The governor of the Central Bank of Pakistan warned that if advanced economies do not take early action to deal with rising global inflation, emerging markets are vulnerable to a dwindling tantrum.
The comments of Reza Baqir, a former senior official of the International Monetary Fund, indicate that policymakers in developing economies are increasingly uncomfortable that central bankers in rich countries are not doing enough to contain monetary stimulus measures during the pandemic and contain price increases.
In an interview with the British Financial Times, Baqir stated that if foreign investors eventually dump emerging market and frontier market assets due to unexpected interest rate hikes in advanced economies, this will cause disproportionate harm to developing countries.
“If the financial market fluctuates due to the sudden adjustment of interest rate changes in advanced economies, then such fluctuations will have a greater impact on emerging markets with high debt and moderate or low levels of reserves,” he said.
Prior to Baqir’s comments, the National Bank of Pakistan raised its benchmark interest rate by 150 basis points last week to 8.75%, as the country struggled with rising inflation, currency devaluation and expanding current account deficits.
“In Pakistan, we don’t have many foreign investors in the local currency market,” he said. “But if fund managers exit the emerging market asset class, we may have an impact on credit and sovereign bonds.”
Fearing that loose currencies are fueling continued global inflation, central banks are under pressure to cancel the stimulus plans launched during the peak of the coronavirus pandemic.
Policymakers and investors worry that inaction, followed by a sudden tightening, may trigger a recurrence of the shrinking panic in 2013, when the Fed’s signal to withdraw from the stimulus program triggered a sell-off in emerging markets.
Gita Gopinath, the chief economist of the International Monetary Fund, warned that low- and middle-income countries that have been weakened by the pandemic “cannot withstand” similar shocks.
On Friday, Fed Vice Chairman Richard Clarida said that due to the “upside risk” of inflation, the bank is open to accelerating the reduction of the bond purchase stimulus program launched during the darkest period of the pandemic.
Baqir said: “Gradually, central banks around the world are gradually realizing that there are valid reasons to proactively ease monetary stimulus.”
He added: “For emerging markets with high debt and lower reserve levels than expected, they do not have the luxury of waiting like central banks that issue hard currencies.”
Compared with advanced economies, some emerging market central banks are more active on the issue of inflation. For example, due to concerns about inflation, Brazil last month raised interest rates to their highest level in nearly 20 years-this year is the sixth rate hike.
Recently, index provider MSCI reclassified Pakistan from an “emerging” market to a “frontier” market, which is considered an underdeveloped or smaller market. Concerns about inflation prompted the central bank to convene an early monetary policy meeting.
The inflation rate rose to 9.2% in October, adding to the pressure on Prime Minister Imran Khan’s government. Imports also surged, with the current account deficit increasing to US$3.4 billion in the quarter ending in September, compared with US$1.9 billion in the previous fiscal year ending in July.
Investors are disturbed by the deadlock with the International Monetary Fund. The IMF suspended a multi-year US$6 billion loan agreement, causing the Pakistani rupee to fall to a historical low of about 175 rupees against the US dollar this month.
The International Monetary Fund announced on Monday that it has reached a “staff level” agreement with Pakistan to resume payments, and the next $1 billion is currently awaiting approval by the IMF Executive Board.
Additional reporting by Farhan Bokhari in Islamabad