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Central bank experiments in emerging markets risk reigniting inflation

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wchicken prices It started to rise unusually quickly two years ago, and one group has been quick to react: emerging market central banks. They realized that inflation had arrived long before their peers in rich countries, and kept raising interest rates as prices rose. In difficult policy-making environments such as Brazil and Russia, officials have resisted pressure from politicians to lower interest rates. This comes after two decades in which emerging market central bankers accomplished the impressive feat of bringing down inflation where it seemed intractable. The entire period was a triumph not just for the officials involved, but for the economists who insisted on the need for independent central banks in emerging economies — and for them to focus on maintaining price stability, just as policymakers in rich countries are.

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But even as the inflation monster remains untamed, emerging market central banks are engaged in experiments that put this progress at risk. Some of the new measures were in response to changes beyond their control, such as Vladimir Putin’s invasion of Ukraine. Others are trying to overcome painfully familiar problems, like currency depreciation. All threaten to undermine recent developments, which ultimately rest on the central bank’s credibility. Over the past few decades the better policymakers have been able to stabilize inflation, the more believable their targets and the more restrained prices will be. In 1995 average inflation in emerging economies was 10%; By 2017, it had fallen to 3%. This was the culmination of a slow and miraculous transformation.

The most expensive recent experiments are those that seek to prevent currency depreciation. Central bankers used to make their currencies more attractive by raising interest rates and selling foreign exchange reserves. They are now less keen on raising prices to protect exchange rates, preferring to do so just to tackle inflation, and some of them lacked reserves after selling at the start of the Covid-19 pandemic. So officials are trying new ways to entice depositors to hold funds in local currencies rather than dollars. At the end of 2021, during the collapse that the lira witnessed months ago, the Turkish Central Bank offered to compensate anyone who was still willing to deposit the currency, no matter how much they ended up losing against the dollar. Shortly before Sri Lanka’s government faltered in April, it offered a similar guarantee to citizens abroad. In October, the Central Bank of Hungary opened one-day windows in which depositors can earn plentiful interest rates. The problem is not that these measures are ineffective. By mid-2022, the lira has stabilized although Turkish interest rates remain very low. But by the end of the year, the Turkish government, which covers the central bank’s expenditures, had to find an additional 92 billion lira ($5 billion, or 0.5% of gross domestic product) to cover the cost of the filing system.

The Russian Central Bank is another wild experiment. It stockpiled gold and currencies from China and other friendly countries, which helped when sanctions cut off $300 billion in reserves held by banks in America and Europe. Early in the war, officials also flattened the ship by doubling interest rates, which helped calm the ruble. But things have gotten more difficult since then. As the country runs a larger-than-expected fiscal deficit, an ambiguous rule in the budget forces the central bank to buy back lost reserves in rubles. This has prompted policymakers to experiment with measures that make Russia uncomfortably dependent on China. When officials replenish reserves, they will do so by buying more yuan, with plans for 60% of the country’s total reserves to be issued by Beijing, up from less than 20% before the war. Work on the digital currency has been accelerated; A pilot is due in April. It will be implemented with Chinese banks.

Other experiments include manipulation of central bank balance sheets. Treasuries in advanced economies rarely manage balance sheets on a downward basis, since they are equipped with a lot of capital and have the option to issue more debt. By contrast, governments of emerging markets, such as those in India and the United Arab Emirates, are increasingly closing the gaps by indulging in the central bank’s “ways and means” calculation. This is a risky move. If tax revenues are not higher than expectations, to bridge the gap, the government ends up in an overdraft. As long as the overdraft is small, and interest rates high enough to encourage politicians to borrow elsewhere when possible, it’s hard to go wrong. But in recent years, governments have used these accounts – considered borrowing before imf and the World Bank, but not by the countries involved – to get around debt limits set by local legislators. Nigeria’s overdraft is now roughly equal to the entirety of its entire official domestic debt.


Central bankers in countries like Ghana and Nigeria have come up with what appears at first glance to be a clever solution: converting overdrafts into bonds that have lower interest rates and are easier to restructure. However, there is a problem. Emptying accounts by issuing bonds allows governments to build up overdrafts again, in the process relying on central banks for another lifeline. Ultimately, this is the equivalent of financing back-door government borrowing – something that ends up pricing markets into hyperinflation.

There are already plenty of threats to central banks in emerging markets. Chief among them is the fact that it will be harder to get policy right with low inflation than it was when it was high. As central bankers in emerging markets quickly spotted, global shocks sent prices skyrocketing everywhere. But economies cool in very different ways, based on feedback from consumers, industries, and politicians. Central banks in emerging economies lack the accurate data at the disposal of those in advanced economies to track these changes. It is advisable to spend their time sifting through the limited information available to them rather than contemplating innovations that may undermine their hard-earned credibility.

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