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Emerging-market central-bank experimentation risks rekindling inflation

BusinessEconomyEmerging-market central-bank experimentation risks rekindling inflation
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wchicken prices As the unusually rapid rise began two years ago, one group was the fastest to react: emerging market central bankers. They realized that inflation had arrived long before their counterparts in richer countries, and continued to raise interest rates as prices rose. In a policy-making environment, hardline authorities such as Brazil and Russia have resisted pressure from politicians to cut rates. It follows two decades in which emerging market central bankers achieved the impressive feat of reducing inflation in places where it seemed irresistible. The whole period has been a victory not only for the officials involved, but also for economists who have been stressing the need for independent central banks in emerging economies – and for them, like policymakers in rich countries, to focus on keeping prices stable. .

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Yet while the demon of inflation remains unchecked, emerging market central banks are engaging in experiments that threaten this progress. Some of the new measures are in response to changes beyond his control, such as Vladimir Putin’s invasion of Ukraine. Others are attempts to address painfully familiar problems, such as currency depreciation. All threaten to undermine recent advances, which are ultimately based on central bank credibility. Over the past few decades, the better policymakers managed to control inflation, the more believable their targets were and the more prices were controlled. In 1995, average inflation in emerging economies was 10%; By 2017 this had fallen to 3%. It was the pinnacle of slow, miraculous change.

The most expensive recent experiments are those that try to stem the decline in the value of currencies. Central bankers sometimes make their currencies more attractive by raising interest rates and selling foreign exchange reserves. They are now less eager to raise rates to protect the exchange rate, preferring to do so only to combat inflation, and some are short of reserves after sales at the start of the Covid-19 pandemic. Thus the authorities are trying new ways to entice depositors to hold funds in local currencies instead of dollars. In late 2021, during a months-long collapse in the lira, Turkey’s central bank offered to compensate anyone willing to deposit the currency, even though they lost against the dollar. Shortly before Sri Lanka’s government defaulted in April, it offered similar guarantees to citizens abroad. In October Hungary’s central bank opened a one-day window in which depositors could earn a bumper interest rate. The problem is not that these measures are ineffective. By mid-2022 the lira had stabilised, although Turkey’s interest rates remained very low. But by the end of the year, the Turkish government had to find an additional 92 billion lira ($5 billion, or 0.5%) to cover the central bank’s expenses. Gross Domestic Product) to cover the cost of the deposit scheme.

Russia’s central bank is another enthusiastic experimenter. It stockpiled gold and currencies from China and other friendly countries, which helped cut reserves held by banks in the US and Europe by $300bn. Early in the war, the authorities also steadied the ship by doubling interest rates, which helped to calm the ruble. However, things have gotten tough since then. As the country’s fiscal deficit is higher than expected, an unclear budget rule has forced the central bank to buy back lost reserves with the ruble. This has prompted policymakers to experiment with measures that make Russia uncomfortably dependent on China. When officials replenish reserves, they will do so by buying much more yuan, with Beijing planning to issue 60% of the country’s total yuan, down from 20% before the war. Work on digital currency has gathered pace; A pilot is scheduled for April. This will be done with Chinese banks.

Other uses include tinkering with the balance sheets of central banks. Treasuries of advanced economies rarely run budgets on a hand-to-mouth basis, as they are much more capital-equipped and have the option of issuing more debt. In contrast, emerging market governments, such as those in India and the United Arab Emirates, are narrowing the gap by dipping into a “ways-and-means” account at the central bank. This is a risky move. If tax revenue doesn’t come in more than expected, to make up the difference, the government ends up in an overdraft. As long as the overdraft is small, and interest rates are high enough to encourage politicians to borrow elsewhere whenever possible, it’s hard to go much wrong. But in recent years governments have used these accounts – which are counted as borrowing by the government International Monetary Fund and the World Bank, though not by the countries involved – to get around debt limits set by domestic lawmakers. Nigeria’s overdraft is now roughly equal to the entire pile of its official domestic debt.


Central bankers in countries including Ghana and Nigeria have come up with a seemingly clever solution: converting overdrafts into bonds, which have lower interest rates and are easier to restructure. However, there’s a catch. Emptying accounts by issuing bonds allows governments to build up their overdrafts once again, in the process relying on central banks for another lifeline. Ultimately, this is akin to financing government borrowing through the backdoor – something that ends up in runaway inflation with market pricing.

There are already enough threats to emerging market central banks. Chief among them is the fact that it will be harder to fine-tune policy as inflation falls than at times when it rises. Global jitters pushed prices up everywhere, as emerging market central bankers looked increasingly bullish. But the economy cools in very different ways, depending on the reactions of consumers, industries and politicians. Central bankers in emerging economies lack the granular data at their disposal in advanced economies to track these changes. They would be well advised to spend their time scrutinizing the limited information available, rather than dreaming up innovations that could undermine hard-earned credibility.

Read more from our column on economics Free Exchange:
The case against Google hinges on an antitrust “mistake”. (2 March)
What would the perfect climate-change lender look like? (23 February)
The Case for Globalization Optimism (16 February)

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