- Danske Bank analyses how scorching oil and food prices are sparking inflationary pressure in emerging sovereigns, and may start a new debate on the trade-off between economic growth and stable inflation. “The trade-off is now more visible than it has been over the last couple of years, where an increasingly globalised world has brought lower inflation, and rich access to liquidity on global financial markets has supported economic growth,” the team argues in its monthly Emerging Markets Briefer. The report then surveys strategies employed by monetary authorities in the region.
In the free-floating currency regimes in Latin America, central banks have already tightened monetary conditions, helping to stabilize inflation. But for CEE central banks in Bulgaria and the Baltic region, which have fixed exchange rates, there are no direct monetary policy tools. “These countries are therefore among those who now face the highest inflation in the EM universe - something that is clearly unsustainable for much longer.”
The bank also argues that the largest economies in the CIS – Russia, Ukraine and Kazakhstan – are also de facto “dollar-peggers”, and the greenback’s weakness is incompatible with price stability. Furthermore, government attempts to calm inflation through price controls and export tariffs are “not very useful”.
Philip Poole, head of emerging market research at HSBC, agrees. “Activity in EM is on a different trajectory to the US and it makes less sense than in the past for EM economies to be tied to US monetary policy.” He argues that incomplete sterilization of currency intervention in China, Russia and India is exacerbating the supply side shocks. But more fundamentally, he warns that US Federal Reserve rate cuts have added further complications in the short-term for the monetary authorities in those countries.
“The problem is that the Fed cuts have increased the attraction of carry trades and the resulting inflows into EM are intensifying domestic liquidity and inflationary pressures. This is complication enough but it makes it counter-productive to hike rates in an effort to pressure inflation lower. The result will be that additional tightening is more likely to come through currency appreciation, quantitative measures such as hikes in reserve requirements and controls on inward capital flows as well as controls or subsidies on ‘sensitive’ prices directly.” As a result, he suggests the environment remains currency and equity-supportive and less rates/debt friendly.
- Michael Ganske at Commerzbank in his “Nearly contagion bullet proof” Russia report argues that despite a worsening current account performance, a spike in inflation and a crisis in the interbank market, “Russia offers one of the best fundamental stories in the EM universe.”
He maintains that Russia’s deteriorating balance of payments is no cause for alarm. “Although the current account surplus has retracted by 35% over the last year, it is still at a comfortable 5.5% of GDP.” Additionally, outbound FDI has increased ten-fold this quarter compared with Q1 2006.
Furthermore, although a spending spree is likely in the next couple of months due to the upcoming elections (to the Duma on 2 December, and the presidency in March 2008), the medium-term prospects for Russia’s debt and fiscal dynamics looks solid. “High energy prices have helped a lot as the share of the oil sector is around 21% of GDP and the punitive taxation of the energy sector accounts for 66% of total revenues in Russia’s upstream segment. Even more impressive is the strong increase in FX reserves and past current account dynamics.”
Ganske notes positively the central bank’s role in injecting liquidity to the interbank market, as the contagion of the US sub-prime mortgage crisis caused short-term borrowing rates to spiral up to 10% in September. But he dismisses the idea that a weak banking sector is the country’s Achilles heel. “Two-thirds of bank finance comes from deposits, less than 5% comes from the domestic money market. As a consequence, Russian banks are less vulnerable to a spike in interbank lending rates than their counterparts in more developed economies.” Furthermore, foreign funding now accounts for 20% of bank financing and this mostly through long-dated debt.
Nevertheless, he admits that the fortunes of the private sector are not decoupled from the global economy and the next few months will be crucial for Russian companies that have to refinance about $10 billion this year and $15 billion worth of bonds by the end of Q1 2008. “Any drying up of the bond market financing channel and the domestic banks’ limited lending capacity will result in cuts of capital investment and expansion programs. This will comprise a risk to economic growth as the investment share in GDP has been just above 20%, which is unlikely to sustain growth rates at around 6%.”