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Emerging markets caught between diverging monetary policies
Emerging markets caught between diverging monetary policies

[Image: 151227-Asiya.JPG]

After seven years of ultra-loose monetary policy, the United States increased interest rates this month. The easing cycle started in mid-2007 when the benchmark rate was lowered from 5.25% to 4.75% in a context of financial instability and tightening credit conditions until reaching 0.25%. Since then, macroeconomic conditions have improved markedly: real GDP has been growing consistently above 2% YoY in the last year and a half, the unemployment rate fell from 10% in 2010 to 5% this year and wage growth has stabilized at more than 4% YoY in the last two years. Nevertheless, the American economy still faces substantial threats, mainly on the external front as global demand remains fragile and the USD strengthens. These headwinds, together with low inflation and the Federal Reserve's prudent approach towards tightening, suggest that rate increases will be gradual and that policy will remain relatively loose for the time being.Interest rate changes in the US matter to emerging markets. In Asia, the majority of currencies are under floating regimes, hence not pegged to the USD. These currencies are likely to experience downwards pressure when the Federal Reserve hikes interest rates. USD-denominated assets become more attractive with respect to their equivalents in Asia due to higher returns, resulting in money outflows and depreciation of the currencies. Asian central banks can try to offset the effects of US monetary policy by raising interest rates, but this would squeeze growth and potentially fuel deflationary expectations in a region already facing a deceleration and disinflationary trends. The US hiking cycle under Alan Greenspan in the mid-1990s' caused massive outflows from Asia, but the region's macroeconomic conditions are substantially better: the current account is in surplus (+4% vs. -2% of GDP), external short term debt halved from around 30% of GDP, currencies are not pegged and reserves more than doubled to 140% of GDP. Overall, the effect of the gradual US tightening cycle on Asian monetary policy will not be as considerable as in 1997.

The currency framework in the GCC is radically different than in most Asian countries. Gulf currencies are pegged to the USD, with either a nominal anchor or a softer peg to a basket of currencies such as in Kuwait. A peg implies a loss of policy independence: follow the policy rates of the reference currency or risk capital outflows. In fact, Gulf countries have already adapted to the new situation. For instance, the Saudi Arabian Monetary Agency (SAMA) already hiked its reverse repo rate by 25 basis points to 0.5% and Kuwait, UAE and Bahrain also reacted to the Fed's decision. At the same time, the GCC is highly exposed to the deteriorating energy market, which accounts for half of the economy and 85% of public revenue. The combination of low oil prices and tighter credit conditions could be the perfect storm for the GCC. Apart from the downside risk on growth, the whole currency system could face substantial pressure if current conditions persist as the Gulf continues to spend from its reserves.Emerging markets are split between two magnetic poles. The first element is the gradual tightening of US monetary policy, which will add pressure on US-pegged countries to raise interest rates. The other element is the ultra-loose policies of the European and Japanese central banks, which are hurting emerging markets' competitiveness. Today, monetary policy trends in main economies diverge. Despite low oil prices, the GCC will maintain its peg with the US and gradually increase interest rates. In Asia, given the current economic dynamics, Asian central banks will attempt to track more closely European and Japanese monetary policy - to the extent it is possible.

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Report: Linking GCC currencies to the dollar means the loss of "monetary independence."

Picture: Reuters-Arabian Eye

December 27, 2016 12:24

Weekly analysis of the emerging markets in Asia issued by Asia Investment Company pointed out that the currency in the Gulf states framework is radically different from what it is in most Asian countries, where the Gulf currencies pegged to the US dollar, with a nominal reference to a basket of currencies, as is the case in Kuwait.

The report, which "directly" received a copy of it and added that the currency peg means the loss of the independence of monetary policy, so as to follow the reference currency rate policy or carry the risk of capital flows to the outside.

The report said that the United States has an interest rate hike this month, after seven years of the application of very loose monetary policy.

Détente period began in mid-2007 when an interest rate cut from 5.25% to 4.75% in the context of financial instability and tighter credit conditions until it reached 0.25%.

However, the US economy still faces significant threats on the external front global demand is still fragile in front of the increasing strength of the dollar. These threats indicate coupled with low inflation and warnings Fed to increase interest rate policy will be gradual and will remain relatively flexible at the moment.

The report noted that Asia Investment that the Gulf states have adapted to the new situation, for example, raised the Saudi Arabian Monetary Agency (SAMA), the reverse repo rate by 25 basis points to 0.5% as well as responded to Kuwait, the UAE and Bahrain, the decision of the Federal Reserve Board.

The report also pointed out that changes in interest rates in the United States occupies the emerging markets of Asia, where the majority of currencies fall under the flotation system and therefore does not comply with the US dollar.

The report pointed out that Asian central banks can seek to counter the effects of US monetary policy by raising interest rates, but this will slow down the growth and raises forecasts contraction of the economy in a region already suffering from the slowdown and deflation.

At the same time, the Gulf states are exposed significantly to the deteriorating market power, which accounts for half of the economy and 85 percent of public revenues, which represents a drop in oil prices and the tightening of the terms of access to credit a serious problem for the Gulf States.

Report Asia for investment and believes that emerging markets are divided between two electrodes Mottagazban, the first element is to emphasize the progressive US monetary policy, which will increase the pressure on the dollar-pegged to raise interest rates countries, the other element is the deep relaxation located in the European and Japanese central banks' policies, which limit the ability of emerging markets to competition.

The report also noted that monetary policies in the main countries in conflict significantly, despite the decline in oil prices, Gulf states will remain tied to the United States and will raise interest rates.

In Asia, taking into account the current economic moves, Asian central banks will follow closely the monetary policy in Europe and Japan to the fullest extent possible.

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