Why Policy Easing--not Tightening--Tops Agenda for Some Central Banks

Policy makers from the world's leading central banks gathering at Jackson Hole, Wyo., this week may be wondering how to step back from years of easy monetary policy. But several of their counterparts in emerging markets are heading in the opposite direction--by cutting interest rates.

The number of emerging-market central banks that lowered interest rates topped the number raising rates for the fourth month in a row in July, according to Capital Economics. That trend, largely driven by Latin American countries such as Brazil, is spreading to Asia.

In a surprise step, this week Indonesia's central bank lowered its benchmark rate for the first time in nearly a year, to 4.5% from 4.75%. Its move followed the Reserve Bank of India's decision this month to slash its main lending rate to its lowest level in more than six years.

Lowering rates right now might seem risky. Relatively high interest rates in emerging markets in recent years had helped them to attract foreign capital, part of the "search for yield" phenomenon that has gripped global markets. Inflows have been strong this year: Foreigners poured a net $17.5 billion into India's debt market and bought a net $8.4 billion of Indonesian bonds in the first seven months of 2017, according to ANZ.

Now, though, the days of emerging markets' interest-rate advantage over developed markets look numbered. The Federal Reserve still appears committed to raising rates, and European Central Bank President Mario Draghi is expected to lay out the case for the end of quantitative easing at this week's central-bank symposium.

Even so, several factors are encouraging central bankers in emerging countries to feel confident they can enact rate cuts, or at least not tighten policy further, without causing undue damage to their economies. Low inflation in countries such as India and Indonesia is giving policy makers leeway to take measures to boost growth.

Moreover, Asia's rate cuts have come without negative consequences or evidence that they will spur heavy capital outflows. Indonesia's rupiah slipped by 0.1% after the central bank's policy decision Tuesday but is still up 0.9% versus the greenback this year. India's rupee gained 0.7% against the dollar on the day of its rate cut.

A reason markets haven't reacted violently: Even with the latest cuts, India's main interest rate stands at 6% while Indonesia's is at 4.5%. Those policy rates are the two highest in the region, and the eighth- and 10th-highest among emerging markets globally, according to data compiled by Capital Economics. That should leave currencies and bonds in India and Indonesia attractive to yield-seeking investors.

For sure, another reason investors aren't worrying about rate cuts in Asia is that the region's decent growth levels mean few believe a concerted period of policy easing is needed, even in countries such as India and Indonesia.

"We don't think there's going to be a new wave of central bank easing in Asia," said Aidan Yao, senior emerging Asia economist at AXA Investment Managers in Hong Kong.

"If you don't have expectations for persistent cuts...in the coming year, I don't think there's that much need for investors to take money out," he said.

Some major central banks don't have the same room to lower rates without risking capital outflows. Korea, for example, has a key interest rate of just 1.25%, which is roughly the same as the Fed's target of 1% to 1.25%.

So can another central bank sneak in an interest-rate cut this year? Rob Carnell, head of research for Asia at ING in Singapore, notes that Thailand's export sector has been hit by the value of the Thai baht, which he estimates is one of the most overvalued currencies in Asia, while both growth and inflation are low in Thailand.

"The most obvious contender to follow in Bank Indonesia's footsteps is the Bank of Thailand," he wrote in a recent research note.

(END) Dow Jones Newswires

August 25, 2017 04:04 ET (08:04 GMT)