The increasing integration of global markets and economies, in addition to new technologies that help accelerate the transmission of financial shocks from one region to another, is making it trickier for so-called emerging countries to manage their banking systems.
A surge in dollar-denominated bonds in developing economies, and their dependence of the vagaries of the richest nations, leave policymakers in areas like Latin America, Africa and Asia in difficult, if not entirely untenable positions, according to the International Monetary Fund’s latest report on global financial stability. Currency markets are particularly vulnerable and volatile.
“Because domestic financial conditions respond faster and more strongly to global financial shocks than to changes in the domestic monetary policy stance, implementing timely and effective policy reactions may often be challenging,” said the report, released just ahead of the IMFs annual spring meetings in Washington. “Likewise, given that global financial conditions tend to account for a greater fraction of variability in [financial conditions for] emerging market economies, these countries in particular should prepare for the implications of global financial tightening.”
The US Federal Reserve has raised interest rates twice in the last four months from ultra-low recession levels, and plans to continue tightening policy as US economic growth, while still gradual, has brought the unemployment rate down to a historically-low 4.5%. Unlike the Fed’s first post-crisis rate increase in late 2015, which led to selling in emerging market assets, the latest round of rate rises have been cushioned by a broader rally in riskier assets, including US stocks that keep hitting record highs.
The Fed looms so large over the rest of the world that its policy decisions often move emerging markets more than rate moves by those country’s own central banks, or other high-profile international ones like the European Central Bank or the Bank of Japan.
Emerging market economies have often sparred with the United States over the spillovers of American policy overseas. When the Fed was buying bonds by the tens of billions to support the economy and keep interest rates low, from 2009 to 2013, the emerging world often complained it was being flooded with more capital than it could control. Brazil’s ex-finance minister Guido Mantega famously accused the US of starting a currency war. When the Fed started to pull back on stimulus, many countries complained about the reversal. Fed officials argue, with merit, that their mandate is domestic, and they must be mindful of the world economy but are only in charge of meeting US economic objectives. Furthermore, the Fed said a strong US economy, its ultimate mandate, is generally in the interest of world growth.
The IMF says emerging economies have the tools to deal with higher rates — they just have be willing to use them.
“Despite the significant influence of global financial conditions, the analysis indicates that countries, on average, are still able to steer their domestic financial conditions — specifically, through monetary policy,” the report says.
Other measures, such as steps to stem the flow of excess capital to particular industries or restricting leverage in the banking system, should also be employed the IMF says, although most officials there would likely recognise this is easier said than done.
“Countries also have other policies at their disposal. For example, macroprudential measures can be used to limit risks from a further buildup of vulnerabilities that increase domestic financial conditions’ sensitivity to external financial shocks,” the Fund said. “Likewise, there may be circumstances that warrant a temporary role for capital flow management measures.”