Photograpehr: Mark Bowden

Central Banks Run in Place as Inflation Slide Outpaces Rate Cuts

Emerging market central banks can’t cut interest rates fast enough.

Real rates -- benchmarks minus inflation -- are higher now than they were at the start of the year in South Korea, Poland and Israel despite easier monetary policy, according to Bloomberg data.

India’s has barely changed, while China’s is just half a percentage point lower. South Africa’s real rate is also higher having resisted easing.

With Mexico and Russia potentially loosening again this week, central banks in developing nations face the risk that so long as real rates keep rising, the inflation and expansion they want to encourage will be inhibited.

“Emerging-market monetary conditions have actually become tighter over the last six months and there has been little support for growth,” Morgan Stanley economists Manoj Pradhan and Patryk Drozdzik told clients in a report last week.

What may be happening is such central banks are seeking to provide some support for their economies without kick-starting a surge in credit growth that could ultimately do more damage than a dose of weak inflation, Pradhan and Drozdzik wrote.

Monetary Accommodation

They gave three reasons for such an approach.

First, credit ballooned in emerging markets following the global financial crisis of 2008, raising concerns of a misallocation of capital that undermines their economies today.

Secondly, policy makers may only want to do enough to offset the disinflation from abroad in the form of lower oil prices and weak demand rather than spur domestic inflation.

Thirdly, the Federal Reserve’s pending interest-rate increases may mean they are forced to raise borrowing costs too so as to prevent sharp declines in their currencies again. Better not to cut rates now only to reverse in a few months.

The risk is that by not being more aggressive those economies currently suffering from weak inflation will face even harsher disinflationary forces, making debts harder to manage. Those at threat include China, South Korea, Israel and central and eastern European nations, according to Morgan Stanley. India may suffer weaker growth than it wants.

“Far from generating enough monetary accommodation to promise high future inflation to bring real interest rates down today, central banks are allowing falling inflation to tighten the monetary stance by raising real rates,” said Pradhan and Drozdzik.

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