Emerging Policy: Rate cuts proliferate
Emerging market central banks have clearly taken to heart the recent IMF warning that there is “an alarmingly high risk” of a deeper global growth slump.
Two central banks have cut interest rates in the past 24 hours: Brazil extended its year-long policy easing campaign with a quarter point cut to bring interest rates to a record low 7.25 percent and the Bank of Korea (BoK) also delivered a 25 basis point cut to 2.75 percent. All eyes now are on Singapore which is expected to ease monetary policy on Friday while Turkey could do so next week and a Polish rate cut is looking a foregone conclusion for November.
South Africa, Hungary, Colombia, China and Turkey have eased policy in recent months while India has cut bank reserve ratios to spur lending.
The BoK’s explanation for its move shows how alarmed policymakers are becoming by the gloom all around them. Its decision did not surprise markets but its (extremely dovish) post-meeting rhetoric did. The bank said both exports and domestic demand were “lacklustre”. (A change from July when it admitted exports were flagging but said domestic demand was resilient) But consumption has clearly failed to pick up after July’s surprise rate cut — retail sales disappointed even during September’s festival season. BoK clearly expects things to get worse: it noted that ” a cut now is better than later to help the economy”.
Analysts argue that more EM central banks could and should cut interest rates. After all, developed rates are rock bottom and falling (Australia cut rates last week and Japan is expected to ease policy again at the end of October). ING’s chief EEMEA economist Simon Quijano-Evans urges central banks in emerging Europe, especially Poland, to follow the example of Brazil and Korea. He notes:
The old argument of having high real interest rates as a risk premium simply doesn’t hold under current global conditions.
But how effective are these rate cuts? In Brazil’s case, not very so far. Despite 525 bps of rate cuts since July last year, growth this year will be 1.6 percent according to the central bank (versus the previous forecast of 2.5 percent) — that’s less that G7 nations such as the United States, Japan and Canada. In Korea, the hope is that lower rates will stimulate domestic spending and help the debt-burdened household sector. But the country’s high reliance on exports (53 percent of the economy, according the World Bank) makes it unlikely that growth can be significantly lifted. The BoK in fact acknowledged a worsening growth picture, cutting 2012 and 2013 GDP forecasts even more aggressively than the IMF did.
South Korea and Brazil have cut rates within the last 24 hours. More emerging central banks are expected to follow as growth gloom worsens Join DiscussionIs the rouble overhyped?
For many months now the Russian rouble has been everyone’s favourite currency. Thanks to all the interest it rose 4 percent against the dollar during the July-September quarter. How long can the love affair last?
It is easy to see why the rouble is in favour. The central bank last month raised interest rates to tame inflation and might do so again on Friday. The implied yield on 12-month rouble/dollar forwards is at 6 percent — among the highest in emerging markets. It has also been boosted by cash flowing into Russian local bond market, which is due to be liberalised in coming months. Above all, there is the oil price which usually gets a strong boost from Fed QE. So despite worries about world growth, Brent crude prices are above $110 a barrel. Analysts at Barclays are among those who like the rouble, predicting it to hit 30.5 per dollar by end-2012, up from current levels of 31.12.
All that sounds pretty bullish. But there are reasons why the rouble’s days of strength may be numbered. First the QE effect is unlikely to last. As we argued here, QE’s impact will be less strong than after the previous two rounds. Analysts at ING Bank point out that in 3-6 months after the launch of QE2 oil prices gained 40 percent, pushing the rouble up nearly 10%. This time oil won’t repeat the trend this time, and neither will the rouble, they say:
A chance for higher policy rates may support the rouble in the short-term, but we doubt it will steadily gain from these speculative carry-trade
Second, flows to the rouble-denominated OFZ bond market may be overhyped, ING says, noting that the finance ministry has cut 2013 borrowing forecasts by 30 percent. Capital flight, Russia’s old headache, continues unabated and is expected around $70 billion this year.
