Fitch cautions over emerging market monetary policy

LONDON

Emerging market monetary policy settings are on the loose side from the perspective of domestic economic conditions as the U.S. Federal Reserve tightens monetary policy, credit ratings agency Fitch Ratings said Tuesday.

These policy settings could tighten by more than the consensus expects as global monetary conditions normalize, according to the latest research from Fitch's economics team.

Fitch looked at the monetary policy stance of 10 large emerging markets through the lens of 'policy rules' that attempt to describe in a very simplistic fashion how central banks set interest rates in response to domestic economic conditions, namely inflation relative to target and the level of unemployment.

“Fitch's analysis shows that six of the emerging market 10 are currently running policies that are looser than would be implied by these simple policy rules: Turkey, China, Poland, Brazil, Indonesia and India.

Among these, Turkey is found to have the most overly-accommodative stance using this policy rules-based analysis.

“Brazil also has an overly-loose policy according to this analysis, although our framework does not factor in the likelihood of a large output gap in Brazil following the recent deep recession there.”

Fitch noted that emerging market policy rates could see more upwards adjustment than currently expected by financial markets as global monetary conditions normalize.

This could be exacerbated by any generalized appreciation in the U.S. dollar and associated declines in emerging market capital inflows, according to Fitch.

“Russia, Mexico and South Africa are running a tight monetary stance relative to their domestic cycle. But the reversal of capital flows and the rising U.S. dollar, in part spurred by the gradual ending of easy money by the Federal Reserve, has deterred these three countries from easing their policies and to remain cautious.

“Only Korea is found to have current interest rates broadly in line with what domestic economic conditions would warrant,” it added.