MNI INTERVIEW: Emerging Markets Face "Last Mile" Test-IMF's Wu
EMs have shown surprising resilience in the current Fed hiking cycle but the job is not yet done on inflation.
Completing the job on inflation in the U.S. and Europe could require higher-for-longer interest rates and bring new bouts of volatility to emerging market economies, challenging their central banks to stay focused on their own inflation fight even as they fend off currency depreciation and capital outflows, Jason Wu, who oversees the IMF's global markets analysis group, told MNI.
Even the IMF has been surprised by the resilience displayed by emerging markets thus far in the current Fed hiking cycle, he said, attributing their success to improved monetary policy frameworks and an unusually robust global recovery.
"All and all the direction is positive. But I want to reiterate that central banks must remain vigilant on inflation. Back and forth inflation gyrations or the de-anchoring of inflation expectations have historically proven to be very costly to the economy and to financial stability," Wu told MNI's FedSpeak podcast this week.
"The challenge continues to loom large for emerging markets. While lots of progress on inflation has been made, the job isn't really done, and there could be bumps on the so-called last mile of disinflation, which requires them to manage policies cautiously,"
DONE WELL
Emerging economies have been ahead of their rich counterparts in responding to high inflation. Rate hikes in Brazil, Chile, Hungary and others came well before those of the Fed and ECB, driving better returns on their assets and building a buffer against shocks -- and boosting central bank credibility. Commodity exporters also benefitted from soaring prices in 2021 and 2022, while some countries in Southeast Asia didn't see much inflation at all, Wu noted.
At the same time, emerging markets benefited from the tailwinds of a strong global economy and easy financial conditions -- which are more likely to reverse the longer global interest rates stay high, Wu said.
QE appeared to have helped too, he said. Roughly a dozen emerging market central banks experimented with asset purchase programs during the pandemic, albeit on a more modest scale than their developed market counterparts and primarily with the purpose of stabilizing markets rather than lowering borrowing costs. (See MNI INTERVIEW: Latam Neutral Rates Stable Through Pandemic)
Because the purpose and implementation of these programs were well understood by markets, they were successful, Wu said. Upon their conclusion, the central banks were able to pivot back toward dealing with inflation. (See MNI INTERVIEW: BCB Likely To Keep Cuts Guidance -Schwartsman)
"There is a case to be made that this should be a regular part of the toolbox, because while the policy rate affects the front end, it seems like that there needs to be some other tools that will affect the longer-term interest rates, and that often comes in the form of quantitative easing or quantitative tightening," Wu said.
VOLATILITY AHEAD
The IMF's advice for emerging economies is the same as for the developed markets: "commit to getting the job done on inflation," Wu said. If EMs do begin to ease policy, narrowing rate differentials could make emerging market currencies less attractive, too.
There's no one-size-fits-all policy prescription for emerging economies, given the variety of challenges different countries face. But clear communications with markets and investors is important, Wu said. (See MNI INTERVIEW: CBRT On Track, But Risks Remain - Ex-Vice Gov)
"Helping them understand why certain monetary policy decisions have been taken, what are the external forces that they're facing and how is that taken into account in their policy decisions. Those are all key ingredients in ensuring that they can stay focused on bringing inflation down on the one hand, while on the other hand, containing exchange rate and capital flow volatility."