The longer-picture is most troubling. A major source of support for the rouble has been Russia’s current account surplus. But ING calculates this will more than halve in 2013 from this year’s expected levels around $80 billion — a consequence of lower oil prices and Russia’s WTO accession which will encourage imports. The central bank has gone a step further to concede Russia will actually swing into deficit by 2015. Unless Russia puts in big reform by then, it could be in trouble, says Capital Economics:
Investors are keen on the rouble which is backed by the central bank's rate rises and prospective flows to Russian bond markets. But some reckon the currency's days of strength are numbered. Join DiscussionThe big risk going forward is that oil prices fall, thus requiring either domestic demand or the rouble (or both) to weaken in order to limit the deterioration in the external position.
This week in EM, expect more doves
With the U.S. Fed having cranked up its printing presses, there seems little to stop emerging central banks from extending their own rate cut campaigns this week.
The most interesting meeting promises to be in the Czech Republic. We saw some extraordinary verbal intervention last week from Governor Miroslav Singer, implying not only a rate cut but also recourse to “unconventional” monetary loosening tools. Of the 21 analysts polled by Reuters, 18 are expecting a rate cut on Thursday to a record low 0.25 percent. Indeed, in a world of currency wars, a rate cut could be just what the recession-mired Czech economy needs. But Singer’s deputy, Moimir Hampl, has muddled the waters by refuting the need for any unusual policies or even rate cuts. Expect a heated debate (forward markets are siding with Singer and pricing a rate cut).
Hungary is a closer call, with 16 out of 21 analysts in a Reuters poll predicting an on-hold decision. The central bank board (MPC) is split too. Analysts at investment bank SEB point out that last month’s somewhat surprising rate cut was down to the four central bank board members appointed by the government. These four outvoted Governor Andras Simor and his two deputies who had favoured holding rates steady, given rising inflation. (Inflation is running at 6 percent, double the target). That could happen again, given the government just last week reiterated the need for “lower interest rates and ample credit. So SEB analysts write:
The 4-3 majority of the MPC has shown their appetite for cuts which according to the minutes could continue as long as “the perception of the economy continue to improve”. The current 282 level of the euro/forint would not in our view stand in the way of another cut.
Elsewhere in the region, Israel and Romania are expected to make no change to interest rates, with both banks swayed by recent spikes in inflation.
In Latin America, investors’ eyes will be on Colombia which has delivered back-to-back interest rate cuts and may provide another on Friday. Sure, Colombia’s economy was robust in the second quarter but since then economic data has been hinting at some weakness ahead. Inflation is well-behaved. Most importantly, Bogota cannot afford to let its peso appreciate even as its neighbours and trade partners weaken their currencies. The central bank has already been intervening to buy dollars — a rate cut would take some of the pressure off, say Goldman Sachs analysts:
The Czech Republic, Hungary and Colombia may all cut interest rates this week. Join DiscussionThe authorities, particularly the Treasury, remain every concerned with the exchange rate dynamics and the peso’s overvaluation. Hence, another 25bp rate cut also helps the authorities’ to contain/mitigate the pressure on the COP to appreciate.
Russia: a hawk among central bank doves?
This week has the potential to bring an interesting twist to emerging markets monetary policy. Peru, South Korea and Indonesia are likely to leave interest rates unchanged on Thursday but there is a chance of a rate rise in Russia. A rise would stand out at a time when central banks across the world are easing monetary policy as fast as possible.
First the others. Rate rises in Indonesia and Peru can be ruled out. Peru grew at a solid 5.4 percent pace in the previous quarter and inflation is within target. Indonesian data too shows buoyant growth, with the economy expanding 6.4 percent from a year earlier. And the central bank is likely to be mindful of the rupiah’s weakness this year — it has been one of the worst performing emerging currencies of 2012.
Korea is a tougher call. The Bank of Korea stunned markets with a rate cut last month, its first in three years. Since then, data has shown that the economy is slowing even further after first quarter growth eased to 2008-2009 lows. Exports are falling at the fastest pace in three years. But most analysts expect it to wait it out in August and then cut rates in September. Markets on the other hand are bracing for a rate cut as yields on 3-year Korean bonds have fallen well under the central bank’s main 7-day policy rate.
