STRAIN BUILDING FOR SOME EMERGING MARKET CENTRAL BANKS / THE WALL STREET JOURNAL

Strain Building for Some Emerging Market Central Banks

By Jon Hilsenrath
 

China, the U.S. and Europe are stealing many of the economics headlines in 2015 with China’s economic slowdown and currency devaluation, an impending interest rate increase in the U.S. and Greece’s perpetual fiscal crisis. Perhaps, however, it is time to look beyond these three large economic forces to the challenges building among the broad array of emerging markets around them.

Their economies aren’t growing very fast, in part because of the slowdown in China, a major consumer of their goods and services. At the same time, they face limits on what they can do to provide stimulus because of the Fed’s move toward raising interest rates. If they cut interest rates to boost their domestic economies when the Fed is moving toward raising rates, they face a risk of investment outflows and currency instability. If they don’t respond, they run the risk of even worse growth outcomes.

In an interview with my Wall Street Journal colleague Ryan Tracy last week, Augustin Carstens, governor of the Bank of Mexico, pointed to the dilemma.

“Mexico is growing below its potential and therefore we have a negative output gap, and that, together with the monetary policy that we have conducted, has allowed us to not only comply with our objective, which is 3% inflation, but to have an inflation below our objective. Right now our inflation is 2.76%, so that is quite comfortable.” Despite slow growth and low inflation, however, he has been talking about raising interest rates, not cutting them.

“We have prepared ourselves to pretty much adjust interest rates when (U.S.) liftoff takes place, but if the conditions in the peso market require, we can act ahead of the Fed,” he said.

In a recent research report, J.P. Morgan economist Bruce Kasman shows how this isn’t just a problem for America’s southern neighbor.

“First-half global growth disappointed broadly, but it is the weakness in (emerging market) domestic demand that has represented the central shock to the global economy this year,” Mr. Kasman said.

Domestic demand in emerging economies (which comes from consumer spending and in-country investment, as opposed to trade) grew at a pace of less than 2% in the first half of the year, Mr. Kasman estimated. That is half of last year’s pace and less than the pace in developed economies. In an email exchange he pointed to second quarter contractions in Brazil, Russia, Singapore, Thailand, Taiwan and Chile. South Africa is estimated to have been flat.

China’s devaluation now gives emerging market central banks an incentive to let their own currencies depreciate. But they quickly expressed trepidation about taking this too far.

A Bank of Korea official reminded my Wall Street Journal colleague Kwanwoo Jun that a too-weak won could lead to capital flight. “A weaker yuan is not a simple but a complex issue that can have simultaneously conflicting ramifications on Korea. We will keep an eye on it,” the official said.

Bank Indonesia’s senior deputy governor, Mirza Adityaswara, said the yuan devaluation won’t lead to greater weakness as the country’s currency, the rupiah, is already trading at 17-year lows and is undervalued.

Mr. Kasman notes that monetary authorities in South Africa have hiked rates to stem a pass-through from foreign exchange depreciation to inflation and sees similar pressures to stabilize the currency and inflation in Russia, Colombia and Chile.

In short, China’s slowdown and U.S. liftoff could lead to a failure to launch in much of the rest of the world.