The Federal Reserve and other powerful central banks have viewed a curiously long bout of low inflation as proof that stimulating the economy through unconventional money-printing measures can ease the pain of downturns. Those tactics traditionally were considered off-limits to less developed economies with unstable politics and weaker currencies.
But Covid-19 changed that. As the pandemic spread, a slew of central banks from India to Turkey to South Africa for the first time delved head-long into their own unconventional monetary policy, so-called “quantitative easing”, buying up government debt and corporate bonds to stabilize their currencies and boost their recoveries.
Prioritizing economic support over inflation risk seemed like the right move: Many emerging market central banks initially offset the impact of fleeing foreign investors and rising borrowing costs, while helping to lift their stock prices. But risks remain for countries that depend on borrowing in foreign currencies, since that debt can become untenable if their own currencies fall in value. International investors who pile into emerging market currencies can quickly pull back at signs of market distress.
Declining currency values can in turn be damaging to emerging markets reliant on foreign imports of basic goods like food and fuel. Countries like Turkey, Brazil, and Nigeria are now smarting from the pain of food inflation, a major contributor to overall inflation for many emerging markets.
Food prices account for more than half of the inflation index in countries like Nigeria and Bangladesh, for instance, compared to roughly 10% in richer economies like the US and Germany. Central banks are wary of food price spikes, which historically have been a trigger for civil unrest. Rising food prices spurred on the downfall of Suharto in Indonesia and sparked the Arab Spring.
In Turkey, food inflation has risen more than 20% in a year, thanks in part to the government’s massive bond-buying program launched last spring. Prices of food and other basic goods have also risen sharply in Latin America, with Brazil reporting its largest monthly inflation uptick in January since 2003 and Argentina threatening to slap taxes or quotas on food exports to tame domestic prices.
Some countries have started to unwind monetary easing in response. Turkey’s central bank sharply hiked interest rates starting in November. Brazil’s central bank warned of persistent inflation in January, and floated the possibility of raising interest rates. Russia shifted gears on its interest rate cuts in December, opening the door to a rate hike. Colombia is making draconian cuts to economic relief measures to appease skittish foreign investors.
Controversial QE policies may work out better in emerging markets that have deepened their domestic capital markets and improved their spending track record, like Chile and Poland. For less reliable testers of QE like Brazil and Russia, investors will be watching interest rates and inflation closely. Any sudden moves could force countries to prioritize fickle traders abroad over domestic needs.