Russia’s meeting on Friday promises to be the most interesting one. Inflation has risen sharply in the past two months while utility tariff hikes from August were seen adding 1 percent to this year’s headline price growth number. Year-end inflation could be 6.6 percent, analysts reckon, well above the central bank’s 5-6 percent target range. Deputy Governor Alexei Ulyukayev (who has been making hawkish noises for a while) told reporters last month rates could be “changed” in August.
Analysts at ING suggest the central bank may raise its deposit rate (which would narrow its interest rate corridor) and/or its reserve ratios for banks rather than move its key lending rate, which would have little impact anyway on food price inflation. “This could be more about signalling than about a real anti-inflation move,” ING analysts write.
Peru, Indonesia and South Korea will likely keep interest rates steady this week. In Russia there is a chance of a rate rise Join DiscussionIndia, a hawk among central bank doves
So India has not joined emerging central banks’ rate-cutting spree . After recent rate cuts in Brazil, South Korea, South Africa, Philippines and Colombia, and others signalling their worries over the state of economic growth, hawks are in short supply among the world’s increasingly dovish central banks. But the Reserve Bank of India is one.
With GDP growth slowing to 10-year lows, the RBI would dearly love to follow other central banks in cutting rates. But its pointed warning on inflation on the eve of today’s policy meeting practically sealed the meeting’s outcome. Interest rates have duly been kept on hold, though in a nod to the tough conditions, the RBI did ease banks’ statutory liquidity ratio. The move will free up some more cash for lending.
What is more significant is that the RBI has revised up its inflation forecast for the coming year by half a percentage point, and in a post-meeting statement said rate cuts at this stage would do little to boost flagging growth. That, to many analysts, is a signal the bank will provide little monetary accommodation in coming months. and may force markets to pedal back on their expectation of 100 basis points of rate cuts in the next 12 months. Anubhuti Sahay at Standard Chartered in Mumbai says:
On economic growth, though the moderation has been noted, the RBI sees limited role of rate cuts in stimulating growth. Overall, it affirms our view that any rate cut from the RBI is unlikely in the rest of 2012.
Elsewhere in emerging markets too, no rate cuts are expected this week, with Czech and Romanian central banks likely staying on hold when they meet on Thursday.
Czech rates were cut in June to record lows but analysts reckon that fear of further currency weakness, especially against the dollar will prevent the central bank from cutting rates any further this year. In Romania, a raging political storm and doubts over the fate of an IMF loan deal has pushed the leu currency to record lows meaning the central bank has little room at the moment to move interest rates lower.
A raft of emerging market central banks has embarked on rate cuts. Not India. The RBI did not cut interest rates today and stuck with a hawkish tone. Central banks in the Czech Republic and Romania too are unlikely to ease policy this week. Join DiscussionRisks loom for South Africa’s bond rally
Investors are wondering how much longer the rally in South Africa’s local bond markets will last.
The market has received inflows of over $7.5 billion year-to-date, having benefited hugely from Citi’s April announcement that it would include South Africa in its elite World Government Bond Index (WGBI). But like many other emerging markets, South Africa has also gained from international investors’ hunger for higher-yielding bonds. And the central bank’s surprise rate cut last week was the icing on the cake, sending 5-year yields plunging another 30 basis points.
There are some headwinds however. First positioning. Around a third of government bonds are already estimated to be in foreigners’ hands. Second, markets may be pricing in too much policy easing (Forward rate agreements are assigning a 77 percent probability of another 50 bps rate cut within the next six months). That’s especially so given local wheat and maize prices have been hitting record highs in recent weeks.
For these reasons, UBS analysts say it is time to book profits. They note that the 2026 bond they recommended buying on June 15 has already rallied more than 100 bps. Analysts at the bank write:
We did not anticipate the global grab for duration to be as intense as it has been. Yields have come in a lot and we think it is now time to get out of this trade.
