eco TV Week

Monetary tightening in emerging countries

11/5/2021

Monetary stance is tightening in Emerging Europe and Latam. The reason: inflation resurgence. This may seem premature at this stage since activity in these countries has just come back to its pre- Covid shock.  Is it justified and what are the consequences ?

François FAURE

TRANSCRIPT // Monetary tightening in emerging countries : November 2021

In emerging countries, monetary policies are tightening due to an acceleration of inflation. Is this monetary tightening justified? What are the consequences?

This phenomenon was rare in the second semester of 2020 but higher key interest rates are a trend since the beginning of the year.

For the moment, we can observe a tightening in Europe and in Latin America but not in Asia. This monetary tightening is due to a global acceleration of inflation triggered by a hike in raw material prices, by rising costs of building materials and of industrial products, electronic products in particular.

This monetary tightening is justified because we also observe an acceleration of core inflation, that is to say excluding food and energy prices.

Asian central banks did not react because in these countries, core inflation remained rather low, below 2%.

The tightening is also justified by the fact that some currencies have depreciated significantly since last year, see the Brazilian real and the Turkish pound.

What could be the negative impact of such measures? Two main points, here.

First, it could impede the recovery when the 2020 budgetary support stops.

According to the IIF estimates, in the ten big emerging countries, the impact of the expected drop in primary budget expenditures, excluding interest charges, will have a cumulative negative impact on growth ranging between 0.5% and 1.5% by 2023.

For now, the increase in key interest rates has been less than the acceleration of inflation.

We cannot say that monetary policies are restrictive.

Monetary tightening can make borrowing costs increase for states, households or companies and therefore weigh on their debts.

In the two areas, Europe and Latin America, the median increase in the public debt ratio was of 11 points of GDP in Europe and 8 points in Latin America. The debt ratio for households and companies showed weak and even negative developments. But the increase in public debt ratio combines with higher interest rates on local currency sovereign debts. It reaches higher levels than in late 2019 in Latin America and Turkey in particular.

To conclude, monetary tightening may seem premature given that economies have only just returned to their pre-pandemic levels. But the aim of central banks is to not reawaken inflation expectations because in emerging countries, the risk would be an increase in real interest rates, and not a decrease.

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