Emerging Markets’ Crisis Could Derail Global Economic Recovery

Taylor Scott International News

http://www.gulf-times.com/Default.aspx 7 September 2013 The current emerging market (EM) crisis in Asia and Latin America may derail the incipient global economic recovery, QNB has said in a report. The financial turmoil unleashed by the Federal Reserve (Fed) announcement that it will start tapering its asset-purchasing programme soon—the so-called Quantitative Easing (QE) — has led to  large capital flight from most emerging markets, a large weakening of their currencies, and higher long-term interest rates  globally. If the Fed starts QE tapering in its forthcoming meeting on September 17 and 18 as announced, this is likely to unleash further EM capital flight, thus undermining their economic growth and reducing global export demand. This, QNB said, will inevitably have a knock-on effect on the relatively weak growth in the US and the incipient recovery in Europe.   Ultimately, QE tapering may well be self-defeating as it could in fact lead to lower growth both in the US and the rest of the world, thus derailing the global economic recovery. In June Fed Chairman Ben Bernanke had announced a tapering of its QE policies contingent upon continued positive US economic data. This announcement marked an end to three waves of QE that have flooded US financial markets since 2009 with an estimated $2.9tn (19.3% of US GDP), according to the economic research of the Federal Reserve Bank of St. Louis. The opportunities, however, to invest these resources have been limited in advanced economies given near-zero interest rates in Europe, Japan, and the US. Global financial institutions therefore used a significant portion of this liquidity to invest in EM, which offered higher returns. This led to higher EM exchange rates, lower interest rates, and to some extent higher growth momentum. Unfortunately, the QE party for emerging markets came to an end on June 19, the day Bernanke made the announcement. As has been the case in previous EM crises, it pays to be the first one out of the door, because exchange rates are still high and it is easier to liquidate large financial investments when foreign exchange liquidity is still plentiful. Accordingly, global financial institutions have rushed to liquidate their EM investments since the Fed announcement in order to cash in their capital gains and avoid being faced with policy measures that could restrict their capital movement. The result has been a panic selling of EM exchange rates. The Fed announcement has also lowered demand for government bonds globally,  thus leading to higher long-term interest rates in EM and, to a lesser extent, in advanced economies. This has shaken EM consumer and investor confidence, which will inevitably lead to lower economic growth going forward. Emerging markets central banks have added to the capital flight by trying to lean against the wind. They have used their international reserves and raised policy rates to defend their currencies. Most prominent in this defence has been the Reserve Bank of India (RBI), which has witnessed a decline in the rupee of 14% since June 19. In response, the RBI has used its international reserves to defend the rupee and tightened liquidity. Restrictions on gold imports and capital account outflows have also been tightened in order to stem the outflow without success. At the same time, there are early signs that the Indian economy is slowing down rapidly, with the HSBC Purchasing Managers’ Index indicating the manufacturing sector contracted in August for the first time since the global economic crisis of 2009. There is even talk of a possible IMF credit line to help India weather the storm. Similar narratives are occurring in other emerging markets, like Brazil, Indonesia and, to a lesser extent, Malaysia and Thailand. Overall, the emerging markets crisis resembles in many aspects the Asia crisis of the late 1990s. Today’s emerging markets crisis has serious implications also for advanced economies. Unlike in the 1990s, advanced economies are today more than ever dependent on emerging markets for their own growth. China, the US, Germany and Japan were the world’s largest exporters in 2012 and an increasing share of their exports have flown to emerging markets in recent years. A significant decline in emerging market growth would inevitably have a knock-on effect on their own exports and therefore on their growth momentum. Taylor Scott International

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