Interest rate pressure tests emerging market policy credibility

By Sujata Rao

LONDON (Reuters) - Falling oil prices and rate cuts in Europe are giving emerging market central banks the green light to ease their own monetary policies but investors are fearful that political pressure may be prompting some shifts in stance.

Already fragile trust in policymaking in some countries is being tested by central bank actions and the demands of politicians such as Turkish President Tayyip Erdogan for deeper and faster rate cuts.

Turkey is among several emerging economies that have cut interest rates in 2015 in response to plunging oil prices and aggressive easing in the developed world, and swap markets are pricing in rate cuts of 30-350 basis points in other countries.

That has driven average emerging debt yields a full percentage point lower to 20-month lows, according to the GBI-EM bond index.

But some of these decisions may be dictated by what Societe Generale analyst Benoit Anne dubs "shadow banking" and risk eroding even the partial rate-setting autonomy that emerging central banks have managed to win over the past decade and half.

The challenge comes from governments keen to pump up lacklustre economic growth via lower interest rates.

"It seems to me that there is an official monetary policy board and a shadow one, often based at the Presidency," Anne said. "What I mean is that political interference has become a major consideration for central banks. And when political pressure is going up, usually credibility is going down.

"This feels to me as if the old demons are coming back."

Russia shocked markets last week with a 200 basis point cut just a month just after it hiked rates by 650 bps to support the rouble and tame inflation. Turkey's 50 bps rate cut in January was widely seen by analysts as premature given high inflation.

Even in investor favourite India, analysts suspect the central bank may have come under pressure to cut rates sooner than planned.

Oil's 50 percent fall since June has unleashed massive disinflationary forces, however, and food prices hit four-year lows late last year, pushing inflation below target in most emerging economies.

DIFFERENTIATION

Russia's rouble has fallen 6 percent since the Jan. 30 rate cut, which cemented beliefs that growth had replaced inflation as the focus of policy.

Comments by Erdogan on Wednesday meanwhile pushed the Turkish lira to record lows.

Unicredit said Turkish rate cuts had started too early, hurting the lira and potentially endangering future inflation. "We had also not expected the level of political pressure on the (central bank) to cut rates," its analysts added.

Future inflation is a key gauge of policy credibility. If inflation expectations -- often measured via surveys of households and businesses in the absence of liquid forward markets -- are well anchored, investors are likely to view the central bank as credible and its monetary policy as effective.

Indian inflation expectations appear to validate its Jan. 15 rate cut, following which the rupee has firmed.

But Turkish inflation was expected to be 6.4 percent in two years from January, versus a targeted 5 percent. Russian expectations too are for inflation to stay well above the 4 percent target.

Salman Ahmed, fixed income strategist at Lombard Odier, cites India as an example of a "good" rate cut, but sees those in Russia and Turkey as politically influenced.

"A rate cut is probably correct for Turkey but government noise is ... taking away central bank credibility," he added. "In Russia, it's a more fundamental issue, because with this rate cut, a policy mistake which wasn't there before has come into play."

But with huge amounts of cash sloshing around the world as Europe and Japan print money, and negative bond yields in many developed countries, investors may let offending emerging markets off lightly.

"The investing public wants to see rate cuts in a world where growth is low but they are not appropriate everywhere," Standard Life bond fund manager Kieran Curtis said.

High rouble debt yields had looked interesting, Curtis said but the rate cut has made him "cautious". Instead he likes Indonesia, where inflation is falling but interest rates remain at 7.7 percent.

Other central banks have also held policy steady, some as a precaution for when the U.S. Federal Reserve starts hiking rates. South Africa has said it wants to see a sustained fall in inflation before cutting.

Curtis also cited Brazil, which recently raised rates to 12.25 percent because of an anticipated jump in inflation.

"That's the (market) we are most attracted to and that's the central bank following the most conservative approach," he said.

(Editing by Catherine Evans)