Emerging storm reveals ebbing central bank autonomy

LONDON Tue Oct 8, 2013 11:43pm IST

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LONDON (Reuters) - After a stormy year for global emerging markets, one long-term casualty may be the decade-long push for central banking free from politics and the inflation-busting kudos that earned.

Investors see governments once more intent on pumping up economic growth via low interest rates even at the risk of inflation and currency volatility.

The trend is effectively rolling back more than 10 years of growing consensus on the benefits of inflation targeting and greater rate-setting autonomy across emerging markets.

Efforts by central banks such as India's and Turkey's to support currencies over the past few months were widely seen as hobbled by government pressure - direct or indirect - to keep interest rates low, especially if elections are near.

"We are definitely seeing more pressure on central banks ... Turkey is one place where the government influence (on central banking) has become quite large," said Christian Keller, head of EEMEA research at Barclays in London.

Keller said such attitudes had been implicitly encouraged by the blurring of fiscal-monetary policy lines in the West, where the U.S. Federal Reserve and its peers are busily printing money and buying bonds to cap government borrowing costs.

But whatever the outcome in the developed rich world, the erosion of central bank autonomy could lead to deeper damage in developing economies, where dependence on foreign finance and histories of high inflation exaggerate investor suspicions.

"Though the Fed is not doing (money-printing) because of pressure from the Senate, EM governments are using it as a pretext to say: 'They are doing it, so should we'," Keller said.

"The tricky part is that emerging markets do have cyclically weak growth and that puts central banks in a dilemma. Growth is too weak to please governments but currency weakness is starting to pass through into inflation."

In Turkey, for instance, lira weakness is driving up the cost of imported goods. Data shows annual inflation at almost 8 percent, approaching the double-digit levels that prevailed for two decades before 2004.

Brazil's inflation has exceeded 4.5 percent, the centre of the target range, for three years - partly due to a 15-month-long rate-cutting cycle that slashed rates to record lows.

Rates are rising now but many see this as stemming from the government's wariness of inflation before 2014 elections.

HISTORY

Over the past decade, developing countries have allowed central banks a wider latitude in setting rates, recognising benefits in politically neutral monetary policy.

A 2008 IMF working paper rated emerging economies highly on independence and transparency compared with a decade earlier.

The study scored Brazil 0.5 on a 0-1.0 independence scale, from 0.2 between 1980-89. Peru, Poland and Philippines rose to around 0.8 from 1980s scores of 0.1 to 0.4. Turkey's score improved to 0.8 from 0.4 in 1989.

The rewards have been substantial. Twentieth century-style hyper-inflation is in abeyance. Policy predictability has driven a boom in emerging local currency bonds - a $7 trillion market of which international investors own a third.

While the study has not been updated, applying its criteria - central appointment procedures, resolving conflict between banks and governments, adherence to explicit policy targets, and rules limiting lending to government - shows central bank autonomy has slid, in emerging as well as developed countries.

That may not necessarily be detrimental. Credit Suisse economist Kasper Bartholdy says lesser central bank autonomy may be good for an economy like Hungary where high interest rates had hobbled growth.

"(Hungary) have a less independent central bank and as a result they have more sensible policies," Bartholdy said.

Hungary's central bank was rated highly independent in the 2008 study, but the government has now grabbed control of the board and named economy minister Gyorgy Matolcsy as governor.

Interest rates have fallen by 340 basis points since.

"The standard view is an independent central bank will be more rational (but) there is nothing to say that will always be true," Bartholdy said. "You need some coordination between fiscal and monetary policy."

And with a few exceptions, emerging markets do not currently have a major inflation problem. Consumer inflation for 54 countries was 4.4 percent in August on a GDP-weighted basis, well below long-term averages, according to Capital Economics.

"It's hard to demand big rate hikes when growth is a bigger threat," said UBS strategist Manik Narain. "If inflation comes back during the recovery, policymakers' credibility may be called into question. But that's tomorrow's problem."

SAYING 'NO'

It could still be a big one. New Reserve Bank of India boss Raghuram Rajan, who stunned markets by raising interest rates at his first meeting as governor last month, has warned central bank policies could fuel fresh asset bubbles.

The new governor of Russia's central bank, a former Kremlin advisor, has so far defied calls for rate cuts.

And once the comfort blanket of Fed money-printing is yanked away, investors will punish policy slippage, especially in countries such as Indonesia where foreigners own a big chunk of the bond market, or India, where government borrowing is high.

"There will always be a tendency for ... the government to inflate their way out of the mess," says Abheek Barua, chief economist at India's HDFC Bank. "So you need a reasonably assertive monetary authority, who ... puts its foot down and says enough is enough, inflation is spinning out of control." (Additional reporting by Carolyn Cohn in London and Tony Munroe in Mumbai; Editing by Ruth Pitchford)

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