned negative, if first-quarter inflation projections are any indication. Even bigger economies such as India, Taiwan and Turkey offer bond returns below price growth, leaving little room for borrowing costs to fall further.
The clamor for poorer nations to mimic the Federal Reserve in combating the coronavirus impact may be misplaced for two reasons. Unlike the U.S. or Europe, most developing nations are seeing an increase in inflation, making rate hikes a more appropriate response. Also, these nations have a poor record of converting rate cuts into economic growth — the problem of monetary transmission.
Easing expectations have sent developing-nation stocks toward the biggest weekly gain since November 2018 and currencies into the best week this year. But average bond yields have fallen to a record low, while inflation is seen at the highest level since 2014. This would be the first time in more than three years that real rates are negative, and underscores the lowest investor returns in more than a decade.
A further erosion of these returns could spark a currency selloff and the fight against inflation would be lost before it began.
The following countries have seen their inflation-adjusted benchmark rates flip to negative, or close, in the past six months:
India
Even before the coronavirus, growth in the south Asian nation had slowed down amid falling consumer demand, rural distress and a shadow-banking crisis. Rate cuts totaling 135 basis points did nothing to arrest the slide. A surge in inflation for December, initially dismissed by some economists as a one-off shock, continued in January, rising to the highest level in Prime Minister Narendra Modi’s six years in office.
Even cheaper oil may not reduce inflation as domestic pump prices aren’t falling as fast as international crude prices, and a weaker rupee is contributing too.
Turkey
President Recep Tayyip Erdogan, who believes rate cuts reduce inflation, is seeing that idea challenged after price growth accelerated for four successive months on the back of 1,325 basis points of rate cuts. Turkey’s refugee crisis has added to the pressure on local assets and the country is firmly in the negative real-rate regime despite double-digit yields on 10-year sovereign securities.
Taiwan
Taiwan’s 10-year yield fell to a record low after a debt auction, pushing inflation-adjusted returns lower. Economic growth is projected to slow for a third successive year even though faster price growth may return.
Kenya
Inflation quickened in February after a slight cooling in the previous month as unseasonal rain destroyed harvests and fuel prices rose. The country’s problems vary from rising food prices to a threat to agricultural output from a locust invasion. Meanwhile, the central bank’s decision to increase foreign reserves has already undermined the shilling.
Thailand
A World Bank report this week showing an increase in Thailand’s poverty rate and inequality came with the caution that any further weakening of the economy may hurt households. Inflation isn’t a problem yet, and the impairment to its tourism industry from virus concerns may support the case for rate cuts. But yields are already at record lows and foreign investors are taking out money.
Lebanon
The government must honor a $1.2 billion debt repayment on Monday but is yet to give a firm commitment it will do so. A partial restructuring is being considered which may see at least foreigners being paid off. However, investor confidence beyond the March 9 deadline will depend on the nation’s economic health and its ability to contain public anger about falling living standards.
Lebanon has seen the most dramatic drop in real rates over the past six months, from 8.55% to a slightly negative number. The pound is overvalued, according to the International Monetary Fund. A large current-account deficit (20% of gross domestic product) is adding further pressure on the currency peg.
Brazil
The effect of ill-timed rate cuts is already spooking investors. Brazil, whose real rates have fallen close to zero from a robust 2.78% in September, has seen its currency plunge to an unprecedented 4.6 per dollar. That cements the real’s place as the world’s worst performer this year, after the central bank opened the door for further easing.- Bloomberg
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