Foreign Capital Outflow Causes Currency Value to Plummet... Emerging Markets Face Interest Rate Hikes

Pressure to raise amid declining capital inflows... 'Base rate cuts' increasingly unlikely
Turkey raised rates last month
Rising debt burden and default concerns
IMF Managing Director: "Global economy faces a long uphill climb"

[Image source=EPA Yonhap News]

[Asia Economy Reporter Jeong Hyunjin] Emerging markets that have been implementing accommodative monetary policies amid the novel coronavirus disease (COVID-19) crisis are now facing a situation where they must raise their benchmark interest rates. Although inflation remains low and the economy is struggling to recover, capital outflows and depreciating currency values have made interest rate hikes inevitable. Some voices express concerns that this could lead to a debt crisis or defaults.

According to a report on the 6th (local time) citing financial information firm Refinitiv, among 25 emerging markets last month, only three countries?Mexico, Egypt, and Nigeria?cut their interest rates, the fewest since April last year. Emerging market central banks lowered rates immediately after the COVID-19 outbreak earlier this year to supply liquidity. In March, 20 out of 25 emerging market central banks, accounting for 80%, cut rates. In April and May, 11 countries each lowered their benchmark rates, but since then, the number of emerging markets cutting rates has gradually decreased.

Recently, some have even started to raise rates again. At the end of last month, Turkey raised its one-week repo rate, the benchmark interest rate, by 2 percentage points from 8.25% to 10.25%. Turkey is the only emerging market to have raised rates this year. Hungary maintained its benchmark rate at 0.60% during last month's monetary policy meeting but raised its one-week deposit rate by 0.15 percentage points. This suggests that central banks, which had supported markets with accommodative policies during the COVID-19 crisis, are beginning to change their policy direction.

The shift toward raising rates is interpreted as a response to concerns over capital outflows and currency values. Central banks generally lower interest rates to induce inflation when inflation rates are low. Given the persistent low inflation due to the COVID-19 crisis, markets expected ultra-low interest rates to continue for some time. However, recently, foreign investors have begun net selling in emerging market stock and bond markets, and currencies like the Turkish lira and Hungarian forint have depreciated, increasing the need to respond with rate hikes. The Turkish lira exchange rate against the US dollar rose about 31% from the beginning of the year to 7.7990 lira on the day, and the Hungarian forint has risen more than 8% since early August. Brazil, South Africa, and Russia show similar trends.

The problem is that raising interest rates increases the debt burden on emerging markets. When currency values fall, the interest paid to investors holding government bonds also increases accordingly. According to the Institute of International Finance (IIF), emerging markets raised $145 billion (approximately 168.8 trillion won) in the global bond market and $630 billion in the domestic bond market from January to September this year, $135 billion more than the same period last year. Zeremin Zettelmeyer, Deputy Director of Strategy, Policy, and Review at the International Monetary Fund (IMF), mentioned that the number of countries at risk of financial crises could increase from 3 to 8 in advanced economies and from 15 to 35 in emerging markets, indicating a greater impact on emerging markets.

Adam Wolf, an emerging markets economist at macroeconomic research firm Absolute Strategy Research, said, "In the past month, external financial conditions appear to have ended accommodative policies and are moving toward tightening." Robin Brooks, Chief Economist at the IIF, stated, "A decline in emerging market currencies means concerns about further depreciation and an added risk premium on credit spreads," suggesting that debt burdens could increase.

However, foreign media assessed that not all emerging markets face these difficulties. In China, Taiwan, and Vietnam, the spread of COVID-19 has subsided, and economic activities have nearly recovered to pre-pandemic levels, leaving their governments relatively less vulnerable. Johanna Chua, Asia head at Citigroup, explained, "Asia is very different from other emerging markets," adding, "Many countries have secured their own financing."

Kristalina Georgieva, IMF Managing Director, said on the same day that while the upcoming world economic outlook report next week will be revised upward, she did not ease concerns, stating that the global economy "faces a long, bumpy, and uncertain 'long uphill climb' that is difficult to overcome."

This content was produced with the assistance of AI translation services.