Rate cuts could push emerging markets into runaway inflation

Bloomberg

Pressure is building for interest-rate cuts that could push emerging economies into a quagmire of runaway inflation and currency weakness.
That’s because average real yields in emerging markets may have already turned negative, if first-quarter inflation projections are any indication. Even bigger economies such as India, Taiwan and Turkey offer bond returns below price growth, leaving little room for borrowing costs to fall further.
The clamour for poorer nations to mimic Federal Reserve in combating the coronavirus impact may be misplaced for two reasons. Unlike the US or Europe, most developing nations are seeing an increase in inflation, making rate hikes a more appropriate response. Also, these nations have a poor record of converting rate cuts into economic growth — the problem of monetary transmission.
Easing expectations have sent developing-nation stocks towards the biggest weekly gain since November 2018 and currencies into the best week this year. But average bond yields have fallen to a record low, while inflation is seen at the highest level since 2014. This would be the first time in more than three years that real rates are negative, and underscores the lowest investor returns in more than a decade.
A further erosion of these returns could spark a currency selloff and the fight against inflation would be lost before it began. The following countries have seen their inflation-adjusted benchmark rates flip to negative, or close, in the past six months.

India
Even before the coronavirus, growth in the south Asian nation had slowed down amid falling consumer demand, rural distress and a shadow-banking crisis. Rate cuts totaling 135 basis points did nothing to arrest the slide. A surge in inflation for December, initially dismissed by some economists as a one-off shock, continued in January, rising to the highest level in Prime Minister Narendra Modi’s six years in office.

Taiwan
Taiwan’s 10-year yield fell to a record low after a debt auction, pushing inflation-adjusted returns lower. Economic growth is projected to slow for a third successive year even though faster price growth may return.

Kenya
Inflation quickened in February after a slight cooling in the previous month as unseasonal rain destroyed harvests and fuel prices rose. The country’s problems vary from rising food prices to a threat to agricultural output from a locust invasion.

Thailand
A World Bank report shows an increase in Thailand’s poverty rate and inequality came with the caution that any further weakening of the economy may hurt households. Inflation isn’t a problem yet, and the impairment to its tourism industry from virus concerns may support the case for rate cuts. But yields are already at record lows and foreign investors are taking out money.

Lebanon
The government must honor a $1.2 billion debt repayment on Monday but is yet to give a firm commitment it will do so. A partial restructuring is being considered which may see at least foreigners being paid off. However, investor confidence beyond the March 9 deadline will depend on the nation’s economic health and its ability to contain public anger about falling living standards.
Lebanon has seen the most dramatic drop in real rates over the past six months, from 8.55% to a slightly negative number. The pound is overvalued, according to the International Monetary Fund (IMF).
A large current-account deficit (20% of gross domestic product) is adding further pressure on the currency peg.
Brazil
The effect of ill-timed rate cuts is already spooking investors. Brazil, whose real rates have fallen close to zero from a robust 2.78% in September, has seen its currency plunge to an unprecedented 4.6 per dollar. That cements the real’s place as the world’s worst performer this year, after the central bank opened the door for further easing.