India feels the heat of Japanese rate cut

The Central Bank of Japan has cut its benchmark interest rate to a range of 0% to 0.1%, signalling its willingness to resort to extraordinary measures to revive a flagging economy, but the monetary developments in the developed world herald difficult time for the emerging economies.

In stark contrast to central banks in the developed world, monetary authorities in the emerging markets have had to take measures to manage the surge of capital flows, which have also created asset bubble concerns.

"This could signal absolute desperation on part of the Japanese authorities," said Abheek Barua, chief economist, HDFC Bank , pointing out that it could have policy implications for the rest of Asia.

Near zero interest rates have been one of the key policy levers central banks in the developed world have used after the global financial crisis of 2008 to revive growth. With the economy showing signs of waning, they are now looking for more measures to stall another recession.

“After enjoying a robust recovery from the latter part of 2009 into early 2010, the global economy is slowing as the impact of fiscal stimulus and inventory rebuilding fades,” said Deutsche Bank in a recent research note.

Last month US Federal Reserve chairman Ben S Bernanke signalled that the central monetary authority would continue to buy government bonds, a practice known as quantitative easing.

The Japanese central bank too has set up a $60 billion fund to buy government bonds, commercial paper and other asset-backed securities.

But the availability of cheap money in the developed world is causing headaches for emerging economies. The last two months have seen foreign fund inflows of $10 billion into the stock markets. This inflow is primarily on account of interest rate differentials between the developed markets and the emerging economies and the strong growth prospects. “This clearly shows the contrast between the monetary policies of the developed and the emerging markets,” Sujan Hajra, chief economist at Anand Rathi, said.

Last week the Brazilian finance minister said there was a global currency war, referring to actions by other nations to keep the value of their currencies down, hinting at the policy divergence among nations.

The developments in Japan could also cause more yen funds to flow into India as borrowers access cheaper funds there. India recently increased the foreign investment limit in government and corporate debt by $5 billion each. "There is a possibility of a change in the composition of currencies flowing into India," said Mr Barua.

Central banks in emerging economies will have to raise rates to neutralise the rising tide of liquidity, particularly in the case of India, which is also grappling with a serious inflation issue. The RBI has already raised policy rates five times this year, with its benchmark lending rate currently at 6%.

A higher interest differential and rising currencies could encourage even greater flows — rupee has already breached Rs 45 to a dollar mark.