Policy makers in emerging economies from Russia to Vietnam may have to start acting less like Ben S. Bernanke and more like Paul Volcker if they want to bring inflation under control.
With currencies tied to the U.S. dollar, officials in many developing countries have had to keep their monetary policies linked to the Federal Reserve's. Now, after chairman Bernanke led the Fed's most aggressive easing in two decades, their central banks find themselves with interest rates too low for their economies and the worst bout of inflation in a generation.
“There's a lack of independent monetary policy; it's been inappropriately stimulative,” says Nariman Behravesh, chief economist with Global Insight in Lexington, Massachusetts. The answer, he says, may be to “tighten credit more aggressively,” the way then-chairman Volcker did in the early 1980s.
Such a policy shift would mean pushing borrowing costs above the level of inflation and keeping them there even at the cost of a steep slowdown that might send commodity prices into a tailspin. Faced with inflation that approached 15 percent in 1980, Volcker pushed interest rates as high as 20 percent and drove the U.S. into its deepest recession since the 1930s.
Price surge:
Prices are now surging across the developing world. China's inflation rate stayed near a 12-year high of 8.7 percent in May; prices in Vietnam jumped 27 percent in June and Indian wholesale prices increased 11.6 percent last month, the fastest in 13 years. Inflation exceeds benchmark lending rates in China, Russia, India and at least a dozen other emerging economies.
“They … need to start reacting in order to be seen to be doing something,” says Robert Prior-Wandesforde, an economist at HSBC Holdings in Singapore. “Interest rates do need to go a lot higher.”
Rate increases big enough to slow down some of the world's fastest-growing economies would help Bernanke, 54, and European Central Bank President Jean-Claude Trichet in their own inflation fights by cooling the commodity-price boom.
Trichet, 65, said last month that there's a risk of inflation “exploding” if central banks don't act decisively. The ECB last week raised its benchmark lending rate a quarter point to a seven-year high of 4.25 percent. The price of oil has almost doubled in the past year, touching a record $145.85 on July 3, and wheat and rice prices jumped more than 50 percent in the same period.
Food and energy costs:
The surge in commodity prices poses a particular problem in emerging economies because food and energy account for a bigger share of overall inflation than in the U.S. or Western Europe - more than 40 percent in India, Thailand and Turkey, compared with about 25 percent in the U.S., Morgan Stanley says.
Volcker's track record is already being invoked by some officials in Asia. Singapore Finance Minister Tharman Shanmugaratnam on June 27 praised the former Fed chairman for “reversing the psychology of inflation” and said Asian central bankers must realize they need to tighten credit before it's too late.
While India, Taiwan, the Philippines, Chile, Mexico, Egypt, Brazil and Russia all raised interest rates last month, the danger is that they've already waited too long, and that measures strong enough to curb inflation now would risk sinking their economies.
“The sheer difficulty of achieving stability on the growth and inflation fronts will be a shock for Asian assets, equities and currencies,” says Stephen Jen, chief currency strategist at Morgan Stanley in London. “It's almost impossible for them to get ahead of inflation.”
Jen says China needs to lift its real interest rate, currently near zero, by about 8 percentage points. JPMorgan Chase & Co. calculates that the average real rate across emerging nations stands at 2.3 percent, compared with 3.7 percent a year ago.
“They are hundreds of basis points away from a restrictive policy,” says David Hensley, JPMorgan's director of global economic coordination in New York.
Emerging problem:
The monetary policies of emerging economies, devised in the aftermath of the Asian financial crisis a decade ago, now are part of the global inflation problem. By tying their currencies to the dollar, many emerging economies suffer the imported inflation that normally accompanies a weakening exchange rate.
Inflation-targeting systems have also had limited success. Turkey last month abandoned its price goal after missing it for two years; Russia is struggling to hit its own target while managing the ruble. Morgan Stanley says inflation exceeds targets in at least 19 emerging economies.
In the absence of effective strategies, a “hard landing” may be the only way to get inflation down, says Morgan Stanley's Jen. “There does not seem to be another way out,” Jen says. “Until recently, emerging markets were seen as a safe haven from the financial crisis. The tables have turned.”