Emerging Monetary Divergence

  • Emerging Monetary Divergence
  • When It Comes To Debt, How Long is Too Long?
  • “Soft” Data versus “Hard” Data

Over the last decade, a combination of unprecedented global financial integration and unconventional monetary policy in global financial centers created new challenges for central banks in emerging markets (EM). Faced with the ebbs and flows of capital that followed changes in the monetary stance at the U.S. Federal Reserve, EM monetary policy makers were forced to align their stances with the U.S. to avoid violent currency moves or financial instability.

Often, this defensive posture ran counter to the needs of their domestic economies. This was acutely visible during the so-called “taper tantrum” during the summer of 2013, when Federal Reserve Chairman Ben Bernanke hinted at reductions in the Fed’s asset purchases. The remarks prompted an outflow of capital from EMs. Central banks from India to Brazil reacted by tightening monetary conditions to stem the flight of capital, despite fairly tepid domestic economic activity.

So as the Fed promises to reduce its balance sheet and deliver a total of 3-4 interest hikes this year, and speculation continues about tapering asset purchases by the European Central Bank, one might have expected EM central banks to follow suit and become more restrictive. But they haven’t—and they won’t. Times have changed.

Among major EMs, many are either expected to cut policy rates (Russia, Brazil, Chile and Colombia) or hold steady (including South Africa, India and Korea). Exceptions are Hungary, Malaysia, Turkey and Mexico, where either inflation remains high or politics are weighing on the currency.

A number of factors are driving the divergence in monetary policy between developed and developing nations.

    • Oil is expected to trade in a fairly narrow band of $45-$55 per barrel in the near future, comparable to its price a year ago. (During the taper tantrum era, oil was on its way up from $80 per barrel to $110 per barrel.) This keeps price pressures in check through both the direct impact on energy costs and the second order effect on core prices. More importantly, it keeps current account and fiscal balances in check in oil importing EMs, and economic activity subdued in oil exporting EMs. All of these allow central banks to keep policy accommodative or neutral.

    • The taper tantrum was in large part a reaction to an unanticipated shift in the Fed’s tone. It prompted the unwinding of excesses that had built up in the global financial system since the financial crisis and forced EM central banks to hike rates to halt capital flight. However, as we noted last year, the global economy has been in the process of self-correction and rebalancing since then. Current account deficits are narrower, external buffers are more robust and policy stances are typically much more prudent. Furthermore, the Fed has taken great care over the last year to move with care and preview its intentions carefully.