Central banks in emerging economies are struggling to respond to a double bind of slowing growth and war-driven inflation, unlike their counterparts in advanced economies, where artificial intelligence investment has energized activity.
Japan's Nihon Keizai Shimbun reported on the 30th, citing data from Maruyama Yoshimasa, a researcher at SMBC Nikko Securities, that the average policy rate in emerging economies stood at 7.4% as of the 23rd of last month, down 0.13 percentage point from February, when the Iran war began. That compares with an average policy rate of 3.02% in advanced economies, up 0.31 percentage point from February — meaning emerging-market rates moved in the opposite direction.
The gap reflects how solid growth, underpinned by expanding AI investment, has made it relatively easy for advanced economies to decide on rate increases. Higher energy prices stemming from the Iran war are indeed pressuring central banks worldwide to tighten. Eighteen central banks globally raised rates between July and September, up sharply from six in the January-March period before the war.
Emerging economies, particularly in Asia, hold smaller oil reserves and depend heavily on the Middle East for energy, leaving them with little choice but to absorb greater pain. Some have moved to raise rates. The central bank of the Philippines lifted rates at three consecutive meetings through August. Governor Remolona told a news conference that monetary policy pre-emptively addressing the risk of price increases is essential. The South African Reserve Bank also decided to raise rates last month.
Others, however, are holding off on increases out of concern about a contraction in growth. The Reserve Bank of India kept its policy rate unchanged at four straight meetings through August, and Bank Indonesia decided last month to hold its policy rate for a third consecutive time.
By contrast, the central banks of the United States, Japan and Europe all moved to raise policy rates last month, and Norway's central bank decided on an increase this month. An official at the Bank of Japan said advanced economies find it easier to prioritize curbing inflation than to worry about downward pressure on growth from higher rates. Rate increases by the U.S. Federal Reserve could also weigh on emerging-market central banks, because Fed tightening strengthens the dollar while investors pull funds out of emerging markets, weakening their currencies.
Nikkei said the El Nino phenomenon, which triggers abnormal weather, could also add to pressure for rate increases. Goldman Sachs estimated that an El Nino event raising temperatures by 1.65 degrees would push global food prices up by a cumulative 15.8% through 2028. Some forecasts suggest such abnormal weather could sustain inflation through rising food prices even if the Iran war ends.
Why Brazil Went the Other Way and Cut Rates
Brazil is a special case. The country decided last month on its fifth consecutive rate cut. The backdrop is the pain Brazil endured after pursuing aggressive monetary easing during the COVID-19 period, only to run into severe inflation that forced it to raise its benchmark rate by 1,175 basis points in 18 months. One basis point equals 0.01 percentage point.
Brazil uses as its benchmark rate the average rate on ultra-short-term money market transactions collateralized by government bonds. It is also called the Selic rate, named after the government bond infrastructure operated under the Central Bank of Brazil. The system was introduced in earnest when the BCB, after record inflation, adopted inflation targeting in March 1999. It gives the central bank greater control than the practice in other countries of using unsecured interbank transactions as the benchmark.
But in August 2020, as the pandemic froze economic activity, the BCB cut its benchmark rate to 2.00%, the lowest level in its history. The problem was that ultra-low rates drove foreign capital out, sending the Brazilian real tumbling, while a severe drought sent energy bills soaring — pushing Brazil's consumer price index, the IPCA, up 10.06% in 2021.
With prices entirely out of control, the BCB hit the accelerator on rate increases, bringing Brazil's benchmark rate to 13.75% by August 2022. The BCB later lowered the rate for a time, but as concerns over fiscal deficits and price increases resurfaced, it raised the rate to 15.00% in June last year. Brazil's benchmark rate now stands at 13.75%. Its solitary rate-cutting path is, in effect, the aftermath of having the world's highest benchmark rate, created during the pandemic period.
The statement the BCB released immediately after this month's rate-setting meeting nonetheless conveyed caution about further cuts. According to Brazil's national statistics agency (IBGE), consumer prices last month rose 4.47% from a year earlier, exceeding market forecasts. The BCB said it will determine the pace of its rate-adjustment cycle based on new information so that inflation converges to the target.
The BCB's decision next month is set to draw even greater market attention, as the meeting comes within days of the conclusion of Brazil's presidential runoff on the 25th of this month. This year's election is expected to produce a tight contest between leftist President Luiz Inacio Lula da Silva, who is seeking re-election, and right-wing Senator Flavio Bolsonaro.
Also notable is Israel, which joined the United States in striking Iran in late February and cut its benchmark rate for a third consecutive time last month. Israel's benchmark rate now stands at 3.25%, down 25 basis points from the previous level and the lowest since the end of 2022. Andrew Abir, deputy governor of the Bank of Israel, told Reuters that inflation had been on a downward trend over the past few months and that he had found no valid reason not to continue the rate-cutting process. He signaled that rate cuts could continue if prices remain stable.
