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February 22, 2002, 8:20 a.m. Easing Does It Emerging markets are lowering interest rates . . . a good development.

ince the beginning of this year, many emerging markets around the globe have begun lowering interest rates. This is a good development, and one that could enhance growth prospects worldwide.

Here's some background to the cuts. During 2001, many emerging-market countries suffered from recession and currency weakness. While the U.S., Europe, and the U.K. reduced interest rates in 2001 — dramatically in the case of the U.S. — many emerging markets had to either maintain their interest rates or raise them in an effort to protect their currencies and the lean against capital outflows.

With the U.S. beginning to recover, emerging markets are now getting the opportunity to reduce
interest rates. Here's the scorecard:

China cut the 1 year lending rate by 0.54% to 5.31% and the one year deposit rate by 0.27% to 1.98% on February 20.

Brazil cut the Selic rate by 0.25% to 18.75% on February 20.

Chile has cut the benchmark nominal interest rate by 0.5% twice since the beginning of the year, bringing it down to 5.5%.

Turkey cut the interbank rate by 2% to 57% on February 19.

The Philippines cut the overnight repo rate by 0.25% to 7.5% on February 15

Poland cut the intervention rate by 1.5% to 10% on January 31.

Czech Republic has cut its 2-week repo rate by 0.25% twice since the beginning of the year, bringing it down to 4.25%.

Of course, the global environment is still a challenging one for emerging markets.There is still weak nominal growth, low commodity prices, and a stubborn tendency toward deflationary strength in the U.S. dollar. But even these factors are beginning to improve, and the news on interest rates is a real positive.

Lower interest rates improve growth prospects — strengthening the currency, attracting foreign investment, and allowing more interest-rate cuts. But this virtuous circle is heavily dependent on a currency-oriented focus for monetary policy, and we're not yet at the point where there is a broad reallocation of capital flows to emerging markets.

Just as the U.S. economic recovery is a piece-by-piece process, the recovery in emerging markets will be too.
China, Korea, and Taiwan are already seeing capital inflows, currency stability or strength, and an increase in international reserves. For many other countries, two key issues remain: the strength of the U.S. and European recoveries, and the issue of whether their currencies and international reserves will respond positively to the interest-rate cuts.

So how does the global investor proceed? Investors should look for countries which achieve stable or strengthening currencies, increasing international reserves, and then use repeated interest-rate cuts to raise their growth expectations. That's the winning formula.

— Mr. Malpass is the Chief International Economist for Bear Stearns.