The Bad Trade-Offs Emerging Markets Face
Emerging markets worried about their falling currencies and investors rushing to the exits are raising interest rates and keeping a lid on spending, even though doing so is likely to hurt their long-term prospects.
Central banks in developing countries including Indonesia and the Philippines have raised their official borrowing costs multiple times this year to keep up with rising rates in the U.S. Economic growth has already slowed in the Philippines from earlier in 2018. While the Indonesian economy grew at the fastest pace in more than four years in the latest quarter, the worry is that higher rates there could start to drag.
Countries are making these trade-offs for fear the turmoil that has gripped emerging markets such as Turkey and Argentina could spread more broadly.
“The main question is, for how long will you see markets discriminating good guys from bad guys,” Colombia’s central bank chief Juan José Echavarría said.
Tough policy decisions by governments in the developing world could help keep the market trouble contained. The risk is that it crimps the long-term growth prospects for these countries, and for the global economy as a whole.
Central bankers and finance ministers attending the annual gathering of the International Monetary Fund and the World Bank in Bali, Indonesia, debated the ability of emerging markets to withstand higher interest rates, which make their dollar debts more expensive to repay. The Federal Reserve has signaled it will continue to lift interest ratesthrough next year, and the European Central Bank has indicated it will push ahead with its plan to phase out its easy-money policies.
Policy makers said they are reassured that investors have so far separated the stronger from the weaker countries as investors soured on emerging markets this summer. The currency slumps in Argentina and Turkey, which are both facing deep economic troubles, have far outpaced the declines elsewhere this year.
But some also expressed concerns that the response to the turmoil could hurt emerging-market growth prospects. Countries could feel compelled to run current account surpluses to fend off financial markets, even though they need to incur deficits at this stage of their development, said Tharman Shanmugaratnam, chairman of the Monetary Authority of Singapore.
“It’s very normal to expect the emerging markets that need investment to have some current account deficits,” said Subhash Chandra Garg, India’s economic affairs secretary.
Investors seeking juicy returns poured money into emerging markets in 2017. This year, however, higher U.S. rates, a strong dollar and the troubles in Turkey and Argentina have slammed developing economies, sending prices of their stocks and bonds falling. The MSCI Emerging Markets Index fell into bear territory, commonly defined as a 20% drop from a recent high, in September.
The turmoil has sharpened an enduring dilemma for emerging markets: They must spend heavily to develop their economies, but that leaves them vulnerable to instability during periods of capital flight.
The deficit-fueled growth strategies pursued years ago by countries such as South Korea and Singapore aren’t as available now that capital moves more quickly around the globe, said Andrés Velasco, dean of the School of Public Policy at the London School of Economics and Political Science and a former finance minister of Chile.
“It is very hard even for a well-behaved country with all the right policies to follow the path of sustained current-account deficits, high investment and high growth,” he said. “The flows of capital that are necessary to make this happen tend not to be…as reliable as you would need them to be.”
South Africa’s central bank has kept its benchmark rate steady at 6.5% even after it fell into a recession in the second quarter, depriving its economy some relief from easier monetary policy in an attempt to prevent capital outflows. The rand has slumped nearly 15% against the dollar this year.
The Philippine central bank’s current bias is to continue tightening monetary policy, Deputy Gov. Diwa Guinigundo said.
“It is also very important that one should consider the impact of your tightening on the real sector,” Mr. Guinigundo said.
Saumya Vaishampayan & Josh Zumbrun