In this video Brian Lawson, Global Economic and Financial Consultant, looks at the common characteristics of countries likely to be most affected, as well as the types of policy response available to emerging markets. This video accompanies a full article published in the Fall 2013 edition of the Country Risk Quarterly on Egypt’s likely political scenarios and their commercial implications.
Fed QE Tapering – The Impact On Emerging Markets. Published: Oct 18, 2013
The common characteristics of countries affected by Fed Tapering are multiple. The one with which we start is the current account deficit, but we then look at how that is funded with particular emphasis on whether or not the countries rely on foreign portfolio investment and direct investment as their means of financing. If they’re funding from official sources, bilateral organizations and the like, there is far less risk to them in this process.
We should also clarify that Fed Tapering is not the only potential threat, there are multiple other elements which can cause pressure on emerging markets going forward. The concern that we have is where there’s a sizable current account deficit, in the past that’s been funded very readily by the wall of money that’s been coming into emerging capital markets for the last few years, and that process took yields to abnormally low levels, to the point where some African countries were actually yielding below their European counterparts of far higher rating, and that’s something that we’ve viewed as unsustainable for quite some time.
The process of correction is now focusing most closely on those countries who are very reliant on external capital flowing to them, be that in the form of portfolio or direct investment. One additional element – and this has unfortunately been particularly painful in areas such as Turkey and Brazil this year – is where political disorder, civil problems, major demonstrations on the streets, and in the case of Turkey an unfortunate geography with the very serious problems currently going on in Syria, these are additional factors which come through to bite as well. So we’re looking at a multiple number of risks, all of which add into an overall package which we have to analyse line by line and in considerable detail.
The most urgent thing which emerging markets need to do is to restore confidence, because basically we’re looking at a market that has become imbalanced in a negative way, with a lot of funds trying to sell at the same time, and there have been very sharp changes in interest rates in a number of major emerging markets. So the first and most critical thing is to stop that flow and restore a degree of confidence that the country has a set of policies that are valid and viable.
Within this process the most immediate or readily available to emerging markets is spending the reserves. And fortunately in this cycle most major emerging markets have far more sizable reserves than they had for example in 1998. Asian countries stand out in that regard, they had very limited reserves in the ’98 crisis, they’re far better prepared going into this process, and indeed the likes of Brazil have actually volunteered that they would spend sizable quantities of their reserves as a means of defending the currency if they needed to do so.
But just spending the reserves on its own does not necessarily solve fundamental imbalances within the economy, and in that regard an additional policy tool has to be making sure that the country is not overheating, not growing over-quickly within its own domestic activities. In that regard, interest rate changes will certainly feature in a lot of places. We’ve seen this a number of times so far in Brazil and Indonesia, Turkey has made one change, and further changes are indeed quite likely if the outward flow continues.
Then, going beyond interest rate changes, we have to look at other fundamental measures, measures that enable more capital to be attracted on a long term basis into the country. As an example of that, India is changing its very restrictive rules on foreign direct investment, and it has done so directly in response to the adverse conditions which are prevailing, and we think there’ll be more occasions in which countries either provide tax incentives trying to lure investment in, or at least do some work to reduce the existing blockages.
And the last - and perhaps least welcome - component of policy fix is to have changes which involve trade blockage, and an example of that would be the way in which India increased its tariffs on gold and silver, trying to stop the very sizable popular inflows of those products into the country. So there may be further elements of protectionism which governments will resort to as a last stage measure.