And despite falling long-dated yields, most of the bond rally has actually been concentrated in short-dated paper, meaning South Africa’s yield curve is among the steepest in emerging markets. That, according to UBS analysts, is a reflection of the country’s longer-term fiscal and trade deficits and the likelihood of more bond issuance in coming years.
There is also the currency risk. The rand tends to react fast to risk negative news and unlike the Turkish lira, is not actively supported by the central bank. Expectation of more rate cuts will likely weigh on the currency.
South Africa's bond rally may not last much longer. Positioning is crowded, inflation is creeping up again and currency weakness could put returns at risk Join DiscussionSouth Africa’s joins the rate cutting spree
Another central bank has caved in and cut interest rates — South Africa lowered its key rate to a record low of 5 percent at Thursday’s meeting. In doing so, the central bank noted growth was slowing further. ”Negative spillover effects (from the global economy) likely to intensify,” it said.
Very few analysts had predicted this outcome, reckoning the central bank (or SARB as it’s known) would hold fire until its next meeting due to concerns over the currency and inflation. But in fact, forward markets had guessed a cut was coming, especially after June inflation was lower than expected. And after all, even the conservative Bank of Korea cut rates last week to buck up domestic growth and compensate for slumping exports. There have also been some policy easing in Taiwan and Philippines in the past week while earlier on Thursday, Turkey’s central bank unleashed more liquidity into the banking system. Kevin Lings, chief economist at Stanlib in Johannesburg says:
(South Africa’s rate cut) would suggest that the Reserve Bank feels they are a little bit behind the curve when they look at interest rate movements in other countries and hence the decision.
SARB’s surprise has given a further boost to South Africa’s ongoing bond rally. 10-year yields for instance had already fallen more than 100 basis points since the start of June to record lows below 7 percent while 30-year yields have slumped 80 bps. Yields collapsed another 25-30 bps on Thursday. Forward markets are now pricing 75 bps in rate cuts by end-2012, a shift of over 30 bps since last week.
Yet another emerging central bank cut interest rates today. South Africa lowered rates to a record low 5 percent. Join DiscussionMore EM central banks join the easing crew
Taiwan and Philippines have joined the easing crew. Taiwan cut interbank lending rates for the first time in 33 months on Friday while Philippines lowered the rate it pays banks on short-term special deposits. Hardly surprising. Given South Koreas’s shock rate cut on Thursday, its first in over three years, and China’s two rate cuts in quick succession, the spread of monetary easing across Asia looks inevitable. Markets are now betting the Reserve Bank of India will also cut rates in July.
And not just in Asia. Brazil last week cut rates for the eighth straight time and Russia’s central bank, while holding rates steady, amended its language to signal it was amenable to changing its policy stance if required.
Worries about a growth collapse are clearly gathering pace. So how much room do central banks have to cut rates? Compared with Europe or the United States, certainly a lot. And with the exception of Indonesia and Philippines, interest rates in most countries are well above 2009 crisis lows. But Deutsche Bank analysts, who applied a variation of the Taylor rule (a monetary policy parameter stipulating how much nominal interest rates can be changed relative to inflation or output), conclude that in Asia, only Vietnam and Thailand have much room to cut rates. Malaysia and China have less scope to do so and the others not at all (Their model did not work well for India).
Deutsche said of Korea:
After this week’s rate cut, our model suggests rates are essentially in line with the rule as defined by the past behaviour of the Bank of Korea
But there are also doubts that the doves can deliver.
More central banks have switched to easing mode. But they don't have a lot of room to cut and it may not do too much good. Join DiscussionKorea shocks with rate cut but will it work?
Emerging market investors may have got used to policy surprises from Turkey’s central bank but they don’t expect them from South Korea. Such are the times, however, that the normally staid Bank of Korea shocked investors this morning with an interest rate cut, the first in three years. Most analysts had expected it to stay on hold. But with the global economic outlook showing no sign of lightening, the BoK probably felt the need to try and stimulate sluggish domestic demand. (To read coverage of today’s rate cut see here).
