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Economy

Emerging nations pivot toward monetary easing

Low inflation, smaller outflow risks present a window of opportunity

Brazil's food prices are falling as inflation subsides, giving the government room to rebuild the economy with interest rate cuts.

NEW YORK/SAO PAULO -- Emerging nations are jumping on the monetary easing bandwagon just as advanced nations head toward tightening, taking advantage of slower inflation and a reduced risk of capital flight to nurse their economies back to health.

Emerging-market interest rates have fallen precipitously this year, particularly in South America. Brazil's central bank has cut its policy rate a total of 4.5 percentage points in five rounds since the beginning of 2017, arriving at 9.25% in July. Colombia's has made six cuts and Peru's has made two, to 5.5% and 3.75%, respectively.

On Tuesday, Bank Indonesia joined the pack, trimming its policy rate for the first time since last October to 4.5%. The Reserve Bank of India did the same at the beginning of the month, bringing a key rate to a seven-year low of 6%. South Africa's policy rate is close behind at a five-year low of 6.75% as of July, and Russia cut rates to 9% in June, meaning all the BRICS nations except China are now in easing mode.

These cuts are possible largely because fierce inflation has subsided in many of these countries. Brazil, which has long struggled with high prices, logged just 2.7% year-on-year price growth in July -- the lowest rate in 18 years. The price of beans, a staple of the country's cuisine, paints a vivid picture of this change: One kilogram now sells for between 4 and 5 reais ($1.27 and $1.58), down from 12 reais at the end of last year. "It's a rare thing for food prices to fall in this country," noted a grocer. Growers have produced a bumper crop, while a slack economy has encouraged consumers to tighten their purse strings, according to the Brazilian Institute of Geography and Statistics, leading to a soft food market.

Food prices have led inflation lower in India as well, and Bank of America Merrill Lynch anticipates the central bank will cut rates again in December. Pressure for inflation is unlikely to resurge, given the softening dollar and other factors, while high lending rates and scanty demand are likely to remain for some time, according to lndranil Sengupta, the bank's India economist.

Rare reprieve

Typically, for emerging nations to embark on monetary easing would risk spurring capital flight, particularly if advanced nations were simultaneously moving toward tightening. In fact, the U.S. Federal Reserve is preparing to reduce its asset holdings, while the European Central Bank looks to begin reining in its own easing program. These movements could narrow the gap in interest rates between advanced and developing economies and slow the cycle of investment in emerging markets.

But concern about a capital exodus is not especially high, at least for the time being. Many market players expect the U.S. to proceed slowly along the path to tightening, and emerging nations have experienced net inflows of investment via bonds and equities each month since last December, according to the Institute of International Finance. While those countries saw sizable outflows last November in the wake of U.S. President Donald Trump's electoral victory, driven by predictions that America would hike rates more quickly, dwindling expectations for U.S. policy and stagnant prices there have since reversed that trend.

China has forgone rate cuts and strengthened controls on capital flows and the currency market to curb depreciation in the yuan. But as factors that would contribute to capital flight have weakened, so has the need for Beijing to buy up its currency, and foreign currency reserves are growing again. Other emerging nations, which have been forced by a combination of high inflation and capital flight to raise rates even when their economies are slack, are using their newfound leeway to pursue monetary policy that will encourage a true recovery.

There are, of course, risks to this strategy. A number of countries have grown increasingly dependent on easing as stimulus measures and lax management have thrown government finances into disarray. Brazil on Aug. 15 raised its budget deficit targets for all fiscal years through 2020, and a slew of corruption allegations against President Michel Temer have spurred doubts about his ability to carry out plans for fiscal reform. Political factors are of similar concern in South Africa and Turkey, which some expect will cut rates soon.

Nor is there any guarantee that concern over tightening in Europe and the U.S. will not flare up again. Central bankers from around the world hold their annual conference in Jackson Hole, Wyoming, U.S., starting Thursday. Investors will carefully evaluate comments by leaders such as U.S. Federal Reserve Chair Janet Yellen and European Central Bank President Mario Draghi for signs as to what path so-called policy normalization will take, and could alter their investment decisions accordingly.

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