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Turbulence could approach as the US central bank prepares to cancel its massive stimulus package, and emerging economies are said to be in the forefront.
the International Monetary Fund this morning warned that emerging markets could suffer a painful fallout once the US Federal Reserve begins to tighten monetary policy. With US inflation hitting near 40-year highs, US interest rates may soon rise.
This fallout could include the influx of capital out of emerging markets, causing their currencies to fall. This would be particularly serious for countries with high debt or high inflation.
The IMF explains in a new blog post this morning:
Widespread wage inflation in the United States or persistent bottlenecks could push prices up more than expected and fuel expectations of faster inflation. More rapid Fed rate hikes in response could shake financial markets and tighten financial conditions globally.
These developments could be accompanied by a slowdown in demand and trade in the United States and could lead to capital outflows and currency depreciation in emerging markets.
The Fed is on track to end its asset purchase program in March and plans to hike interest rates three times this year.
The minutes from his December meeting show he may soon begin to reduce his balance sheet, known as quantitative tightening (QT), news that rocked markets last week.
Such a tightening could have more serious implications for vulnerable countries, adds the IMF:
In recent months, emerging markets characterized by high public and private debt, currency risks and lower current account balances have already seen their currencies move more strongly against the US dollar.
The combination of slower growth and high vulnerabilities could create unfavorable feedback loops for these economies.
So, as the Fed looks hawkish and the omicron hits supply chains and pushes costs up, policymakers in emerging markets need to brace for a storm.
Several emerging economies, such as Brazil, Russia and South Africa, have raised interest rates in 2021, due to high inflation.
But more action may be needed. Those with high debt denominated in foreign currencies should seek to reduce or hedge that exposure, while those with high debt may need to cut spending or raise taxes more quickly, according to the IMF.
Such a “fiscal tightening” would of course weigh on growth and jobs, highlighting the dilemma facing emerging market policymakers and central bankers.
Worryingly, the IMF is also warning that there could be bank failures in some weaker countries, saying:
For countries where corporate debt and bad loans were high even before the pandemic, some banks and weaker non-bank lenders may face credit problems if financing becomes difficult. Resolution regimes should be prepared.
The current Covid-19 pandemic is also threatening emerging markets – many of which have not benefited from the mass vaccination deployments seen in advanced economies.
The IMF concludes:
While the global recovery is expected to continue this year and into the next year, risks to growth remain high due to the continuing resurgence of the pandemic.
Given the risk of this coinciding with faster Fed tightening, emerging economies should prepare for possible economic crises.
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