More EM central banks to join rate-cutting party

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The Reserve Bank of India (RBI) surprised the market with a larger-than-expected 50bp cut to its policy rate to 6.75% at its scheduled meeting on Monday. This should perhaps not have come as such a surprise given the collapse in WPI and CPI-inflation, resilient rupee nominal effective exchange rate and regional and global growth slowdown, not to mention the Fed’s recent decision to delay its hiking cycle once again.

Put differently, the RBI’s central bank real policy rate was too high relative to India’s fundamentals and the global outlook – a point which I made more generally for emerging market (EM) economies on 6 August 2015 in Asymmetric Risk to Emerging Market Monetary Policy.  I argued that EM central banks would likely cut their policy rates further as real rates remained high by historical standards. This was still the case by end-August (the last available data point), as Figure 1 shows, particularly if China is excluded.

olivier desbarres em cuts 1

The RBI is the third major emerging market central bank since early August to have cut its policy rate, after the People’s Bank of China cut its one-year lending rate 25bp (to 4.6%) on 25 August and Taiwan’s central bank cut its discount rate – the first time in six years – 12.5bp (to 1.75%) on 24 September. The central bank of Nigeria left its headline policy rate unchanged at its 22 September meeting but cut banks’ reserve requirement ratio to 25% from 31%.

Subdued inflation points to further EM central bank rate cuts

For most countries September inflation data will not be released for another 1-2 weeks. But weaker than expected preliminary CPI-inflation in Germany and Spain of 0% yoy and -0.9% yoy, respectively, suggests that global inflation remained subdued this month.

This would in turn point to further EM monetary policy loosening, including policy rate cuts and/or cutting lenders’ reserves requirements. Indeed Figure 2 shows that a GDP-weighted average of EM central bank policy rates is still high today relative to its 10-year average, particularly when China is excluded from the calculations.

Olivier Desbarres EM Rate Cuts Fig2

The case for further policy rate cuts is even stronger when the EM-excluding China real policy rate (2.4%) is compared to meagre GDP growth of 1.9% yoy in H1 2015 (see figure 3). Turning to country specifics, candidates for future central bank rate cuts include:

India: The RBI real policy rate is high relative to other countries and by India’s historical standards, even when the policy rate is deflated by the much higher CPI and after taking into account the recent 50bp rate cut. Any softening of so-far resilient GDP growth would be an additional argument for further RBI rate cuts.

Nigeria: One of few EM countries where the central bank real policy rate at end-August (3.7%) was higher than real GDP growth in H1 2015 (3.1% yoy).

Taiwan: The CBC real policy rate remains high relative to history and GDP growth even after the recent 12.5bp cut.

Philippines: The BSP real policy rate was at a 8-year high at end-August 2015, but GDP growth was amongst the strongest within EM at 5.3% yoy in H1.

In Brazil, the real rate is very high relative to negative GDP growth, but this is likely necessary in order to offer the beleaguered Brazil real some support.

Olivier Desbarres EM Rate Cuts Fig3

Olivier Desbarres currently works as an independent commentator on G10 and Emerging Markets. He has over 15 years’ experience with two of the world’s largest investment banks as an emerging markets economist, rates and currency strategist.

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