Central Banks

Are rate hikes on the cards for emerging markets?

Leslie Shaffer | Writer for CNBC.com
Should emerging markets brace for rate hikes?

Turkey's central bank appears set to use its emergency meeting to hike rates and the Reserve Bank of India surprised the market with an increase, but it isn't clear whether other emerging markets will follow suit as their currencies face another market spasm.

"The classic response if you're a central bank and your currency is getting hit is to get ahead of the market and overperform," Paul Gruenwald, chief economist for Asia Pacific at Standard & Poor's, told CNBC. "The worst case scenario is you're sort of chasing your tail and the market's going after you so you've got to get out in front."

Many emerging markets have seen their currencies take another hit in the latest selloff, partly due to concerns over the Federal Reserve's moves to taper its asset purchases. After the Fed cut it asset purchases by $10 billion a month to $75 billion in January, markets are closely watching whether there will be further tapering announced when the latest meeting concludes on Wednesday.

(Read more: Will the Fed throwemerging markets a bone?)

Turkey has certainly taken it on the chin, with the lira falling around 10 percent over the past month to record lows, spurring the country's central bank to announce an emergency meeting barely a week after its regular one.

Kerem Uzel | Bloomberg | Getty Images

So far the bank has resisted raising interest rates amid political opposition from Prime Minister Tayyip Erdogan, who faces local and presidential elections in coming months.

(Read more: Turkish lira's dive wrecks balance sheets, deters foreign investment)

"In this situation, you want to be aggressive. So certainly, large rate hikes at an absolute minimum," Robert Rennie, global head of forex strategy at Westpac Bank, told CNBC.

"You do not want to under-deliver in that situation. So we're not talking 25 bps here. The market would like to see a very aggressive, clear, forthright move on the part of the central bank. And hopefully that will be enough to settle markets down into the Fed meeting later on this week," Rennie said.

But it isn't clear if any move by Turkey's central bank to hike rates will offer a model for other emerging markets, partly due to country-specific factors.

(Read more: The 3 culprits behind the emerging markets rout)

Some of Turkey's turmoil is due to a graft investigation, which has seen a score of senior business people, officials and police officers detained and which may shake Erdogan's 11-year grip on power.

What should EM central banks do?

India's currency has also weakened over the past month. After its central bank surprised the market with a rate hike, its third since August, the rupee strengthened, with the U.S. dollar fetching around 63 rupees, compared with around 63.30 before the decision and around 61.70 at the start of the year.

The central bank said further rate hikes are unlikely in the near term.

(Read more: Are emerging markets on the brink of another crisis?)

After the Fed first broached the idea of tapering in May, emerging markets convulsed over the May-to-September period, with India and other countries with current account deficits, such as Indonesia, particularly hard-hit. India's rupee weakened to a record low, with the U.S. dollar fetching nearly 70 rupees in late August.

"India was forced to adjust last summer," Gruenwald said. Because of upcoming elections in both India and Indonesia, authorities struggled over that period to get ahead of the market moves, Gruenwald said.

"The market did the adjustment for them," he said. "But I think relative to what happened last time when the rupee and rupiah were hit with double-digit declines, they look mid-pack right now. They just need to stay the course. I think the RBI (Reserve Bank of India) gained a lot of credibility since last summer."

(Read more: 'Freaking out' about emerging markets may be wrong)

Raghuram Rajan took over as India's central bank governor in August and has made targeting inflation a priority. The RBI has aimed to shift toward making controlling inflation its main policy objective, in line with many of its peers.

India's headline wholesale price inflation rose 6.16 percent on year in December, down from November's 7.52 percent.

Indonesia's central bank has also raised its interest rates by 175 basis points since June.

—By CNBC.Com's Leslie Shaffer; Follow her on Twitter