Rate cuts by central banks to have limited macroeconomic effects, says SEB

Per Hammarlund, chief EM strategist at SEB, says monetary easing in emerging markets will have limited-to-no impact on economic activity until trade, production and travel restrictions are lifted…

Central banks in emerging markets (EM) have cut interest rates aggressively to support economic activity in the face of the global slowdown caused by how governments have responded to the Covid-19 outbreak, and additional actions are in the pipeline. While monetary policy easing has a calming effect on financial markets, it will have limited-to-no impact on economic activity until governments reduce restrictions on trade, production and travel. The fiscal policy response has been slower, but will be key to mitigating the economic crisis following the Covid-19 outbreak.

 
As many as 35 central banks have cut monetary policy rates so far in March (through March 23 2020), with six banks even cutting twice, and we expect additional interest rate cuts in the coming weeks and months as the effects of the shutdowns spread. Interest rate cuts have been welcomed by the markets, however, other means of introducing liquidity into markets such as the US Fed’s swap lines with other central banks and short-term emergency lending and lower rates for banks have been more important. Nevertheless, the cuts will have very little or no macroeconomic impact until restrictions on economic activities have been eased. If consumers cannot consume and producers cannot produce, it doesn’t matter how much money they can borrow.

Fiscal policy will be crucial for how the global economy pulls out of the Covid-19 economic crisis. Governments have started to announce fiscal emergency packages, but the focus has been on providing various forms of loans and support for consumers and the unemployed. Most likely in the coming weeks, governments will recognise the need to support business with direct cash transfers to compensate for lost revenue.
 
Expansionary fiscal policy in the EU, US and China will have a positive spill-over effect on EM, but it will not be enough to drag all economies out of recession. EM economies best placed to boost fiscal spending are the Philippines, Korea, Thailand, Russia, Poland, the Czech Republic and Chile. High government debt in India, Malaysia, Hungary, Ukraine, Brazil and South Africa severely limit the room for these governments to spend their way out the crisis once they ease restrictions on economic activities. When it comes to Indonesia, Turkey and Mexico, vulnerable external finances and a dependence on oil prices will constrain these governments’ ability to boost spending.

Once the Covid-19 outbreak starts to recede, the tide of improving risk appetite will likely lift all EM assets (FX, bonds and equities), at least temporarily. However, those EM countries that are now slashing interest rates, and increasing spending and borrowing despite already high debt levels - notably Turkey and most likely followed by South Africa and India - could experience renewed market turbulence.

Mexico, Indonesia, South Africa, Brazil, Czech Republic, Poland, Turkey and Chile may have less room to provide additional monetary policy stimulus given a sharp weakening of their currencies with the potential to drive up inflation. Russia is in a special situation and if it decides to cooperate with OPEC and Saudi Arabia to restrict production, oil prices would increase, creating room for the Central Bank of the Russian Federation to cut rates. The central banks with the most room to cut and stimulate growth are primarily based in Asia - South Korea, Thailand, Philippines and Taiwan - but also Peru.