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Fed admits it triggered emerging markets sell-off but says some countries' policies made them vulnerable

Turkey, Brazil and India top vulnerability index, but China's low debt, high foreign reserves leave it in good shape

PUBLISHED : Wednesday, 12 February, 2014, 11:56am
UPDATED : Wednesday, 12 February, 2014, 2:14pm

The US Federal Reserve acknowledged on Tuesday it likely triggered a financial market sell-off in the developing world but said policies in countries such as Turkey, Brazil and India made them especially vulnerable to external shocks.

The Fed said in a report to Congress that the “stresses that arose in the middle of last year appeared to be triggered to a significant degree by Federal Reserve communications”.

In mid-2013, the US central bank said it could soon start winding down a bond-buying stimulus programme, sending stocks, bonds and currencies plunging across many emerging markets.

The announcement stoked global tensions over potentially destabilising shifts in international money flow, as when India’s central bank chief fretted that the United States should be more aware of how its policies affect the world.

In its report, however, the Fed pointed a finger back at some developing countries, saying they need to look in the mirror when assessing why their markets took a big hit.

Fed analysts built an index measuring economic vulnerability across 15 major emerging markets. They found Turkey was the most vulnerable, followed by Brazil and then India. Indonesia and South Africa followed in the ranks of the most vulnerable.

The index was based on six factors, including current account balances and foreign currency reserves relative to economic output.

The Fed analysis found that the most vulnerable countries tended to experience the biggest currency depreciations as well as larger increases in interest rates for government borrowing.

“This evidence is consistent with the view that reducing the extent of economic vulnerabilities is important if [emerging market economies] are to become more resilient to shocks,” the Fed said.

The analysis highlighted how some developing economies have made strides to reduce their vulnerabilities.

China, for example, was listed as one of the least vulnerable countries. The country has amassed a massive war chest of foreign currency reserves over the last decade and has a relatively low level of government debt.

The Fed said some developing countries have countered the market volatility by hiking interest rates, intervening in currency markets and other “stopgap measures”.

It said global investors would be carefully watching which countries take steps to reduce “fundamental vulnerabilities”.

“Continued progress implementing monetary, fiscal and structural reforms will be needed,” the Fed said.

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singleline
Perhaps one way out for the EM countries is to form a certain quasi monetary union, in which they could swap US dollar (and later Renminbi) with each other in case of emergency.
Just the very existence of such an organization will quell a lot of fear.
Then they don’t have to depend on the mercy of the unreliable IMF.
China could contribute a lion’s share of the US dollar to begin with.
The institution is best located in Hong Kong.
But perhaps China is not yet ready to perform a greater role in the world market.
She is now busy reforming her own economies.
Of course this arrangement is easier said than done, considering also the potential political issues.
For one thing the Philippines may not cooperate with China (and Hong Kong).
Anyway if the EM countries do not hang together they will be hanged separately.
singleline
The economic size and population of most EM countries are not large enough.
Which means they don't have large, deep and sophisticated debt and stock market to finance their growth.
As a result, they have to partly rely on the foreigners, in the form of long-term capital inflow, like the FDI, or short-term capital inflow, like the speculative smart or hot money.
So, the hot money comes and goes, comes and goes.
And we have boom and bust, boom and bust.
The situation is made worse by the EM countries' own political problems.
I don't know how to solve this problem.
Do you?
 
 
 
 
 

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