Trump's trade war tougher test for emerging markets than Covid crisis: IMF

IMF's Gita Gopinath says emerging market central banks face more complex challenges amid Trump tariff shocks, capital flight risk and rate dilemmas

The ongoing global trade war, reignited by US President Donald Trump's trade policies, poses a more complex and difficult challenge for emerging market central banks than the Covid-19 pandemic did, First Deputy Managing Director of the International Monetary Fund (IMF) Gita Gopinath said.

 

In an interview with the Financial Times, Gopinath explained that while the 2020 pandemic allowed central banks worldwide to act in unison by slashing interest rates and introducing stimulus, the current environment is far more fractured. The unpredictable impact of tariffs is creating asymmetric shocks, complicating policy decisions across the developing world.

 

“This time the challenge is going to be greater for them compared to the pandemic,” Gopinath said, noting that during Covid, central banks “were moving in the same direction... easing monetary policy very quickly". 

 

 

Trump trade war creates rate cut dilemma for emerging markets

Unlike the uniform demand collapse of Covid, the trade war’s impact is uneven. While developed economies like the US grapple with inflationary pressures from tariffs, emerging markets are experiencing what Gopinath described as a “demand shock”, characterised by slower growth and subdued inflation.

 

This divergence creates a dilemma: while central banks in emerging markets may need to cut rates to support domestic demand, higher interest rates in the US may force them to hold steady or raise rates to defend their currencies and stem capital flight.

 

The Reserve Bank of India, in its upcoming Monetary Policy Committee (MPC) meet on June 6, is largely expected to cut repo rates by 25-50 basis points. This would be the third consecutive repo rate cut taken by the central bank this year.

 

Meanwhile, US' federal bank, despite pressure from Trump, has indicated it will wait to ease rates until it is confident tariffs won’t add further inflationary pressure. This type of situation, according to Gopinath, can potentially tighten global financial conditions and constrain the policy space for emerging economies.

 

OECD flags risks of capital flight and depreciation

 

The Organisation for Economic Co-operation and Development (OECD), in its latest report, also flagged increased risks of capital outflows in emerging markets if global investor sentiment deteriorates or growth prospects weaken further. The OECD has also warned of potential currency depreciation and rising borrowing costs.

 

“Many emerging markets are at risk of experiencing capital outflows... which could lead to depreciation pressures and higher financing costs,” the OECD report said. 

 

Emerging markets steering through the fog: Gopinath

Gopinath described the outlook for emerging markets as “steering through the fog”, with the volatile and retaliatory nature of US trade policy adding a layer of uncertainty. While a brief truce was reached between the US and China during talks in Geneva, Trump later accused Beijing of violating the agreement and announced plans to double tariffs on steel and aluminium to 50 per cent, escalating tensions once again.

 

For central bankers in developing economies, the unpredictability of trade policy, coupled with the threat of capital flight and the need to cushion domestic growth, makes for a uniquely difficult monetary environment.