28th June 2022

G-20 emerging markets : Rapid inflation-driven rate hikes will be double-edged sword for banks--Moody's

"An acceleration of inflation in many G-20 emerging markets has prompted central banks in most of the economies to raise interest rates despite a fragile economic recovery from the coronavirus pandemic. We expect more rate hikes in 2022 especially by those central banks that are still early in the rate increase cycle or haven't started yet", says Moody’s Investors Service in a report published this week.

“The US Federal Reserve's rate hikes add to inflationary pressure on import prices by weakening local currencies. Central banks in the majority of the 10 emerging markets have hiked their policy rates in response to inflation, as well as to curtail potential capital flow volatility. We expect that monetary tightening in most of these countries will continue in 2022, “ said Eugene Tarzimanov, VP and Senior Credit Officer at Moody’s.

Key points:

-Inflation has accelerated in most G-20 emerging markets, prompting interest rate hikes. Central banks in the majority of the 10 economies have hiked policy rates in response to rising prices
-The impact of rises in inflation and monetary tightening on banks is not clear cut. While the impact of rises in interest rates to contain inflation is complex for banks, there are two key opposing effects. Higher rates normally result in wider net interest margins(NIMs), boosting banks' top-line profitability. At the same time, higher rates lead to slower economic growth and heavier debt repayment burdens for borrowers, leading to a weakening of loan quality and increases in credit costs
-A rise in inflation typically leads to a widening of banks' NIMs. In 9 out of the 10 emerging markets, banks' margins have historically widened in tandem with rises in inflation. Moody's expect that banks in India, Saudi Arabia and South Africa will see larger increases in margins in 2022-23. If inflation accelerates above our expectations, banks in Brazil and Turkey will post the smallest increases in margins
-However, credit costs also increase when inflation accelerates. An acceleration of inflation also has historically led to increases in credit costs in seven out of the 10 systems. We expect banks in Russia and Turkey to post larger increases in credit costs. If inflation accelerates further, credit costs will also rise in Argentina, South Africa and Brazil
-Asset risks for banks would outweigh margin benefits if inflation rates rise sharply. While we expect inflationary pressure to abate in all 10 markets in 2023, an acceleration of inflation beyond Moody's expectations would lead to higher credit costs that outweigh benefits of gains in NIMs. Historically, the profitability of Brazilian and Turkish banks has shown the highest negative correlation with high inflation rates.

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