Modern Monetary Theory is becoming mainstream in developed markets. Governments are suddenly pursuing plans that lead to deficits that would have been unimaginable a decade ago. The US, UK, and Japan, for example are all engaging in record spending sprees to support the economy in the wake of Covid-19.
Yet MMT has been slow to catch on in emerging markets. A recent article in Bloomberg explains why:
Emerging markets have reasons to be wary of MMT. They don’t strictly meet its preconditions. While every country does print a legal tender and collects taxes in its own currency, not all can borrow in them. Nor can they allow their exchange rates to float freely, especially if they import vital commodities like food or energy. The degree of economic freedom enjoyed by the governments of the U.S., Japan, or the U.K. is simply not available in most places.
Emerging market countries might end up feeling political pressure to pursue MMT like policies in spite of these contradictions. As Bloomberg notes:
…New Delhi is finding it tough to explain to people why, with India’s economy expected to shrink by 10% in real terms this year, it’s hesitant to boldly expand the budget deficit. The states are unhappy that the federal government is pushing them to borrow, rather than using its own unlimited power to print money
If MMT catches the fancy of the global working classes, emerging markets won’t have a choice. They’ll set out to assert whatever little financial freedom they have, ignoring debt and deficits. The question is, will the experiments succeed, or sink them in an Argentinian-style quagmire of hyperinflation, sovereign defaults and erosion in living standards?
Here are possible implications for the Indian Rupee:
For now, the Indian rupee is stable because import demand has cratered more than exports. But trying to spend 10% of GDP in one year on things like renewable energy, rainwater harvesting and wages could easily switch the currency market’s view. The rupee might collapse in anticipation of higher import demand for everything from Chinese solar panels to shirts made in Bangladesh.
Other countries will experience similar issues:
A sharp, one-time increase in government deficit, monetized by the central bank, is easy to sell to markets as a temporary measure to deal with Covid-related supply dislocation and demand funk. Indonesia has shown the way. Running such deficits permanently would butt heads with investors.
Emerging market countries around the world will likely experience similar issues. The rise of populism and left wing politics will lead to more creative fiscal policy. Central bank independence will become ever more a thing of the past. With all the countries breaking the rules it will be hard to predict currency markets. Even countries that meet all the theoretical requirements for MMT will need to come perilously close to inflation in pursuit of economic growth.
Is modern monetary theory really for emerging markets? For now, they’re right to have reservations. But if the shock of the pandemic lingers and left-wing politics turn ascendant, there’s no telling where the MMT juggernaut will stop.
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