Savings and technology
In the early 2000s, the classical mechanism worked like this: As a result of cross-border inflows, consumption of both tradables and non-tradables increased in EMs. Since non-tradables ought to be produced locally, labor flowed from the tradables sector to the non-tradables sector. Physical marginal productivity of labor fell in the non-tradables sector and rose in the traded sector.
Since, in equilibrium, the value of the marginal product of labor needs to be equal across sectors, the price of nontraded goods in terms of traded goods must increase, i.e. real exchange rate appreciation.
This is the consequence of what was called the global savings glut. Because local currencies appreciated, and because inflation targeting/central bank independence kept monetary policy in control, inflation fell throughout. Interest rates began to fall afterwards.
Consumption demand for tradables would therefore expand more than demand for non-tradables, and the trade balance would deteriorate. The resulting trade deficit, translated into the current account deficit, would be financed through the part of cross-border inflows not claimed by the government.
This is how the corporate sector was able to pile up a huge FX-denominated debt, and banks offered finance credits at a rate much higher than local deposit growth would have allowed.
In the end, such dependence on developed countries’ savings, i.e. capital inflows that show up in the financial account, specifically entails a squeeze of tradable production that is likely to become a long-term feature of the economy. It took a long time to build, but now it has taken its toll, finally. Therefore, it isn’t just the rate of interest or the Fed coming closer to an easing cycle, etc., that explains things. Well, rates will be cut everywhere but we have seen this before. It won’t change much unless technology and capital – not debt - play a genuine role in any growth story. Just looking at rates, and inferring how much there may be room for easing can only highlight a couple of months into the future.