So how much impact is the cut going to have? I wrote yesterday about Brazil, where eight successive rate cuts have borne little fruit in terms of stimulating economic recovery. Korea’s outcome could be similar but the reasons are different. The rate cut should help Korea’s indebted household sector. But for an economy heavily reliant on exports, lower interest rates are no panacea, more a reassurance that, as other central banks from China to the ECB to Brazil ease policy, the BoK is not sitting on its hands.
Nomura economist Young-Sun Kwon says:
We do not think that rate cuts will be enough to reverse the downturn in the Korean economy which is largely dependent on exports.
Exports make up 53 percent of South Korea’s economy, World Bank data showed last year. That’s one of the highest rates in the world, far higher than China’s 29 percent or Brazil’s 12 percent. Nearly half these exports went to China. Europe and the United States – growth is looking shaky in all these destinations. Look at the figures to see how this is affecting Korea. Exports grew 19 percent last year. But in 2012 export growth is estimated at 3.5 percent, half government’s initial forecast. And correlation is high between exports and manufacturing — no wonder Korean factory activity shrank in June for the first time in five months.
Rather than reassure investors, the rate cut appears to have spooked, with stock markets falling more than 2 percent and many analysts criticising the BoK for surprising markets.
There could be a bright side. The won fell 1 percent after the shock announcement. It has been flat this year against the dollar while other Asian currencies, including China’s yuan, have lost ground. If the BoK stays dovish (which looks likely) and the won weakens more, that could help exporters compete better with Asian rivals. As Nomura’s Kwon says, ultimately the cut could limit downside growth risks via “confidence and foreign exchange channels”.
Worried about growth, South Korea's central bank shocked markets with an interest rate cut. But lower rates may offer little shelter to the country's export-reliant economy. Join DiscussionIn Brazil, rate cuts but no economic recovery
Brazil’s central bank meets today and almost certainly will announce another half point cut in interest rates, the eighth consecutive reduction since last August. But so far there is little sign that its rate-cutting spree – the longest and most aggressive in the developing world – is having much success in resuscitating the economy.
HSBC’s closely watched emerging markets index (EMI), released this week, shows Brazil as one of the weak links in the EM growth picture, with sharp declines in manufacturing and export orders in the second quarter.
The government is expected to soon revise down its 4.5 percent growth projection for 2012; the central bank has already done so. Industrial output is down, and automobile production has slumped 9 percent in the first half of 2012. Nor it seems are record low interest rates encouraging the middle classes to take on more debt — the number of Brazilians seeking new credit fell 7.4 percent in the first half of this year, the biggest fall on record, according to credit research firm Seresa Experian.
And investors aren’t too happy with Brazil either. Despite the steep rate cuts, Brazil’s stocks are among the worst performing in emerging markets this year. (See here for what I wrote on Brazilian stocks a few weeks back)
Grappling with the slowdown in China and other export markets, Brazil, understandably, is trying to stimulate domestic demand. But its problem (and indeed that of many others such as India) is that it is trying to repeat the strategy it pursued in 2009 when countries resorted to huge stimulus to kickstart growth after the Lehman Brothers disaster. It worked back then but may not be quite so successful again, says Karen Ward, senior global economist at HSBC who worked on the EMI report. Ward notes that China, in contrast to Brazil, has been measured in its monetary easing this year, even though its growth too is slowing.
China learned its lesson from 2009 and is revamping its stimulus strategy but Brazil is back to doing what it did last time, trying to tempt the consumer, and it is not having the desired effect. They should be thinking more imaginatively about the kind of stimulus they want. Brazil and India are trying to look at reviving third quarter growth but they should take a leaf from China’s book in terms of using fiscal policy more effectively to generate better quality growth.
Michael Henderson of Capital Economics points out that growth in recent years was propelled by a credit boom and commodity-linked inflows but neither of these factors is now in place. On the other hand, rates of savings and investment remain low at less than 20 percent of GDP (in Asia they are between 30-50 percent). He says:
Brazil's central bank is set to cut interest rates again. But its efforts are bearing little fruit so far. Join Discussion